Emma Chamberlain assesses inheritance tax planning. Emma Chamberlain is a Barrister at 5 Stone Buildings Lincoln’s Inn London WC2A 3XT. She specialises in private client tax and trust matters and writes and lectures widely. This article appeared in the December 2002 issue of Tax Adviser.KEY POINTS
- the implications of IR Commrs v Eversden with particular reference to the family home
- some of the advantages and disadvantages of such inheritance tax planning
- the main principles so far established in Eversden
- Court of Appeal, May 2003, may shed further light
You have several well-off married clients in their sixties. Typically the couples each own a house valued between £500,000-700,000 and have reasonable pension and investment income. They want to do some inheritance tax (IHT) planning now while they have a chance of surviving seven years, but the only asset they can easily give away is the family home. They have been reading in the newspapers about the Eversden case and ask whether it is now possible to give away the home, but continue living in it without reservation of benefit problems.
Before looking into this further you remind yourself of the main difficulties that can arise when giving away the family home:
- Avoiding reservation of benefit which makes the whole exercise totally ineffective for IHT purposes.
- Creating an unnecessary capital gains tax (CGT) charge through loss of the principal private residence (PPR) relief on the home. If the client no longer owns the house, it is going to be difficult to preserve the PPR exemption.
- Manufacturing a gain by creating a different type of chargeable asset.
- Creating an unnecessary income tax charge by payment of rent etc.
- Creating a structure which makes moving difficult later for the clients.
- Ensuring the structure does not jeopardise the client’s security and does not result in unforeseen IHT charges or matrimonial claims by the children.
With this in mind you read the case of Essex, Executors of Somerset Deceased and IR Commrs
(2002) STC (SCD) 39, a Special Commissioner’s decision which was then appealed. Judgment was given by Lightman J in IR Commrs v Eversden
(2002) STC 1109.
The facts of Eversden
Mrs Greenstock set up a trust in 1988 in favour of her husband for life remainder on discretionary trusts for a class of beneficiaries which included herself.
She transferred into that trust on interest in possession trusts for Mr Eversden a 95 per cent interest in her home - Beechwood Cottage - retaining five per cent personally. Nothing further was done. Husband and settlor occupied the property. Mr Greenstock died in 1992 and IHT was paid on the full value of the assets held in trust since he had an interest in possession in the whole. (Contrast this with the normal situation where there is no IHT payable until the last spouse’s death.)
On Mr Greenstock’s death, Mrs Greenstock decided to move and in due course the property was sold and a replacement property - 6 Barn Meadows - was purchased along with an investment bond. Meadows and the Bond were also owned as to five per cent by Mrs Greenstock personally and 95 per cent by the trust on discretionary trusts. Mrs Greenstock occupied the Meadows until her death, but received no benefit from the bond.
On the settlor’s death, the trust fund was worth £171,000 (the Meadows) and £149,213 (the bond). The Inland Revenue assessed her to IHT on the basis that having regards to Finance Act 1986 (FA 1986), s. 102 she had reserved a benefit in the trust property. She was among the class of beneficiaries and had occupied Meadows. Her executors appealed on the basis that she was excluded from benefit and in the alternative that the initial interest in possession given to the husband meant that s. 102(5)(a) operated to disapply s. 102 and the reservation of benefit provisions: the disposal of property by way of gift was an exempt transfer by virtue of Inheritance Tax Act 1984 (IHTA 1984), s. 18 (transfers between spouses).
So far, the executors have won at the Special Commissioners and at the High Court. The Revenue has appealed and the case is due to be heard in May 2003.
There are three important points that have so far emerged from the Eversden case.
(1) Being a discretionary object means a reservation of benefit
The Executors of Mrs Greenstock failed in their argument that despite Mrs Greenstock being a discretionary beneficiary she had not reserved a benefit. Lightman J held that given that Mrs Greenstock was a potential beneficiary within the class of beneficiaries, the fact that she may not have ever been the positive object of the trustees’ discretion was irrelevant. There was still a reservation of benefit. This confirms what was generally thought to have been the law. The mere possibility of adding the settlor as a beneficiary would also be considered by the Revenue as a reservation of benefit. Equally, if the spouse of the settlor is a member of the class of discretionary beneficiaries this will not generally cause IHT problems (unless, for example, there are reciprocal settlements) although of course it may raise income tax and CGT issues.
(2) No carve-out on replacement property
Lightman J also made certain comments referring to The Trusts of Land and Appointment of Trustees Act 1996 (TLA 1996) regarding entitlement to occupy the family home. Like the Special Commissioner he appeared to accept that in relation to the original property, Beechwood, the settlor’s occupation was attributable to her retained interest and therefore to this extent the ‘carve-out’ principle worked (and by implication then there was no reservation of benefit by virtue of her continued occupation per se although there was still a reservation of benefit under the first head above).
However, he felt that there was a change in respect of the replacement property, Meadows. While the occupation of Beechwood might be ‘referable to a specific proprietary interest retained’ along the lines set out in Ingram v I R Commrs  AC 293 his argument appears to have been that the settlor did not occupy the replacement property under the same carve-out principle, but rather by reason of a new agreement entered into between the settlor and the trustees. The settlor had no right to occupy the new property purchased merely because she had contributed to the purchase price. Having ‘regard to the real nature of the transactions and the beneficial interests concerned’, the settlor did not succeed in carving out a separate proprietary interest. Instead the settlor and trustees entered into a separate and new agreement to give her a right of occupation over Meadows, thus conferring a benefit on her. There was no carve out, but a ‘conferring’ of benefit by the trustees.
This reservation of benefit in itself would not matter given the protection of s. 102(5) (see next point below). However, Lightman J seems to go further:
‘Far from the settlor being excluded from benefit she thereafter enjoyed this benefit effectively to the exclusion from benefit of the beneficiaries under the Settlement.’
He did not explicitly state that she had an interest in possession in the whole which in effect would mean that the whole trust property would be taxed as part of her estate by virtue of IHTA 1984, s. 49 anyway and the question of reservation of benefit would be irrelevant. However, the Revenue now appears to take this view. The taxpayer is cross-appealing on this point.
The statements of Lightman J suggest that the position where nil rate band Will Discretionary Trusts are set up on the first spouse’s death with the deceased’s half-share in the house going into that trust will need to be reviewed with considerable care. The Revenue has sometimes queried these arrangements arguing that the surviving spouse has an interest in possession in the trust by virtue of her exclusive occupation. It may be less easy to refute this argument now given the comments of Lightman J and SP 10/79 (Power for trustees to allow a beneficiary to occupy a dwelling house).
(3) No reservation of benefit
Lightman J upheld the taxpayer’s contention that a disposal of property into an interest in possession trust for the spouse is treated as one exempt gift from settlor to spouse. It is not three separate gifts into trust, only one of which is exempt (the life interest) and the others (being the discretionary trusts and the ultimate default trusts) are not. (The multiple gifts idea was broadly the argument of the Revenue before the Special Commissioners.)
Lightman J agreed that since the whole value of the house gifted was attributable immediately after the transfer to the donee spouse’s estate, IHTA 1984, s. 18 must apply to exempt the gift. The fact that the gift is made into a trust for the spouse, to be held on successive interests, does not mean that the donor spouse makes more than one disposition. Nor should it matter if the transfer of value (i.e. the loss to the donor’s estate) is in fact greater than the value of the gift to the spouse (see Revenue Press Release of 15 April 1976). (This could occur in relation to gifts out of a controlling shareholding.) The exemption still extends to the whole value transferred.
The duration of the life interest of the spouse was also held by Lightman J: ‘after anxious consideration’ to be irrelevant and so the Revenue failed in its further argument raised in the High Court that the reservation of benefit arose at the point of of the life tenant spouse’s interest.
In effect then, the current state of the law is that the provisions of FA 1986, s. 102(5) apply so as to exclude the operation of the reservation of benefit provisions when there is an exempt gift of the house by one spouse into an interest in possession trust for the other spouse. The reservation of benefit exception for exempt transfers to spouses contained in s. 102(5) is equally applied to s. 102A and 102B in relation to land by virtue of s. 102C(2). The result is that although Mrs Greenstock reserved a benefit in the property she had given away (either because she was within the class of beneficiaries or had continued to live in the house) this did not matter because she had the protection of s. 102(5)(a). Clearly the principle is applicable not just to houses, but can apply to any asset in which the settlor wishes to retain some possible interest.
Implications for tax planning
How does this help us in relation to tax planning now? Suppose you have a married couple Mr and Mrs Savage and the family home is unmortgaged and owned in Mr Savage’s sole name. One simple option might be for Mr Savage to give away his interest in the family home into an interest in possession trust for his wife.
There is no stamp duty on the gift into trust and no CGT assuming the house has been their principal private residence at all material times. Mr and Mrs Savage should not be trustees of the trust.
The trustees may after a suitable interval consider exercising their powers so as to terminate Mrs Savage’s interest in possession in the trust in part. Instead, part of the trust fund could then be held on defeasible interest in possession trusts for the children. However, it would be sensible to ensure that the parents also have an interest in possession in at least a small part of the trust fund and that all interest in possession beneficiaries are given the right to live in the property. It is expressly stated that no such person is excluded from occupation.
You stress to Mr Savage that all the children’s interests are defeasible i.e. they can be ended by the trustees at any time. This gives some protection if one of the children divorces, although for this reason it is not advisable that the children are trustees.
The parents and the children and remoter issue and anyone else thought appropriate will be within the class of potential beneficiaries. A power to exclude beneficiaries (e.g for the divorcing child situation) might also be useful.
You explain to Mr and Mrs Savage that one problem is that there is a deemed potentially exempt transfer (PET) on the termination of Mrs Savage’s interest in possession. She will certainly need to survive for seven years and therefore a downside of the scheme is that if she dies in the next seven years IHT will be payable earlier than would otherwise have been the case. Normally there is only IHT payable on the last spouse’s death. You suggest that maybe decreasing term assurance should be taken out by the trustees on her life to cover this problem.
There should not be a reservation of benefit made by Mrs Savage on termination of her life interest so the home should not remain taxable in her estate. For the reservation of benefit provisions to apply, the disposition of property must be made by way of gift. Although on termination of her interest Mrs Savage has made a transfer of value, the value transferred being equal to the value of the settled property (IHTA 1984, s. 52(1)), that transfer is not a gift unless the wife consents to the termination of her interest. It would also be preferable that she is not a trustee. The wife has done nothing voluntarily at all - there is no element of bounty by the wife since she does nothing herself.
On future disposals of the house there should not be CGT. By letting the parents have an interest in possession in part only of the property, this should secure the PPR CGT exemption on the whole of the house held in trust if there is a later sale – see Taxation of Chargeable Gains Act 1992 (TCGA 1992), s. 225. Thus the trustees can sell the house and buy a replacement property without a tax charge.
There are, however, various difficulties even on the simplest type of Eversden scheme, particularly where the planning is in relation to the house. A few of these which you will need to point out to clients include:
(1)What trusts should arise on the determination of Mrs Savage’s interest, particularly in the light of Lightman J’s comments?
If there are discretionary trusts (generally only used when the value of the home is small) and the settlor and/or spouse are left in sole occupation, there is a risk that the Revenue will contend the spouse and settlor have interests in possession in the whole. The tax planning exercise is frustrated and the whole house is still subject to tax on their deaths. See also Woodhall v IR Commrs (2000) Sp C 261 and Faulkner v IR Commrs (2001) Sp C 278 for further comments in this area.
If all interest in possession beneficiaries including the children have a right to occupy the home and no beneficiary is excluded arguably they should each be treated as having an interest in possession in their percentage share, but the provisions of TLA 1996, s. 12 and 13 still need to be considered.
(2) How long should the initial interest in possession of Mrs Savage last?
Her interest in possession in the whole must endure for a reasonable length of time, see for example Hatton v IR Commrs  BTC 8,024and compare Fitzwilliam (Countess) v IR Commrs  BTC 8,003. The court might excise a short lived or illusory interest in possession and of course in those circumstances the spouse exemption would not be available.
One would want to avoid a situation where the trustees include the parents and the trustees must exercise their discretions (for example to terminate the interest in possession) independently.
(3) Reversal on appeal and legislation.
Eversden may be reversed when the appeal is heard next May. In that event any planning done now will have failed. In order to avoid the difficulty that Mrs Savage may then have made a PET for no good result, one might want to set up the trust now with an interest in possession in her favour, but the trustees do nothing further until the case is heard. At that point they review the position. Indeed, legislation may be introduced in Finance Act 2003 and announced in the November statement stopping the scheme although it is unlikely that such an announcement will be retrospective and therefore trusts already established may still be worthwhile.
(4) Death of child
If a child dies holding an interest in possession in the home, there would be IHT payable on his share even while the parents are alive. It may be possible to avoid such a charge e.g. if the child is married, but the position can be uncomfortable.
(5) Associated operations
There is of course the question of associated operations under IHTA 1984, s. 268 to consider. The operations (namely the gift into trust and the termination of the life interest) are surely associated, although they may not be relevant. Do the two operations together increase the transfer of value made by Mr Savage? Arguably not. It is just the first gift into trust which constitutes the transfer of value (albeit an exempt one). Alternatively under Finance Act 1986, Sch. 20, para. 6(1)(c) has the settlor obtained a benefit by virtue of any associated operations?
These issues will need to be considered carefully in the light of cases such as Macpherson v IR Commrs  AC 159 and compare more recently Reynaud v ICommrs (1999)Sp C 196 and Rysaffe Trustee Co Ltd v IR Commrs (2001) Sp C 290. The words in s. 268(3):
‘except to the extent that the transfer constituted by the earlier operations but not that made by all the operations together is exempt under section 18 above’
might suggest that even if the two operations are relevant and associated although there is no credit for the gift to the spouse it is not as such ignored.
Eversden could have a useful role to play in some clients’ IHT planning although it is not the easiest scheme to implement in relation to the family home. The usual health warnings must be given and in particular the possibility of the decision being reversed on appeal must be pointed out to clients.
Which earlier on in the judgment he stated it was always important to consider in relation to carve outs.
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December 2002 by