Essex Lass Wins Again

JEREMY de SOUZA, consultant to White and Bowker comments on a recent High Court decision concerning inheritance tax and gifts with reservation.

THE CASE OF Commissioners of Inland Revenue v Eversden and another (Executors of Greenstock) [2002] EWHC 1360 has been followed with considerable interest by estate planners. The case was reported at the Special Commissioner stage under the anonymised name Essex (SpC 296) and a decision on appeal to the Chancery Division of the High Court was handed down on 10 July 2002. It was decided against the Revenue, both by the Special Commissioner and, on appeal, by Mr Justice Lightman, but there was a difference in approach on some of the subsidiary issues.

The scheme

Briefly, the arrangements involved a settlement made on 20 December 1988, by which the settlor provided for the income of the trust fund to be paid to her husband for life. Following this, discretionary trusts would continue in favour of a class of beneficiaries which included the settlor. The settlor transferred the property in which she and her husband lived to the trustees, to hold as to five per cent for her absolutely and 95 per cent on the trusts of the settlement.

After the husband died, the property was sold and another purchased with identical shares of ownership and the settlor occupied the new property exclusively until her death in 1998.

The reservation of benefit point

The main issue for consideration was whether, for the purposes of the gift with reservation code at section 102(5), Finance Act 1986, the settlement upon the husband for life failed because the remainder was to a discretionary trust in which the settlor wife was both a discretionary beneficiary and a member of the class of potential appointees. It was common ground that a disposition into a settlement where a spouse holds an interest in possession is not within the concept of reservation of benefit by reason of section 102(5), Finance Act 1986.

The Revenue's submission was that, for the purposes of the gift with reservation of benefit provisions, it was permissible to treat the disposition as three separate gifts, these being the initial life interest, the discretionary trust of income in remainder and the possibility of capital being appointed in remainder. The Revenue argued that the reservation of benefit provisions could be applied independently to the three separate gifts. Both the Special Commissioner and the judge concluded that this was not permissible. Section 102(5), Finance Act 1986 had to be applied at the date of the original gift and, at that date, it took the settlement as a whole outside the gift with reservation régime. This was sufficient to determine the case in favour of the taxpayer and will not come as much of a surprise to practitioners.

Mr Justice Lightman also stated that the duration of the interest gifted to the spouse is irrelevant 'even as it is irrelevant how long the spouse retains the proprietary interest and whether the spouse gifts the proprietary interest onto someone else, for example the children of the donor and donee'.

Discretionary benefits

This point on its own decided the case in favour of the taxpayers, but had this not been the case, a further contention made was that the gift with reservation of benefit provisions did not apply where the settlor was included in the settlement merely as a discretionary beneficiary or appointee.

This hypothesis did not find favour either with the Special Commissioner or Mr Justice Lightman. It is not possible to distinguish between the income beneficiary and appointee scenarios; both are objectionable under the decision in Gartside v Commissioners of Inland Revenue [1968] AC 553. Indeed, as the judge pointed out, if there was anything in this point a means of totally defeating the plain object of section 102, Finance Act 1986 would have been opened up!

Retention of part ownership

A divergence in approach between the Special Commissioner and the judge appears to be the result of the Revenue's case being argued in a different way on appeal. An additional line of defence provided to the taxpayer under the original scheme was that she did not settle the whole of her beneficial interest in her home in 1988, but only 95 per cent of it.

This was no doubt in anticipation of being able to rely on the decisions of the courts in both Munro v Stamp Duties Commissioner [1934] AC 61 and Bull v Bull [1955] 1 QB 234. Under these authorities, a house held upon trust for sale under the Law of Property Act 1925 provided each and every co-owner an equal right to occupy the whole of it.

Similar schemes have been put in place in other cases with a view to avoiding liability under the employee accommodation benefit in kind provisions at sections 145 and 146, Taxes Act 1988 and also the offshore capital gains tax code at section 87, Taxation of Chargeable Gains Act 1992. Rather more than is immediately apparent will therefore be dependent on the outcome of this aspect of the case.

Had this point have been relevant, the Special Commissioner would have determined it in favour of the taxpayer, albeit by reference to a combination of Oakes v Stamp Duties Commissioner [1954] AC 57 and Ingram v Commissioners of Inland Revenue [1999] STC 37, rather than on consideration of the normal authorities. Her attention does not, however, appear to have been directed by the Revenue at that stage to two further points which Mr Justice Lightman held to be relevant. But first, it is necessary to consider the effect of Lord Hoffmann's speech in the Ingram case.

Prior division of title to an asset

It is of considerable importance to establish whether the principle in the Ingram case can apply where there is reservation of part ownership. Because of the terms in which Lord Hoffmann expressed himself, it is possible to take the view that any equitable division of the gifted property at the outset would suffice to get round the gifts with reservation problem. This could be of considerable importance in relation to some insurance-based products.

The Revenue has, however, never adopted that interpretation, both confining their countermeasures introduced by the Finance Act 1999 (sections 102A and 102B, Finance Act 1986) to transactions in land and having made known that they do not accept that Ingram style carve outs are of assistance to taxpayers who seek to carve out 'leases' of chattels. The Revenue's view of Lord Hoffmann's formulation is that it was confined to situations in which the general law permitted a division of the asset into separate legal interests, that is to land where a lease has, since 1925, been a discrete conveyancing interest from that of the freehold reversion.

One of the issues in the Eversden case was, therefore, whether it was also permissible to carve out an equitable beneficial interest in the same interest in land, one which since 1925 has been capable of existing only 'behind the curtain' of the legal title. Rather strangely this does not appear to have been addressed in terms before the Special Commissioner. It was, however, dismissed by the judge as 'hopeless'. The adverse implications for those who have attempted carve outs of chattels and, perhaps, investment portfolios, are therefore very clear for all to see.

Changing houses

Where the taxpayers ran into difficulty before Mr Justice Lightman, on the particular facts of the Eversden case, was in relation to a complication which was not addressed before the Special Commissioner. This was that a year after the death of the husband in 1992, the trustees of the house agreed (or at least so it had to be assumed) with the settlor to sell the house and invest in a smaller one for her to live in, she retaining the same five per cent beneficial interest in the replacement property. There were surplus funds arising from these transactions and these were invested in the purchase of a life assurance bond, but as the settlor made no withdrawals from the bond, nothing turned on this particular aspect.

The conclusion drawn by the judge from this state of affairs was that, under the agreement for the purchase of the replacement property, the trustees (of both the old property and the settlement) conferred on the settlor the right to occupy that property rent free for an indefinite period, even though she herself had a 5 per cent stake in it. It followed that, far from being excluded from benefit under section 102(1)(b), she enjoyed a new benefit to the exclusion of the beneficiaries under the settlement.

Interest in possession

An alternative point which was open to the Revenue to take, was that the settlor should be treated as if the trustees had exercised their discretion in favour of her being allowed occupation of the property as a beneficiary. As a result, by reason of Inland Revenue Statement of Practice SP10/79, the settlor should be deemed to have acquired an interest in possession in the 95 per cent interest held by the trustees.

In the light of Commissioners of Inland Revenue v Lloyds Private Banking Limited [1998] STC 559, a previous decision of Mr Justice Lightman, it may be thought surprising that this possibility was not raised in the Notice of Determination. Its absence may indicate a reluctance by the Revenue to expose that statement of practice to the judicial scrutiny which many practitioners believe it would not survive.

New trust law

Under the Trusts of Land and Appointment of Trustees Act 1996, the trust of land régime replaced that of the old trust for sale régime as from 1 January 1997. The settlor did not die until 1998, and so the new régime was in force at the date of her death, which was the time when the Special Commissioner has ruled that section 102(3), Finance Act 1986 fell to be brought into consideration. Mr Justice Lightman took the view that it was, therefore, also of relevance in the context of the settlor's continued occupation under the agreement made in 1993.

It is far from clear, however, whether, had there been no change in the identity of the property subject to the Bull v Bull régime, this would in itself have sufficed to overturn the Special Commissioner's conclusion of law on the co-ownership point. The change in the law was of general application and not within the contemplation of the parties at the time the replacement property was purchased.

Practitioners will, however, need to give careful consideration to the effect of the Trusts of Land and Appointment of Trustees Act 1996 on subsequent events in the context not only of section 102, Finance Act 1986 and section 49(1), Inheritance Tax Act 1984 (Interests in Possession), but also section 145, Taxes Act 1988 and section 87, Taxation of Chargeable Gains Act 1992.

The critical point at issue was whether the settlor acquired, on 1 January 1997, a right of occupation in the whole property by virtue of section 12(1)(a) or (b) of the 1996 Act. The provisions at section 12(1) give an entitlement to a beneficiary with an interest in possession to occupy land held in trust if either, (a) the purpose of the trust includes making the land available for his occupation, or for occupation of beneficiaries of a class of which he is a member, or (b) the land is held by the trustees so as to be so available. The conclusion drawn by Mr Justice Lightman was that section 12(1) did operate to give the settlor an entitlement to occupy the land.

In cases where the possible application of section 12(1) has to be considered, one has to divine the 'purposes' of the trust instrument relating to the statutory trusts of the property. As the judge indicated, there may be circumstances in which this is not easy to ascertain from the relevant documentation. Fortunately, in this case there was no question of more than one individual being entitled prospectively to occupation, so that the provisions of section 13(7) of the Act, which preserves the rights of those in situ, did not complicate the situation. In different circumstances, this provision may create additional problems.

It is only beneficiaries who are entitled to share occupation who can be given income compensation in lieu under section 13(6). The existence, or otherwise, of such a right may have valuation consequences, but no cases have yet come before the Lands Tribunal. It is also conceivable that, even though Parliament did not envisage that the legislation would have fiscal consequences, this may be regarded at some future date as material to the construction of section 49(1), Inheritance Tax 1984.

Success for the taxpayer

Notwithstanding all these various issues, Mr Justice Lightman held 'after anxious consideration' that any initial interest in possession given to a spouse under a settlement, however short, precludes the operation of the gift with reservation provisions in respect of that settlement. This confirms the existence of a major planning opportunity and it remains to be seen whether new countermeasures will ensue, possibly in next year's Finance Bill.

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