Meeting Points

RALPH RAY FTII, TEP, BSc(Econ), solicitor, consultant with Wilsons, reports an IBC Conference on capital taxes.

Shares in the family home

The position where there is a gift of a share of interest in land is now governed, for inheritance tax purposes, by section 102B, Finance Act 1986. This provides that there is no gift with reservation in such circumstances where either subsection (3) or (4) of the section applies.

Subsection 3 relates to cases where the donor does not occupy the land or, if he or she does, it is to the exclusion of the donee and for full consideration.

Subsection 4 relates to cases where the donor and the donee occupy the land together. Chris Whitehouse, barrister, pointed out that although subsection 4 requires that the donor must not receive linked benefits - in particular the donee must not pay more than his or her share of the outgoings - there is in fact no requirement for proportionate sharing of expenses. Furthermore, there is no reference to full consideration with respect to the interest in the land and hence the donor can give a 90 per cent interest.

Reversionary lease schemes

A reversionary lease involves granting a long lease at a peppercorn rent which takes effect in (say) twenty years time. Chris Whitehouse said that the inheritance tax legislation in the Finance Act 1999 did not seem to be specifically directed at these schemes and they appear to remain valid whether the freehold has already been owned for seven years or if it was acquired (albeit within the seven years) for full value.

Gifts of chattels

Chris Whitehouse said that the full consideration exception to the reservation of benefit rules in paragraph 6(1)(a) of Schedule 20 to the Finance Act 1986 is rarely used in the case of a gift of a residence, but may be satisfactory for a gift of chattels. In these cases, the commercial rent can be manageable, for example it may be 1 per cent of value or, say, 0.75 per cent if the transferor agrees to insure and provide a security system. The procedure in the Bills of Sale Acts should be followed.

The inheritance tax debt scheme

Assume that in 1998, a husband transfers a half interest in the main residence to his wife so that thereafter they own the home in equal shares. The value of the share given is £300,000. Assume further that the wife dies in 2001 and the standard loan arrangement is implemented, namely that the husband accepts an indebtedness of £242,000 to the trustees of a nil rate band discretionary trust under the will. Having given the wife value of £300,000 in 1998, Chris Whitehouse advised that section 103, Finance Act 1986 may apply in such circumstances to deny a deduction for the debt owed to the discretionary trustees on the death of the husband. Having given the wife £300,000, it can be said that the husband has furnished consideration for the loan.

Section 103(1) may apply in two situations:

(a) if on a death there is an outstanding liability arising from a debt incurred by the deceased; or

(b) if the outstanding liability arises from an encumbrance created by a disposition made by the deceased.

Note, therefore, that the section is not capable of applying if the deceased neither incurred the debt nor made the disposition which created the encumbrance.

A simple scheme involving the family home

Chris Whitehouse outlined a simple inheritance tax scheme relating to the family home. S settles her interest in the home on a revocable life interest trust for her husband, with remainder to her children. At a later time the life interest is terminated and the children allow the wife and her husband to continue to live in the property. The gift by S is protected by the spouse exemption and so cannot be a gift with reservation. The ending of the husband's life interest is not a gift, so that also cannot be a gift with reservation. Obviously tax is not the only point to consider here as effectively the parents will no longer own their own home.

Clawback of capital gains tax holdover relief

Assume that S settles an asset worth £500,000 with a base cost of £100,000, holding over the £400,000 gain to the trustees. He retains a life interest in the trust. When he dies, the asset is worth £1 million. On his death there is a tax free uplift for capital gains tax purposes of the £500,000 gain which has accrued while the asset was held in trust, but there is a claw back under section 74, Taxation of Chargeable Gains Act 1992 of the £400,000 gain held over.

A new problem for executors

Where the assets of a deceased's estate include shares in a quoted company and the beneficiary under the will works for that company, Emma Chamberlain, barrister, pointed out that the period whilst the shares are held by the executors does not qualify for business asset taper relief. The relevant rules are in paragraphs 4(5) and 6(3) of Schedule A1 to the Taxation of Chargeable Gains Act 1992. It will be found that, unless the personal representatives have over 5 per cent of the voting rights in the company, their ownership of the shares does not qualify for business asset taper relief and therefore neither can that period qualify for the beneficiary.

Emma Chamberlain therefore advised that executors should be alert to such situations and should distribute the shares to the beneficiary as soon as may be possible.

Inheritance tax business property relief

Securities of a quoted or unquoted company can be 'relevant business property' for inheritance tax purposes but only if, either by themselves or together with other such securities or shares owned by the transferor, they gave the transferor control of the company immediately before a transfer of value; see section 105(1)(b), Inheritance Tax Act 1984.

Barry McCutcheon warned that if a shareholder in a company owns sufficient shares to give him control of the company as well as non-voting securities, the shares will be relevant business property for inheritance tax purposes but the securities will not qualify for any business relief whatsoever. This is because the securities do not give the shareholder control of the company together with the unquoted shares; the shares give control in their own right.

Lifetime gifts by the elderly

Chris Whitehouse contrasted the two-year qualifying period for inheritance tax business and agricultural property reliefs with the seven-year survivorship period required in the case of potentially exempt transfers during lifetime.

Assume for example that Mrs Z, who is elderly, has surplus assets of £1 million. If she gifts those assets to her son, she must survive the seven-year period applicable to potentially exempt transfers if they are to fall out of account on her death.

Alternatively if she were to invest £1 million in a farm and enter into a partnership with her son in relation to that farm, 100 per cent business property relief should be available after two years.

Estate reduction exercise

Assume that a taxpayer borrows money on the security of his home and uses it to subscribe for share capital in his trading company. The result for inheritance tax purposes is that the encumbrance will reduce the value of the home, and after two years the shares will qualify for inheritance tax business property relief at 100 per cent.

Farmhouses and smallholdings

Barry McCutcheon advised that there was a Special Commissioner's decision in 1994, not reported as the decisions were not then published, which contained the following remark:

'Whether or not one can make a living from a given acreage of land cannot be determinative of the question whether a building is a farmhouse…'

Mistakes in documents

In examining 'escape routes when it all goes wrong', Christopher McCall QC advised that one should start by examining the possibility of rectification. This is a retrospective cure for any written instrument which is shown by convincing evidence to have failed to achieve what the parties meant it to achieve. Note that rectification is not appropriate where a document produces results which were unintended had the parties been better informed. Rectification is for cases where a document does not accord with the true agreement between the parties, so what is rectified, as Snell's Principles of Equity puts it, is not 'a mistake in the transaction itself, but a mistake in the way in which that transaction has been expressed in writing'.

Doubling the taxable value of an asset

The case of Commissioners of Inland Revenue v Melville [2000] STC 627 concerned a scheme whereby a substantial gift could be made to a trust with a claim to holdover relief for capital gains tax purposes whilst minimising the transfer of value for inheritance tax. The scheme involved the transferor retaining a right to recover the assets from the trust during a certain period.

Although the High Court found for the taxpayer, Barry McCutcheon warned that the decision is not without its adverse implications. Consider the case of a revocable trust in which the settlor has an interest in possession. In such a case the settlor is treated by section 49(1), Inheritance Tax Act 1984 as owning the trust property. He also owns the right to revoke the trust, which right is apparently according to the Melville decision a freestanding right with a value equal to the value of the property comprised in the trust fund. The result is that the settlor may stand to be taxed by reference to twice the value of the trust fund.

A similar problem arises where there is a right to revoke an offshore trust which contains excluded property and the right to revoke is held by a United Kingdom domiciled individual.

The Benham problem

Chris Whitehouse examined the problem in deceaseds' estates which can arise from section 41, Inheritance Tax Act 1984: 'Notwithstanding the terms of any disposition…(b) none of the tax attributable to the value of the property comprised in residue shall fall on any gift of a share of residue if or to the extent that the transfer is exempt with respect to the gift'.

Thus, assume net residue of £100,000 is to be divided equally between surviving spouse and daughter. The rate of inheritance tax on the estate is 40 per cent.

Option 1: deduct tax on £50,000 and divide balance (£80,000) equally. This is theoretical only as an option as it is contrary to section 41 set out above.

Option 2: divide equally. Spouse gets £50,000, and the daughter's £50,000 then bears the tax so that she ends up with £30,000. This is in accordance with Re Ratcliffe [1999] STC 262.

Option 3: gross up daughter's share so that both end up with the same:

Both receive £37,500; gross value of daughter's share is £62,500.

This is based on Re Benham [1995] STC 210.

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