Special Commissioners - An Exempt Transfer

JOHN T NEWTH FCA, FTII, FIIT, ATT summarises a case recently heard by the Special Commissioner.

IN 1988 MRS S settled a 95 per cent interest in a house on trust to pay the income to her husband for life. After his death, trustees were to hold the capital and income on discretionary trusts for a class of beneficiaries which included the donor, with default trusts in remainder.

Mr S died in 1992 and subsequently Mrs S died in 1998. The Revenue issued a notice of determination on the basis that having regard to, inter alia, section 102, Finance Act 1986, the property held on the trusts on the settlement immediately before the death of Mrs S fell to be treated as property to which she was then beneficially entitled.

The consequence of this was that section 102 provided that where an individual disposed of property by way of gift and, inter alia, at any time in the period ending on the date of the donor's death and beginning seven years earlier the property was not enjoyed to the entire exclusion, or virtually to the entire exclusion of the donor, the property was subject to a reservation of benefit and was to be treated for inheritance tax purposes as if it were property to which the donor was beneficially entitled at death.

The executors of Mrs S appealed on the basis that section 102(5), Finance Act 1986 disapplied section 102 if the disposal of property by way of gift was an exempt transfer by virtue of section 18, Inheritance Tax Act 1984.

However, the Inland Revenue contended that section 102, Finance Act 1986 applied, since Mrs S had disposed of property by way of gift to the trustees; in the period before her death the property had not been enjoyed to the entire exclusion of the settlor, since Mrs S had occupied the house until her death and was also among the class of discretionary beneficiaries.

The Revenue also submitted that the creation of the settlement constituted a disposal of property by way of two further gifts, to the discretionary beneficiaries and the default beneficiaries, to which section 102(5), Finance Act 1986 did not apply, and that the relevant date for the application of section 102 was the date of death of Mrs S.

The Special Commissioner, Dr Nuala Brice, held that the purpose of section 102 was to supplement the potentially exempt transfer provisions by providing that a gift with a reservation, even if made more than seven years before death, was treated as property to which the donor was beneficially entitled at the date of death.

However, section 3A(1)(b), Inheritance Tax Act 1984 provided that only a chargeable transfer could be a potentially exempt transfer. Accordingly, section 102(5) provided that the whole of section 102, which concerned gifts with a reservation, did not apply where the original transfer was an exempt transfer, because such a transfer was not within the potentially exempt transfer régime, and so section 102 was not intended to apply to it. In the current case, because the creation of the settlement was an exempt transfer between spouses, and not a potentially exempt transfer, section 102(5) applied.

The Special Commissioner had to consider also whether, on the creation of the settlement, the disposal of property was by way of one gift to Mr S, or by way of three gifts, two of which were to the other beneficiaries under the settlement. Dr Brice held that as a result of section 49, Inheritance Tax Act 1984, Mr S was treated as entitled to the whole of the trust property when he was alive and on his death. If Mr S had survived Mrs S, then it would not have been argued that on his death his interest was in less than the whole of the trust property. It was therefore consistent with the scheme of the legislation that for the purposes of section 102, Finance Act 1986 there was only one gift of the whole of the trust property and that was to Mr S.

The final question was whether, for the purposes of section 102(5), Finance Act 1986, the relevant date was the date of the settlement or the date of the death of Mrs S. Dr Brice held that while the date of the death of a donor established the relevant period for the purposes of section 102, if section 102(5) applied then the other provisions of section 102 did not and so the date of death of Mrs S was not relevant. Section 102(5) was quite specific and required a reference only to the disposal of property by way of gift, which in the instant appeal was the creation of the settlement. Therefore, on the creation of the settlement the disposal of the property was by way of one gift to Mr S: the provisions of section 102(5) applied so as to exclude the operation of section 102 completely.

This settled the matter in favour of the taxpayers but Dr Brice also expressed her views on the other questions raised which were:

• whether any benefit had been reserved by Mrs S within section 102(1)(b);
• whether the fact that Mrs S was one of the class of discretionary beneficiaries meant that there was a reservation of benefit.

The Special Commissioner concluded that the occupation by Mrs S of the house was a right enjoyed by her as a 5 per cent co-owner and not derived from the interest given away in the settlement. In addition, the fact that Mrs S was one of a class of discretionary beneficiaries under the settlement meant that the whole of the trust property (including the 95 per cent interest in the house) was not enjoyed to the entire exclusion of the settlor within the meaning of section 102(1)(b).

However, on the basis that the original gift was an exempt transfer the appeal of the executors was allowed.

This case is of wider interest since the structure of the gift made (namely, a settlement on a spouse for a period of time followed by discretionary trusts to include the settlor) has been a common device to avoid the gift with reservation provisions. In particular, insurance based schemes have made much use of it.

(Essex and another (executors of Somerset deceased) v Commissioners of Inland Revenue (SpC 296).)

Issue: 3853 / Categories: