Mark McLaughlin looks at interests in possession and outlines their significance for inheritance tax purposes.
Many taxpayers are unfamiliar with the term ‘interest in possession’ (IIP). However, the existence of an IIP has various tax implications; this article focuses on inheritance tax (IHT) implications.
IIPs and IHT
The IHT treatment of an IIP mainly depends on whether it is ‘new’ (i.e., created from 22 March 2006) or ‘old’ (i.e., created before 22 March 2006). For example:
- An individual beneficiary of a ‘new’ IIP is not normally treated as owning the underlying asset. Thus, the value of the interest does not generally form part of the beneficiary’s estate (NB there are exceptions for ‘special’ IIPs, such as an ‘immediate post-death interest’, a ‘disabled person’s interest’, or a ‘transitional serial interest’; these are not considered here).
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The beneficiary of an ‘old’ IIP is generally treated as owning the underlying asset, so its value forms part of their estate.
Furthermore, the lifetime creation of a ‘new’ IIP for the beneficiary is normally treated as an immediately chargeable transfer by the settlor for IHT purposes. By contrast, the lifetime creation of an ‘old’ IIP was generally a potentially exempt transfer, which became exempt from IHT if the settlor survived at least seven years.
What is an IIP?
‘Interest in possession’ is not defined in the IHT legislation, but case law offers some guidance. For example, in Pearson and Ors v IRC [1981] AC 753, a House of Lords judge considered its ordinary and natural meaning to be a “present right of present enjoyment”.
Furthermore, in Statement of Practice 10/79, HM Revenue and Customs (HMRC) explains its position where wills (and trusts) contain a power to allow a beneficiary to occupy a dwelling house (tinyurl.com/HMRC-SP10-79), albeit HMRC’s guidance is not legally binding.
Word it carefully!
The wording of trust documents (including will trusts) can sometimes inadvertently result in an IIP. For example, in IRC v Lloyds Private Banking Ltd [1998] 2 FCR 41, a wife’s will left her share in the matrimonial home upon the following terms:
“While my husband remains alive and desires to reside in the property…my Trustee shall not make any objection to such residence and shall not disturb or restrict it in any way and shall not take any steps to enforce the trust for sale on which the property is held or to realise my share therein or to obtain any rent or profit from the property.”
The High Court considered that the wife’s will conferred on her husband an IIP in the half-share in the property, so it formed part of his estate.
By contrast, in Judge (PRs of Walden deceased) v RCC [2005] SpC 506, a husband’s will included the following provision about the matrimonial home he owned:
“And I declare my Trustees during the lifetime of my Wife to permit her to have the use and enjoyment of the said property for such period or periods as they shall in their absolute discretion think fit pending postponement of sale…” (emphasis added).
The Special Commissioner held that the wife did not have an IIP of the house, because her husband’s trustees had absolute discretion over whether to permit her to occupy the property.
Practical tip
Every case must be considered on its own merits. For a more recent case where no IIP was held to arise, see Trustees of the Carolina Raboni Estate v HMRC
