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Matthew Hutton MA, CTA (fellow), AIIT, TEP reports on potential planning and action points arising from the FA 2006 inheritance tax changes to trusts. 

Context

IBC’s 5th Private Client Tax Conference in London on 26.9.06 threw up a number of interesting suggestions. 

Interest in possession trusts: creating TSIs

Assume that Father is the life tenant at 22.3.06. His life interest could be replaced before 6.4.08 by successive life interests to his children within s 49C.  If so, however, one should ensure that Father is excluded from benefiting from the ongoing trusts.  This is because from 22.3.06 the termination of an IIP constitutes a gift for GWR purposes, whether the IIP arose on or before that date (FA 1986, s 102ZA). 

Reverter to settlor trusts: an idea

Example: In 1996 John established a reverter to settlor trust which acquired a property for £500,000 which his widowed Father has occupied throughout as his main residence.  The house is now worth £1 million.  Under the trust John takes an interest in possession on his Father’s death.

Consider giving John a TSI on 5.4.08 (Father having moved out of the property to avoid FA 1986, s 102ZA) with a view to distributing the property to him on 5.4.11.  In this way:

• the property is removed from Father’s estate free of IHT;
  
• the trustees’ accrued entitlement to main residence relief from CGT is preserved;
  
• the trustees will get main residence relief on a disposal up to 5.4.2011;
  
• on 5.4.2011 John will receive the property with a base cost equal to its market value at that date.  Note that, because the property does not revert to him on Father’s death, TCGA 1992, s 73(1)(b) will not apply;
  
• the tax planning is unaffected by the timing of Father’s death.

Excluded property trusts – action points

• Identify all settlor-interested trusts which were established as IIP trusts.
  
• If the settlor (or spouse) is actually or deemed UK domiciled or may become deemed UK domiciled, then consider:
  - establishing TSIs for the heirs before 6.4.08 in all or part of the trust fund; and/or
  - establishing a TSI for the settlor’s spouse on the death of the settlor in all or part of the trust fund [subject to the s80 risk]; and/or
  - the possibility of the settlor or spouse ceasing to be actually or deemed UK domiciled;
  - the need to identify all other settlor-interested trusts to which additional property was settled whilst IIP trusts subsisted and to trace affected trust assets with a view to partitioning the trust fund and taking appropriate action in relation to the affected fund. 

The future

• Discretionary trusts are unaffected. Therefore:
  -  create a new nil-rate band trust (whether discretionary or IIP) every seven years;
  - one trust or two (s 44(2))? Note that the survivor can safely benefit from a trust made by a deceased spouse.
  - Possibly create settlor-interested trusts.  No CGT hold-over is possible.  Although there is a GWR, there will be a PET on subsequent exclusion of the settlor, to become exempt on his survival for seven years.
  
• Nil-rate band IIP trust offer some benefits:
  - income tax treatment is straightforward;
  - unaffected by ITTOIA 2005, s 633 (old TA 1988, s 677), which affects discretionary but not IIP  trusts
   (capital sums paid by way of loan or repayment of loan).  Therefore one could sell assets into trust on the strength of an IOU from the trustees;
  - the attraction of bare trusts;
  - consider share reorganisations with different classes of shares to retain voting control;
  - continued use of IIP and discretionary trusts for traditional reasons, eg to benefit children and/or grandchildren;
  - to crystallise main residence relief;
  - to secure main residence relief etc for a second property.  However, the value of the trust must now be limited to the nil-rate band if an immediate charge to IHT is to be avoided. 

(Lecture by Nicholas Hughes of Chiltern plc)

Agricultural property relief: occupation and interests

The following case was presented to HMRC Capital Taxes in Nottingham. A longstanding tenant farmer acquired the freehold and the two interests merged.  He then granted a tenancy but died within seven years of acquiring the freehold. 
Capital Taxes initially refused relief on the grounds that:

• the interest owned was the unencumbered freehold;
  
• it had not been owned for seven years; 
  
• there was no mechanism to recognise the expired tenancy interest.

However, they were eventually persuaded to give relief on the value of the tenanted interest retained within the freehold.

Problems arising under Antrobus No. 2

Applying similar principles to the obiter dictum in Antrobus v Twiddy, what farmhouses are brought within the scope of APR if occupied by a retired farmer? If the Lands Tribunal view of what is a farmhouse is accepted, it leads to the absurdity of including houses as type III property (under s 115(2)) which can never qualify for relief -  because the occupation condition in IHTA 1984, s 117 can never be satisfied.  A fortiori, the Lands Tribunal construction renders unnecessary ESC F16, which deems occupation by a retired agricultural worker with an assured occupancy protection to be occupation which satisfies s 117.

The point is this. A farmhouse or cottage does not cease to be such if occupied by a retired farmer; a widow etc of a retired farmer; or a retired (protected) farm worker.  In such circumstances HMRC have traditionally given relief ‘providing that the occupation does not continue for too long a time’ – but this then fails the Lands Tribunal test. It appears that HMRC are suspicious of that statement in Antrobus. The conclusion drawn by the Speaker is that the definition of ‘farmhouse’ cannot require occupation.

(Lecture by Adrian Baird of the CLA)  

Passing on the home: solution 1 – co-ownership (gift of undivided share)

The HMRC guidelines as to the meaning of occupation for POA purposes (storage of possessions etc) are helpful.  The donee should be given a suitable letter and could be made jointly liable for Council Tax, entered in the telephone directory etc.  There is a danger of the donee’s insolvency, falling out with the donor etc, but the risk cannot be avoided. 

Solution 2: sale to family or third party subject to carved-out lease: gift of sale proceeds

For IHT purposes, the gift of the proceeds of sale will be a PET.  There is no gift of property, hence no POA issue (FA 2004, Sch 15 para 10(1)(a)), [though SLDT is payable].  Nor is there an IHT issue under IHTA 1984, s 43(3). 

Sale of part share subject to leaseback (equity release)

Where the sale is made to an unconnected buyer there will be no POA issue (under para 5(1)(b) of the March 2005 Regulations).  If the buyer is connected with the seller, but the consideration is not for money or a readily convertible asset, again no POA [though there is SDLT].  Might it be in order to have a sale to an unconnected person initially who then sells on to a connected party?  This could be acceptable provided it is not pre-arranged! 

Solution 3: arm’s length sale of undivided share: gift of sale proceeds

There will obviously be SDLT for a purchaser to pay.  For IHT the gifts of the proceeds of sale will be a PET.  There is no gift, and therefore no GWR, of the property.  For income tax there are no POA issues if either the sale is made to an unconnected person or, if to a connected person, where not for money or a ‘readily convertible asset’.  One could for example have the consideration be a flat owned by one of the children which is then sold, followed by a gift of the proceeds to the other children. 

Solution 4: sale to spouse (of whole or part share) for debt: gift of debt

This is the most aggressive idea as a variant of the debt scheme.  For IHT there is no gift to the home, so no GWR.  There should be a deduction for the debt in the transferee’s estate assuming that, for purposes of FA 1986, s 103, there have been no gifts by the transferee to the transferor spouse.  The proceeds would then be given as a PET to various individuals.  The sale of the house will of course attract SDLT for the purchaser.  For income tax there is no POA issue as an excluded transaction.

Solution 5: gift of a divided part of the house (eg gift of long lease of part of house)

For IHT there is no GWR if the donor has no right to, and does not, occupy the leased part (FA 1986, s 102A).

For income tax there is no POA if the donor does not occupy.  There should be a physical barrier (a locked door).  The donees alone should have a key to the property.  There should be re-registration for Council Tax and a new telephone number for the donee. 

Remember also CGT issues.

Existing settlements – IIP trusts

Consider creation of TSI under IHTA 1984, s 49C before 6.4.08.  This is a PET but now treated as a gift for GWR purposes (FA 1986, s 102ZA). 

If continued occupation is required, consider termination of an existing life interest as to part (eg 90%), by appointing a defeasible TSI to children, with the remainder to their spouses, and the children jointly occupying with the existing life tenant.  Arguably s 102ZA does not bite, as it applies only to complete terminations.  But if it does, any GWR is removed by s 102B(4), which is not in point on a ‘deemed gift’.  There is no disposal by the individual for CGT or pre-owned assets purposes.  The TSI can be terminated by the trustees if necessary. 

Might a Court apply a purposive interpretation?  Consider s 52(4).

The taxpayer would leave his 10% to his wife.  On her death there would be a chargeable transfer though the implications should not be too bad.  The gift to the children will be a PET only if an outright transfer (ie with considerations of security of tenure).  At least this is one way of deferring the problem.  Note the importance of insurance. 

Existing settlements – discretionary settlements (1)

A long-term family discretionary settlement taxed every ten years at up to 6% is a satisfactory way forward.

Occupation by a beneficiary of home/estate under a trust power

SP10/79 is no longer a real concern for discretionary trusts, because it is no longer possible to create a recognised ‘interest in possession’ out of a trust which was not an IIP on 22.3.06. 

Existing settlements – discretionary settlements (2)

Consider exchanging farmland or BPR property in IIP fund for cash/investments in ‘discretionary’ fund two years before ten year anniversary, with further exchange thereafter.  In effect, this could be described as ‘fiscal ping-pong’.

Consider borrowing and holding BPR property for two years prior to a ten-year anniversary. 

As to perpetuities, can the trust period be extended by Court Order?  Might this trigger a disposal?  There is no decided case on the point, though HMRC appear to say ‘no’.

(Lecture by William Massey QC of Pump Court Tax Chambers)

Options on Will drafting where no IPDI for the surviving spouse

Setting up an IPDI for minor children will for many testators be the most attractive option.  This is because the IIP can be highly flexible: there can be overriding powers enabling the interests both to be enlarged and to be terminated.  And of course it offers the prospect of the property remaining settled without IHT charges for longer periods than are permitted under either bereaved minor trusts or s 71D trusts.  Two points to note:

(a) TA 1925 s 31 must be excluded if the minor is to have the interest in possession which is necessary for an IPDI; and

(b) If the minor child were to die, IHT would be payable on the termination of the IPDI.

The Family Home: the charge route

The PRs will normally have power to charge the nil-rate sum on any property passing to the surviving spouse and can then be protected from claims by the nil-rate band trustees if they do so.  They may then assent the charged property to the surviving spouse who is not personally liable for the debt.  If this procedure is followed, then although there is an encumbrance (a secured debt), it was not imposed by a disposition made by the spouse and the surviving spouse has never personally incurred a debt.  Avoid the surviving spouse being an executor.  If the charged property is sold, the debt falls to be repaid to the trustees.  Provided that the surviving spouse does not need the use of the repaid money, no problems arise, but if she requires any part to be loaned back, the loan will fall foul of FA 1986, s 103 (to the extent that she had made gifts to her husband during the joint lifetimes) – unless residue is left on an IPDI. 

It is at this point that the FA 2006 changes are helpful, since if the trustees were to purchase a share in the replacement property with the spouse (ie no loan), at the same time appointing her an interest in possession, then,

(a) for IHT purposes that appointment is a ‘nothing’;

(b) s103 issues do not arise; and

(c) CGT main residence relief should be secured on the share owned by the trustees.

(Lecture by Emma Chamberlain of 5 Stone Buildings)

Comment

The above constitutes an interesting miscellany of practical suggestions in the context of the Sch 20 regime.  I note a few further specific points below which have emerged in the course of lecturing.

This was an interesting suggestion aimed at maximising the tax efficiency of pre-Budget Day 2006 Reverter to Settlor Trusts, although it did depend upon Father being prepared to move out of the house – which might well not be the case!  The CGT benefit depended on the favourable last 36 months rule in TCGA 1992, s 223(1)(b).  I asked when this had been increased from 24 months.  The answer is with effect from 19 March 1991.  It seems rather amazing that the 36 month period has not been reduced to 24 months given that the present housing market can hardly be described as ‘stagnant’.

The ability for a well-advised taxpayer with more than one residence to get the gain attributable to two residences during the last 36 months of ownership of the first relieved from CGT continues to be an extraordinary ‘bonanza’.  Could some limitation of this benefit be expected in future?  An example in HMRC’s Manual indeed (though hardly extolling the tax planning opportunities) did give an example of the variation of an election from property A to property B for as short a period as one week before being varied back. 

One point has arisen in connection with variations of an election.  Was it necessary to confirm the election on every change in combination of residences and/or interests in residences?  It was thought that HMRC’s Manual suggested as much, though it was unknown whether HMRC took the point.  Such a new election would of course have to be made within two years of the change in combination, as otherwise the issue for any period after the change in combination would fall to be decided on what was as a matter of fact the taxpayer’s main residence. There was a suggestion that a judgment by Vinelott J had suggested that any variation in combinations of residences did require a new election.  The point was made by way of caution.

Agricultural Property Relief:  occupation and interests

One way in which one could avoid in such a case having to rely on a concession from HMRC Capital Taxes would be to have the taxpayer make a statutory declaration of non-merger as between the leasehold and freehold interests (or, perhaps, have the freehold acquired by a nominee).  In addition to the general CGT rule in TCGA 1992 s43 allowing the taxpayer to treat the two interests as separate assets for CGT purposes, there was a specific rule for taper purposes in Sch A1 to this effect, to the advantage of the taxpayer.

Solution Five:  Gift of a divided part of the house (e.g. gift of long lease of part of house)

It would be important also that planning permission for the new dwelling was obtained.

Occupation by a beneficiary of home/estate under a trust power

Could there be a risk of SP10/79 applying from death? I think that the answer to this is probably ‘negative’, at least in the terms in which SP10/79 was written, as it would be practically impossible for HMRC to argue that the trustees had exercised their powers so soon.

More Information

The above article has been taken from Matthew Hutton’s Capital Tax Review, a quarterly update for professional advisers of private clients. For more information, click here.