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Two's Company
RALPH RAY FTII, TEP, BSc (Econ), solicitor, consultant with Wilsons of Salisbury offers a tale of tax-efficient estate planning.
Two's Company
RALPH RAY FTII, TEP, BSc (Econ), solicitor, consultant with Wilsons of Salisbury offers a tale of tax-efficient estate planning.
VICTORIA IS A widow aged 62. Her daughter Louise, aged 40, was divorced in June 1999 and came back to live with her mother on an indefinite basis. Victoria owned her freehold home (5 Acacia Avenue, Fulham, London) under her late husband's will. Her advisers noted the tax planning possibility in this situation under section 102B, Finance Act 1986 whereby in essence, if a share in the home is given away, and the donor and donee together own and occupy the home and the donor receives no measurable benefit at the donor's expense, the gift with reservation rules do not apply. This statutory provision applies as from 9 March 1999 superseding Revenue practice as per Hansard statement of 10 June 1986, that practice being on somewhat less generous terms. Note the importance of such co-ownership and actual occupation by donor and donee. The arrangement would constitute a gift with reservation if Victoria gave the entire home to Louise yet continued to live there on a gratuitous basis.
Victoria and her accountant, Mr Bright, wish to reduce the inheritance tax on Victoria's death, but without jeopardising the capital gains tax position and taking into account that Louise may conceivably cease the joint occupation with Victoria, for example on a remarriage or living with a partner.
Mr Bright gave the following advice to Victoria in July 1999:
(1) When Victoria's husband died in 1995 leaving Victoria the home absolutely in his will, no inheritance tax was payable having regard to the inter-spouse exemption in section 18, Inheritance Tax Act 1984.
(2) If Victoria gives a share of the freehold home (say, 75 per cent) to Louise so that they then hold it as tenants in common and they co-occupy the home, this would constitute a potentially exempt transfer by Victoria, but viable having regard to her actuarial life expectation of some 26 years. This proposed 75 per cent could be transferred to Louise absolutely or by way of a life interest with remainders over. Had Victoria in fact only had a revocable life interest in the home, a similar plan could have been implemented and the termination of that life interest in, say, 75 per cent would also have constituted a potentially exempt transfer.
The risks under the seven-year survivorship period could be suitably insured in trust for, say, Louise. The title to the home would be held jointly as tenants in common as to, say, 25 per cent Victoria and 75 per cent Louise. Accordingly, Victoria and Louise will thereupon both occupy the home with ownership in the above ratios and section 102B(4) should apply. In particular, Victoria's continuing entitlement to occupy will not constitute a gift with reservation. The seven-year potentially exempt transfer period referred to will run from the date of the transfer/conveyance of the 75 per cent share to Louise.
This is subject to a vital point, namely that Louise must not pay more than her share in ownership of the various outgoings of the home, for example insurance, repairs, maintenance, council tax; otherwise a gift with reservation in favour of Victoria will thereupon arise. In practice, the best practical way of arranging the expenditure correctly is for a separate bank account to be fed by the donee and the donor in these proportions and used for the outgoings, etc. (In fact, if Victoria paid more than her share, there should be no gift with reservation problem: the mischief is if Louise pays more than her share.) The Inland Revenue has confirmed that the ownership of Victoria and Louise does not have to be on a 50:50 basis (see the Law Society's Gazette, 1 June 1988 at page 35).
(3) As to capital gains tax, if the house was sold or otherwise disposed of, there should be no capital gains tax having regard to section 222 or 225, Taxation of Chargeable Gains Act 1992 (principal private residence exemption). If Victoria dies possessed of her share, the capital gains tax death exemption will apply (see section 62, Taxation of Chargeable Gains Act 1992).
(4) Should Louise cease actual occupation in the future, it is recommended that prior to moving out, Louise as settlor should grant Victoria a life interest in Louise's share of the home which would revert to Louise on Victoria's death.
In that event, on Victoria's death the normal inheritance tax charge on the capital value of that life interest will not arise because of the revertor to settlor exemption in section 54, Inheritance Tax Act 1984 and assuming Louise survives Victoria (a risk that cound be insured). Moreover, as this life interest will come to an end on Victoria's death, no capital gains tax will arise (see section 72, Taxation of Chargeable Gains Act 1992). However, the usual market value uplift on a death will not apply if the property reverts to Louise absolutely. In order to achieve this capital gains tax uplift, the revertor to Louise as settlor should not be absolutely but as an interest in possession beneficiary with remainders over and power to advance capital to Louise, after a reasonable interval of time. In that case, the capital gains tax uplift should also be obtained (see section 73(1)(b), Taxation of Chargeable Gains Act 1992).
Mr Bright's co-ownership idea was duly implemented. In May 2002 Louise found the love of her life, Ernest, and in July 2002 moved out of 5 Acacia Avenue into Ernest's home on an assumed permanent basis. Accordingly, in June 2002 the plan outlined in (4) above was implemented.
