Making gifts with reservation of benefit
Writing for Taxation magazine, BKL tax adviser Terry Jordan examines Inheritance Tax ‘gifts with reservation of benefit’ provisions. The article includes sections on agricultural & business property and UK residential property.
- Interaction with the various inheritance tax exemptions.
- Making a gift with reservation of benefit is often worse than doing nothing.
- Qualifying for agricultural and business property reliefs.
- Planning points for clients who might take a long-term view.
- Provisions dropped from the Finance Bill that had been planned to take effect from 6 April 2017.
Do you have a reservation? This is not a greeting by the maître d’ at my local fast-food establishment but rather a consideration of the inheritance tax ‘gifts with reservation of benefit’ provisions.
To put those into their historical context, it is interesting to note that, from 1894 until 12 March 1975, estates on death were liable to estate duty. This could be avoided as long as lifetime gifts were made seven years before death and no benefit was reserved in the subject matter of the gift.
In his book, Inside the Treasury, Joel Barnett said estate duty ‘… had become almost a voluntary tax, avoided with ease by even the most incompetently advised taxpayer despite being amended over some 80 years’. With the introduction of capital transfer tax and its original lifetime cumulation of gifts there was no need for any reservation of benefit provisions. But, on 18 March 1986, inheritance tax replaced capital transfer tax and reintroduced the concept of gifts with reservation of benefit.
The income tax charge on pre-owned assets (POAT) came into effect on 6 April 2005, although the key date is 18 March 1986 because transactions on or after that date are potentially within the POAT rules. Note that, if there is a reservation of benefit, POAT cannot apply. Another fundamental point is that benefits can be reserved only in lifetime transfers; gifts by will cannot be gifts with reservation.
What is a gift? Dymond’s Capital Taxes says:
‘Rather surprisingly, neither [FA 1986] s 102 nor Sch 20 contained any definition of the word “gift”. The [Inheritance Tax Act] 1984 … has a definition in s 42(1), but that is merely for the purposes of ch III of Pt II of the Act (allocation of exemptions). In the context of s 102 one might expect “gift” to mean “transfer of value”, and the word is used in that sense in sub-s (5), which refers to various exempt gifts and excludes them from the gifts-with-reservation rules. HMRC notes in its manual that in the context of reservation of benefit “the word must be given its ordinary meaning”.’
IHTA 1984, s 10 (dispositions not intended to confer gratuitous benefit) would save a bad bargain made at arm’s length but not a transaction at deliberate undervalue. Otherwise I could sell the house to my children for £1.
Interaction with exemptions
The inheritance tax lifetime exemptions are:
- the annual exemption of £3,000;
- the small gifts exemption of £250;
- the exemption for gifts on marriage of up to £5,000;
- the unlimited exemption for gifts to charities and political parties; and
- the normally unlimited spouse and civil partner exemption.
Of these all but the annual exemption were excluded from the gifts with reservation of benefit provisions by virtue of FA 1986, s 102(5). It should be noted that the potentially unlimited exemption afforded to habitual gifts out of income by IHTA 1984, s 21 is within the reservation of benefit provisions.
Bear in mind that, on a transfer from a UK-domiciled spouse to a non-UK domiciled recipient, the exemption is limited to £325,000 and for more valuable gifts it may be necessary to consider the reservation of benefit provisions.
The Ingram case
Lady Ingram implemented a lease carve-out or shearing operation in relation to her property. On day one she transferred properties to her solicitor who declared that he held them as nominee for Lady Ingram. On day two the solicitor granted a 20-year lease to Lady Ingram. The next day the solicitor transferred the property subject to the lease to trustees for the benefit of younger generations.
In The Executors of Lady Jane Ingram deceased v CIR  STC 37 the House of Lords held that the retained lease did not amount to a reservation of benefit for inheritance tax purposes. Finance Act 1999, s 104 reversed the effect of the decision by inserting new s 102A, s 102B and s 102C in FA 1986.
For gifts on or after 9 March 1999, s 102A provides that, if the donor or his spouse enjoys an interest that confers entitlement to occupy part or all of the land, the land gifted is property subject to reservation of benefit. So the type of arrangements entered into by Lady Ingram would be caught as gifts with reservation of benefit.
The section does not apply if the right of occupation had arisen more than seven years before the gift. So as long as there was thought to be enough time available there was a potential benefit in creating a lease more than seven years in advance of the anticipated gift of the freehold.
The Eversden case
The exclusion of the spouse exemption from the reservation of benefit provisions was exploited in CIR v Eversden and another  STC 822 in which the Court of Appeal found for the taxpayer.
The settlor transferred assets to trustees to hold for the benefit of her husband for his lifetime and, on his death, in discretionary trusts for a class of beneficiaries including the settlor. When the husband died it was common ground that the trust assets formed part of his taxable estate. When the settlor died the Revenue said her estate included the trust assets. This was on the basis that the spouse exemption applied only as long as her husband had enjoyed his interest under the trust and that she had made a gift with reservation of benefit because she was included in the discretionary class. (Defeasible life interest trusts for spouses had for several years enjoyed a relatively quiet life because they were used mainly in life assurance planning.)
Schemes based on the case were strongly marketed. In general, these required the interest of the spouse to be terminated not on death but during the spouse’s lifetime. In Eversden, the trustees had no overriding power of appointment and that power was essential for the marketed schemes to work. Also, as a general point, the Revenue did not regard death as an ‘associated operation’.
Some advisers suggested that the scheme could be used to deal with the matrimonial home. In my view this was always a vulnerable area since, even if the original gift was not within the ambit of the gifts with reservation of benefit rules, the Revenue might have argued that occupation of the property held by trustees constituted an old-style ‘interest in possession’, thereby bringing its value back into the estate of one or other (or both) spouses.
For a time the scheme was useful for clients who wished to ringfence ‘financial assets’. The Revenue announced on 20 June 2003 that measures were to be inserted in the Finance Bill that would kill off Eversden-type settlements.
Interests in possession
Until 21 March 2006, the termination of an ‘estate’ interest in possession in settled property was not technically a gift and therefore fell outside the reservation of benefit provisions.
A spouse might leave such an interest – nowadays an immediate post-death interest – for the surviving spouse’s benefit and equip the trustees with an overriding power of appointment. That power could be exercised, for example, to appoint a valuable painting to the children while leaving it hanging on the survivor’s wall.
Those arrangements were frustrated by the insertion of s 102ZA into FA 1986 with effect from 22 March 2006.
Worse than doing nothing?
The rules that include the subject matter of the gift with reservation of benefit in the deceased’s inheritance tax estate are a fiscal fiction. In reality, a valid lifetime gift will have been made that, if of a chargeable asset, will have constituted a disposal for capital gains tax purposes. Although the asset could be liable to inheritance tax, the normal capital gains tax-free uplift to market value on death will have been forgone with the potential for a greater taxation liability in total than was necessary.
The family home
The gift with reservation of benefit provisions are most likely to be encountered in the context of the family home. Parents have been prevailed upon to transfer their property to their children or to trust in an attempt to avoid liability for the cost of long-term care. The gifts were often made when the value of the property was within the inheritance tax nil rate band and the planning has fallen foul of the fact that property price inflation outstripped the annual increases in the nil rate band.
For land and chattels FA 1986, Sch 20 para 6(1)(a) provides that the reservation of benefit rules will be avoided if the donor pays full consideration to the donees for future occupation or use of the asset gifted. The Revenue’s Tax Bulletin 9 of November 1993 stated that the consideration must be full throughout the period of occupation and that the rent paid should be reviewed regularly with clauses to this effect being included. However it did accept that what constitutes full consideration is a matter of opinion and if it lies with a range of valuation tolerances it would be regarded as full.
The rent does normally constitute taxable income in the hands of the recipient. Before 22 March 2006 it was sometimes possible to mitigate this liability if, for example, the property was gifted to an accumulation and maintenance trust for the benefit of young grandchildren who were not already using their personal allowances. Such a gift to trust might still be possible if the property is jointly owned and is worth no more than two nil rate bands (currently £650,000).
The Tax Bulletin also gave some examples of when the Revenue would regard the donor as ‘virtually’ excluded from benefit. These include social visits, occasional returns to a house given away to babysit or to visit a library in it no more than four times a year, to stay for short periods of up to two weeks a year (or four if the donee is present) or to convalesce or while the donor’s own house is being redecorated. The guidance went on to say that the gift of a car would be outside the provisions if the donee gave the donor lifts no more than three times a month and that land would not be caught if the donor merely walked his dogs or rode his horse over the land.
There is a further exemption in FA 1986, Sch 20 para 6(1)(b) if the donor occupies land that has been the subject matter of a gift because he suffers an unforeseen (at the time of the gift) change of circumstances and has become unable to maintain himself through old age, infirmity or otherwise and it represents reasonable provision for the donor by the donee, who must be related. Note that the donor does not necessarily need ever to leave the gifted property for the provision to apply.
During the passage of the 1986 Finance Bill the minister of state, Peter Brookes, stated the exemption from the inheritance tax reservation of benefit rules could apply in:
‘the common case where someone gives away an individual share in land, typically a house, which is then occupied by all the joint owners including the donor. For example, elderly parents make unconditional gifts of undivided shares in their house to their children, and the parents and the children occupy the property as their family home, each owner bearing his or her share of the running costs. In those circumstances, the parents’ occupation or enjoyment of the part of the house that they have given away is in return for similar enjoyment of the children of the other part of the property. Thus the donor’s occupation is for a full consideration.’
It should be noted that the statement envisaged occupation of the property as ‘the family home’.
Gifts of shares in land after 8 March 1999 are governed by FA 1986, s 102B(4), added by FA 1999, s 104. When the clause was discussed on 15 June 1999 by the House of Commons’ standing committee, the paymaster general, Dawn Primarolo, said:
‘The original owner can give away part of his or her property as an undivided share in a way in which the recipient and the donor become part owner occupiers side by side. This will be tax effective, as it is under existing law, so long as there is no attempt to frustrate the intention of the clause or the rules set out in existing inheritance tax legislation. Everyone will be able to use the property to which they are entitled and everyone will pay their fair shares of the expenses.
‘In the past the Inland Revenue has issued guidelines and the Country Land Owners Association has sought clarification on the matter. The advice that the association has been given still holds good. That should help to answer any questions on undivided shares.’
Now occupation by the donee is required but not necessarily as the family home. There is no longer a requirement to share the running costs as long as the donor does not receive any benefit from the donee – so the donor can pay all the costs but the donee must pay no more than his share.
It is considered that there is a reasonable technical argument that the donee could receive a share greater than that retained by the donor(s) on the basis that there is no longer reference to full consideration as the basis for provision, but it is understood that HMRC regards such planning as provocative.
‘Sharing’ arrangements might be considered as a way of dealing with a holiday home that is perhaps already being used by the whole family.
A few years ago the Sunday Times reported that a peer had designated as his ‘main home’ a house he gave to his son six years earlier:
‘When a reporter telephoned the house several days ago, his daughter-in-law said: “It was his house but his son and I live here … it’s ours, and he is welcome here every time. This is where he always stays, of course.”’
The article made no reference to whether the peer had paid rent for continued occupation.
A share in a let property can be transferred to a settlor-interested discretionary trust without it constituting a gift with reservation of benefit. The inheritance tax seven-year clock threfore can start running on the value transferred while the settlor can benefit from all of the income generated. However, were the land to be sold and the proceeds reinvested in, say, stocks and shares the protection would be lost. Capital gains tax holdover relief would not be available on the transfer.
Recent lease cases
Buzzoni v CRC  EWCA Civ 1684 concerned a reversionary lease. HMRC won in the First-tier Tribunal and the Upper Tribunal but the taxpayers were successful in the Court of Appeal. It held that the donee’s enjoyment of the gift was not impaired by the positive covenants given by the donee to the donor because the donee had already entered into a covenant with the head landlord to comply with the same covenants.
In Viscount Hood (executor of the estate of Lady Diana Hood) (TC4858), Lady Hood granted her three sons a sub-lease of premises in London on 19 June 1997 and died on 15 March 2008. She retained the head lease of the property. The First-tier Tribunal held that the creation of the sub-lease was a disposal by way of gift of property subject to a reservation within the meaning of FA 1986, s 102. Therefore the sub-leasehold interest fell to be treated as property to which Lady Hood was beneficially entitled immediately before her death.
Agricultural and business property
Property caught by the gifts with reservation of benefit provisions has to satisfy two sets of conditions to qualify for agricultural or business property relief:
- at the date of the gift the property has to qualify for relief; and
- at the time of the tax charge there is the concept of a notional transfer by the donee and that notional transfer itself needs to qualify for relief.
If the reservation continues until the donor’s death the tax charge arises under IHTA 1984, s 4. If the reservation ceases during the donor’s lifetime, FA 1986, s 102(4) deems a potentially exempt transfer to have been made. These are what FA 1986, Sch 20 para 8 refers to as the ‘material transfer of value’. In the case of a deemed potentially exempt transfer the ‘retention’ rules need to be considered, as with an outright lifetime gift of qualifying property. When the gift is of shares the donees should retain the shares for seven years from the cessation of reservation of benefit (or until the earlier death of the donor) and the company must remain unquoted but it does not have to continue as a trading company.
For shares to qualify for agricultural property relief they had to do so at the time of the gift. IHTA 1984, s 122 requires the transferor to have had control of the company. In addition, the donee must have owned the shares during the period between the gift and the date of the gift with reservation of benefit charge and the shares have to qualify for relief under the notional transfer by the donee. Farmhouses can benefit from relief as long as they are of a character appropriate to the land they occupy. Accordingly, a disposal of land could prejudice the relief on a retained farmhouse.
A gift involving a family business or farm will not necessarily amount to a gift with reservation of benefit merely because the donor remains in the business as a director. When shares are gifted, the continuation of reasonable commercial arrangements agreed before the gift in respect of remuneration for the donor’s services to the company would not amount to a reservation if the remuneration is not linked to the gift.
An article in Capital Taxes News & Reports (September 1987, page 273) says: ‘It is possible to argue that unreasonable remuneration might trench on the donees’ enjoyment of the shares ie by decreasing their value or the ability of the company to pay dividends while reasonable remuneration would not.’ When the property has been shorn of particular rights before it is gifted, it is necessary to identify the precise property given and then decide whether the donor has been entirely excluded from benefit associated with it.
There is a technical argument that when premises are owned by a company, ‘property’ in FA 1986, s 102 refers to the shares that are the subject of the gift such that occupation of the premises by the donor of the shares does not constitute a reserved benefit. I do not share this view and nor does tax counsel with whom I have discussed matters informally.
Finance Act 1986, s 102(4) states that, if the reserved benefit comes to an end during the donor’s lifetime, he is treated as having made a disposition at that time which is a potentially exempt transfer.
Clients who before 22 March 2006 might have funded accumulation and maintenance trusts for their young children, perhaps taking the view that it is inadvisable for young people to have too much too soon, might now create discretionary trusts within the limit of their inheritance tax nil rate bands and include themselves as potential beneficiaries. Such gifts would be immediately chargeable, but within the settlors’ nil rate bands the rate of inheritance tax would be nil and also constitute gifts with reservation of benefit. The process could be repeated every seven years. For the time being the settlors would prevail upon the trustees (who might well be one and the same) to distribute income to them.
In the future they might exclude themselves from benefit with the result that they would be deemed to have made potentially exempt transfers that would escape inheritance tax as long as they survived a further seven years. In that way they could build up substantial value in trust for the benefit of younger generations. Note that capital gains tax holdover relief would not be available on the transfer into trust (TCGA 1992, s 169B).
UK residential property
New rules for UK residential property were expected to take effect from 6 April 2017.
Historically non-UK domiciles would shift the situs of UK property assets by having them owned by non-UK companies, the shares in which were ‘excluded property’ in the hands of the owner and outside the scope of inheritance tax.
If becoming deemed domicile was a concern the shares would be held by trustees so that they would remain ‘excluded’.
It was proposed that, from 6 April 2017, all UK residential property was to fall within the scope of inheritance tax regardless of how it was ‘enveloped’. In the case of corporate ownership the value of the shares attributable to the UK residential property was to be potentially taxable.
Occasions of charge were to include:
- the death of the owner with shares in his free estate;
- the death of a life tenant with an ‘estate’ interest in possession in a trust owning shares;
- the death of a person with shares treated as forming part of his estate under the reservation of benefit rules;
- the death within seven years of the previous owner if the shares are the subject of a lifetime gift;
- the transfer of shares during lifetime to a relevant property trust;
- ten-year charges on relevant property trusts; and
- proportionate or ‘exit’ charges on assets leaving the relevant property regime.
Debt might reduce the taxable value but the government has said that connected party loans will not be deductible.
It had been anticipated that some tax relief would be afforded to ‘de-enveloping’ operations designed to extract the property from corporate structures but the government announced that no such relief was to be forthcoming.
Several clients excluded themselves from benefiting from trust structures by 5 April this year for fear that, otherwise, death would occasion a charge to inheritance tax under the reservation of benefit provisions and the spouse exemption would not be available.
At the time of writing, it is unclear whether these proposals, which were omitted from the Finance Bill when the general election was announced, will be reintroduced and, if so, with effect from what date.