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Tottel's IHT Annual 2006-07 by Mark McLaughlin CTA (Fellow) ATT TEP

Mark McLaughlin CTA (Fellow) ATT TEP, co-author of ‘Tottel’s Inheritance Tax Annual 2006-07’, outlines circumstances in which the taxpayer may escape the IHT anti-avoidance rules involving gifts with reservation of benefit.

Gifts made before 18 March 1986

The GWR rules do not apply to gifts before 18 March 1986, even if there is a reservation of benefit after then. For example, a pre-18 March 1986 discretionary trust which would have been caught by the GWR provisions had it been made after 17 March 1986 will escape the GWR charge unless further gifts into trust are made after that date (in which case the GWR rules will apply to those later gifts) (references below are to the Inheritance Tax Act 1984, unless otherwise stated).

Gifts which are exempt transfers

The GWR rules do not apply to certain exempt transfers (FA 1986, s 102(5)). The exemptions are listed below (all references are to IHTA 1984):

• transfers between spouses or civil partners (but see below)(s 18);

• small gifts (s 20);

• gifts in consideration of marriage or civil partnership (s 22);

• gifts to charities (s 23);

• gifts to political parties (s 24);

• gifts to registered housing associations or registered social landlords (from 14 March 1989) (s 24A);

• gifts for national purposes etc (s 25);

• gifts for public benefit (this relief has now been repealed) (s 26);

• maintenance funds for historic buildings (s 27); and

• employee trusts (s 28).

Before changes to the GWR rules were introduced (FA 1986, ss 102(5A)–(5C)), arrangements were possible to take advantage of the exception from the GWR provisions for exempt gifts between spouses. Eversden schemes used the spouse exemption (IHTA 1984, s 18) to avoid a GWR on the gift of an asset to a trust. Such schemes were blocked (with effect for disposals from 20 June 2003), and pre-existing schemes are potentially subject to an income tax charge under the pre-owned assets regime.

Whilst the GWR rules do not apply to a gift (eg to a discretionary trust) in which a benefit is reserved by the donor’s spouse or civil partner (ie as a potential beneficiary), if enjoyment of the gift is effectively shared by the donor (eg if distributions from the discretionary trust are paid into a joint bank account of the donor and spouse/civil partner), the GWR provisions will need to be considered.

It should be noted that the following categories of exempt gift can fall within the GWR rules:

• PETs made more than seven years before the donor’s death (IHTA 1984, s 3A(4));

• the £3,000 annual exemption (IHTA 1984, s 19(5)); and

• the normal gifts out of income exemption (IHTA 1984, s 21(5)).

HMRC take the view that if there is a GWR, and the reservation ceases with the gift becoming a PET, there can be no £3,000 exemption when the reservation thus ends. This is because the gifted property passed to the actual donee at the time it was actually made, not when the reservation ceases.

De Minimis exceptions

As indicated at 5.4, one of the conditions to avoid a GWR is that the gifted property must be enjoyed by the donee to the entire exclusion or virtually to the entire exclusion of the donor (FA 1986, s 102(1)(b)). There is no definition of ‘virtually’ in the legislation. However, in HMRC’s view, the expression ‘virtually to the entire exclusion’ covers cases in which the benefit to the donor is ‘insignificant’ in relation to the gifted property. Examples of situations in which HMRC consider that the donor can benefit to some extent without the GWR rules applying are illustrated in Revenue Interpretation 55, which is reproduced below:

Table—GWR: de minimis exceptions (RI 55)

• a house which becomes the donee’s residence but where the donor subsequently

– stays, in the absence of the donee, for not more than two weeks each year, or

– stays with the donee for less than one month each year;

• social visits, excluding overnight stays made by a donor as a guest of the donee, to a house which he had given away. The extent of the social visits should be no greater than the visits which the donor might be expected to make to the donee’s house in the absence of any gift by the donor;

• a temporary stay for some short term purpose in a house the donor had previously given away, for example—

– while the donor convalesces after medical treatment;

– while the donor looks after a donee convalescing after medical treatment;

– while the donor’s own home is being redecorated;

• visits to a house for domestic reasons, for example baby-sitting by the donor for the donee’s children;

• a house together with a library of books which the donor visits less than five times in any year to consult or borrow a book;

• a motor car which the donee uses to give occasional (ie less than three times a month) lifts to the donor;

• land which the donor uses to walk his dogs or for horse riding provided this does not restrict the donor’s use of the land.

The above guidance warns taxpayers that if a benefit escalates into something more significant, the GWR provisions may apply (eg a house in which the donor then stays most weekends, or for a month or more each year).

Full consideration

If the donor gives full consideration in money or money’s worth there should normally be no reservation. There is a specific rule to this effect for land and chattels. Its effect is that the retention of a benefit by the donor is disregarded if the donor is in actual occupation or actual enjoyment and pays full consideration in money or money’s worth (FA 1986, Sch 20, para 6(1)(a)), eg a ‘commercial lease’ pursuant to which the donor pays a full arm’s length rent for the lease or tenancy retained.

Full consideration is required throughout the period, and regular rent reviews should take place to ensure that this condition is satisfied. HMRC accept that ‘full’ consideration falling within normal valuation tolerances will be acceptable (Revenue Interpretation 55).

Note that the above GWR exception applies to land and chattels. Care should be taken with other assets. The Inheritance Tax Manual (at para 14336) cites an example in which A, who is a partner, withdraws capital from his partnership capital account and gives it to B. B then lends the partnership an equivalent cash sum. HMRC consider that this is a GWR, on the basis that even though A may pay B a commercial rate of interest for the loan, this payment will not prevent the loan being a reservation.

To reduce the possibility of a GWR challenge by HMRC, the ‘full consideration’ should be negotiated at arm’s length between parties with separate professional advisers in accordance with normal commercial criteria at the time. HMRC guidance on the meaning of ‘full consideration’ can also be found in Revenue Interpretation 55 (see 5.28), and specific examples are included in the Inheritance Tax Manual (at para 14341). There is a similar full consideration let-out from the pre-owned assets income tax charge (see Chapter 15) in relation to land and chattels, but not intangible property (FA 2004, Sch 15, paras 4(1), 7(1)).

The donor’s occupation of gifted land is not a GWR if it represents reasonable provision for an infirm relative, if certain conditions are all satisfied (FA 1986, Sch 20, para 6(1)(b)).

Instruments of variation (IHTA 1984, s 142)

The GWR rules cannot apply to a disposition which is subject to a variation by the beneficiary (ie within IHTA 1984, s 142). The variation is treated as having been made by the deceased person whose estate is the subject of the variation, not the persons entitled under his Will. For example, if Mr B died leaving property under his Will to Mrs B, and within two years Mrs B varied the Will (ie by an instrument of variation within s 142) so that the property became settled on a discretionary trust for Mrs B and her adult children, the discretionary trust is treated for IHT purposes as having been made by the deceased, Mr B. Therefore, the GWR rules cannot bite.

Non-UK assets of non-UK domiciliary

The ‘excluded property’ of a non-UK domiciled person (see 1.18) is not subject to the GWR rules.

Example—GWR exception: excluded property

James was born and domiciled in New Zealand. In 1997, he gave away an investment property portfolio in Wellington to his daughter Mary. The lettings income was shared equally between them. James died in 2006, still domiciled in New Zealand.

The gifted property was subject to a reservation at James’ death. However, it was situated outside the UK, and James remained domiciled outside the UK throughout. The property is therefore excluded property (IHTA 1984, s 6(1)), and the GWR charging provisions do not apply.
However, HMRC’s view (as stated in the Inheritance Tax Manual at para 14318) appears to be that if the donor makes the gift and subsequently becomes UK domiciled, there may be a GWR claim on death, or alternatively if the reservation ceased in the donor’s lifetime, a deemed PET may be treated as being made.

A popular IHT planning point has been that if a non-UK domiciliary held assets abroad, those assets should be gifted into trust if there was any possibility of the individual becoming actually or deemed domiciled in the UK (eg settling the non-UK situs assets on discretionary trust with the settlor as a possible beneficiary), in order to continue benefiting from excluded property status. It was commonly thought that the GWR rules could not apply, because the excluded property rules prevailed. However, guidance in the Inheritance Tax Manual has created some uncertainty on this issue. Paragraph 14396 states the following:

‘If the settlor was domiciled outside the UK at the time a settlement was made, any foreign property within that settlement is excluded property and is not brought into charge for inheritance tax purposes.’

‘Foreign property settled by a settlor with foreign domicile remains excluded property if the reservation continues up to the settlor’s death, even though the domicile may have changed between those dates.’

However, the guidance goes on to provide the following example, which appears to contradict the preceding comments:

Example
The donor, who is domiciled in Australia, puts foreign property into a discretionary trust under which he is a potential beneficiary. He dies five years later domiciled in the UK and without having released the reservation.
The property is subject to a reservation and is therefore deemed to be part of the donor’s death estate.
Refer any cases where this is the situation to Litigation.’

In addition, whilst the cessation of a reservation in an ‘excluded property settlement’ was commonly thought not to constitute a deemed PET if an individual who was non-UK domiciled when the settlement was made subsequently became UK domiciled, para 14396 also states:

‘Reservation ceasing during lifetime
However, had the donor in the above example attained UK domicile after the gift and then released the reservation during his lifetime, it is arguable that the release would have been a PET, chargeable on the death within seven years. In effect, the property ceased to be excluded property at the time the reservation was released. The release would thus have triggered a charge which would not have arisen had the release not been made.

Refer any case where you consider that there is such a charge, or any enquiries about the possibility of a charge, to Litigation.’

It therefore seems that there is still some uncertainty (at least from HMRC’s perspective), in which case it seems possible that the interaction of the GWR and excluded property rules may be the subject of litigation in the future. What is not in dispute is that assets which are added to an excluded property trust after the settlor has become UK domiciled will not themselves be excluded property (Revenue Interpretation 166).

An anti-avoidance rule was introduced in Finance Act 2006 to counteract ‘deathbed’ IHT planning. This planning broadly involved an individual purchasing an interest in a pre-existing settlement created by a non-UK domiciled individual. Prior to 5 December 2005, a purchased interest in settled property was not precluded from being ‘excluded property’. However, from that date the exemption in IHTA 1984, s 48(3) is removed if the interest in excluded trust property has been purchased by a UK domiciled individual (IHTA 1984, s 48(3B)–(3C)).

Mark McLaughlin CTA (Fellow) ATT TEP
July 2006

Mark McLaughlin is General Editor of TaxationWeb, Co-author of ‘Tottel’s Inheritance Tax Annual 2006-07’, from which the above article is extracted Mark is also Series Editor of ‘Tottel’s Core Tax Annuals 2006-07’. The series is due to be launched in September 2006. Each of the new Core Tax Annuals costs just £19.95, or all six cost just £99.50! The Core Set comprises:

o Tottel's Corporation Tax 2006-07;

o Tottel's Capital Gains Tax 2006-07;

o Tottel's Income Tax 2006-07;

o Tottel's Inheritance Tax 2006-07;

o Tottel's Trusts and Estates 2006-07; and

oTottel's Value Added Tax 2006-07.

To order Tottel’s Core Tax Annuals 2006-07 click here

About The Author

Mark McLaughlin is a Fellow of the Chartered Institute of Taxation, a Fellow of the Association of Taxation Technicians, and a member of the Society of Trust and Estate Practitioners. From January 1998 until December 2018, Mark was a consultant in his own tax practice, Mark McLaughlin Associates, which provided tax consultancy and support services to professional firms throughout the UK.

He is a member of the Chartered Institute of Taxation’s Capital Gains Tax & Investment Income and Succession Taxes Sub-Committees.

Mark is editor and a co-author of HMRC Investigations Handbook (Bloomsbury Professional).

Mark is Chief Contributor to McLaughlin’s Tax Case Review, a monthly journal published by Tax Insider.

Mark is the Editor of the Core Tax Annuals (Bloomsbury Professional), and is a co-author of the ‘Inheritance Tax’ Annuals (Bloomsbury Professional).

Mark is Editor and a co-author of ‘Tax Planning’ (Bloomsbury Professional).

He is a co-author of ‘Ray & McLaughlin’s Practical IHT Planning’ (Bloomsbury Professional)

Mark is a Consultant Editor with Bloomsbury Professional, and co-author of ‘Incorporating and Disincorporating a Business’.

Mark has also written numerous articles for professional publications, including ‘Taxation’, ‘Tax Adviser’, ‘Tolley’s Practical Tax Newsletter’ and ‘Tax Journal’.

Mark is a Director of Tax Insider, and Editor of Tax Insider, Property Tax Insider and Business Tax Insider, which are monthly publications aimed at providing tax tips and tax saving ideas for taxpayers and professional advisers. He is also Editor of Tax Insider Professional, a monthly publication for professional practitioners.

Mark is also a tax lecturer, and has featured in online tax lectures for Tolley Seminars Online.

Mark co-founded TaxationWeb (www.taxationweb.co.uk) in 2002.