Inheritance tax (IHT) is sometimes labelled a ‘voluntary tax’. This is probably based on the premise that IHT can be avoided by giving everything away and surviving for at least seven years. However, this is something of an over-simplification, not least because there are a number of IHT and other (tax and non-tax) issues to consider when making lifetime gifts.
Gifts with reservation
For example, giving everything away, particularly income generating assets, is likely to affect an individual’s standard of living. To make matters worse, IHT anti-avoidance rules (in FA 1986, ss 102-102C, Sch 20) are designed to prevent ‘cake and eat it’ situations whereby an individual makes a lifetime gift of an asset (which they hope to survive for at least seven years, so that the gift becomes an exempt transfer), but continues to have the use or enjoyment of that asset.
These ‘gift with reservation’ (GWR) anti-avoidance rules apply where an individual gifts property (on or after 18 March 1986), broadly if the recipient does not immediately enjoy possession and enjoyment of the property, or if the donor continues to enjoy or benefit from the gifted property. If the GWR rules apply, that property is treated as forming part of the donor’s death estate for IHT purposes.
If the benefit is ended during his lifetime, the donor is treated as having made a potentially exempt transfer (PET) at that time (FA 1986, s 102(4)), which becomes a chargeable transfer for IHT purposes on death within the following seven years.
The GWR rules were subsequently extended (from 9 March 1999) to disposals of land by gift, broadly where the donor or his spouse (or civil partner) enjoys a ‘significant right or interest’, or is party to a ‘significant arrangement’ in relation to the land. In such cases, the gifted interest in the land is treated as a GWR, unless certain specific exceptions apply.
Exceptions to the GWR rules
The GWR provisions are relatively complex, and a detailed explanation of the rules is outside the scope of this article. However, it should be noted that the gift of an undivided share of an interest in land (from 9 March 1999) is potentially ‘caught’ as a GWR (e.g. the gift of a 50% interest in a house from father to son). The gifted interest is a GWR unless one of the following exceptions apply (FA 1986, s 102B(3), (4)):
- The donor does not occupy the land; or
- The donor occupies the land to the exclusion of the donee for full consideration in money or money’s worth (e.g. a full market rent); or
- Where (such as in the above example) father and son both occupy the property, and father receives no (or negligible) benefit from his son in connection with the gift (e.g. the property expenses are shared appropriately between them).
The first exception above might be relevant where, for example, a share of an investment property is being given away. This exception from the GWR rules does not (at least explicitly) prevent the donor from continuing to benefit from the investment property by continuing to receive the rent.
Example: Keeping the rent
Adam owns 100% of a buy-to-let property worth £250,000. He decides to give a 50% interest in the property to his daughter Bridget. However, it is agreed that Adam will receive all the rental income from the property.
For IHT purposes, Adam’s gift to Bridget of a share of the property is a PET. However, Adam does not occupy the property. The exception from the GWR rules therefore applies (in FA 1986, s 102B(3)(a)) although Adam continues to benefit (i.e. by continuing to receive rent from the property).
It is also considered that no income tax charge should arise under the ‘pre-owned assets’ anti-avoidance provisions (FA 2004, Sch 15), on the basis that the donor (i.e. Adam) does not occupy the investment property.
This arrangement has been mooted amongst professional advisers, such as on the Trusts Discussion Forum (www.trustsdiscussionforum.co.uk/), and leading experts consider that the strategy is effective (e.g. see ‘Trust Taxation and Estate Planning’ (4th Edition) by Emma Chamberlain and Chris Whitehouse (Sweet and Maxwell)).
However, care is needed when considering such gifts. For example:
- Note that the above exception from the GWR rules apply to the gift of an “undivided share of an interest in land” (i.e. not all of it).
- As indicated above, the gift of the property interest in the above example is a PET. The gift could therefore become a chargeable transfer if Adam dies within seven years of making it.
- For capital gains tax (CGT) purposes, Adam has made a disposal of the property interest at market value. A CGT liability may therefore arise if there is a gain on the property (subject to Adam’s CGT exemption, if available).
Could such a gift be caught by other measures, such as the general anti-abuse rule (GAAR)? Whilst some commentators consider that it is not caught, a possible challenge by HM Revenue & Customs cannot be ruled out. Gifting an interest in an investment property, but keeping the rent, is therefore perhaps not for the faint hearted.
Seek expert advice on the tax and non-tax (e.g. legal) implications of the gift of an interest in an asset (e.g. a share of an investment property, such as in the example above) where necessary. This should especially be the case in more complicated circumstances (for example, if the gift of an interest in land is being made into a trust, as opposed to another individual).
The above article was first published by Tax Insider (www.taxinsider.co.uk).