Meg Saksida outlines the current pre-owned asset tax rules and considers the future for these provisions.
The introduction of the gifts with reservation of benefit (GWR) legislation for inheritance tax (IHT) purposes lead to many elaborate tax avoidance schemes in an attempt to circumvent the rules. The ‘pre-owned asset tax’ (POAT) legislation was subsequently introduced to stop these.
In order to understand the POAT rules, it is essential to have at least a broad understanding of the GWR rules (FA 1986, ss 102-102C, Sch 20). These rules emerged out of a practice where individuals ‘gifted’ assets in order to remove them from their estate but kept benefits of the gifted asset themselves. The classic example was to gift the family home while continuing to live in it.
Closed loopholes
These loopholes were closed in 1986 with the introduction of the GWR legislation, and strengthened in 1999. The logic behind the introduction of this anti-avoidance legislation was that for IHT purposes, one cannot give an asset away ‘in theory’ whilst still keeping the rewards of the asset. The disposition needs to be genuine; you really and truly need to gift all the risks and rewards of ownership in order for the gift to be a successful transfer for IHT purposes and remove the asset from your estate. In other words, you can’t have your cake and eat it!
The GWR rules provide that if an asset was not genuinely gifted (i.e. both risks and rewards), the asset remained in the estate of the donor on their eventual death, even if this was more than seven years later. The legislation stated that the rules would apply if a donor ‘continued to derive benefit from the asset’. The GWR provisions bite irrespective of how ‘legal’ the transfer was. In the case of a property, the deeds may have been successfully changed, and the land registry may have been correctly informed of the change of ownership; but if the donor retained any benefit, the asset would remain in the chargeable death estate of the donor as if they had never given the asset away.
Being so penal, several avoidance schemes abounded post the introduction of the GWR legislation in order to avoid it. A popular example that allowed a parent to gift, but still live in, the family home involved the parent selling the family home and gifting the cash to their child. The child then used the cash to buy another family home and the parent then lived in the new family home. As the parent had not ‘continued to derive benefit from the gifted asset’, the GWR rules were generally not flaunted. They were deriving benefit from the new home, which had been bought with cash that was removed enough from the original home, and it could not be traced back to it under the GWR provisions.
The mechanics of the charge
It was this type of scheme that led to the introduction of the POAT regime (FA 2004, Sch 15). Interestingly, POAT is an income tax charge and not an IHT charge. It is imposed broadly where:
• the previous UK resident owner benefits directly or indirectly from an asset that he previously owned; and
• the transfer would not be caught by the GWR rules.
If the asset being gifted was cash, there are tracing provisions that enforce a charge on the cash value where:
• the donor has directly or indirectly provided consideration used to purchase land or other property, and
• the donor is able to benefit from the eventually purchased property.
This would be pro-rated if only a percentage of the total cost of the asset is provided by the donor.
The income tax charge differs according to the type of the asset. If the asset is land, the chargeable amount is the appropriate rental value of the land, which is the rent that the owner might expect from a letting at arm’s length. The value should be regularly reviewed. If the asset is a chattel (e.g. a painting, a boat, antiques or a vehicle), the annual income tax charge is the market value of the chattel when the donee is first liable to pay the POAT, multiplied by the HMRC official rate of interest (currently 2.5%). The value is updated every five years.
Any contributions that the donee makes for the use of the asset can reduce the taxable charge, but these contributions must be legally binding and made under an enforceable contract in order to count. For example, if the donee pays rent for a property, there must be a formal rental agreement (regularly updated) in place, in order for the rent to reduce the income tax charge. Note if the payments made exceed the charge, this cannot generate a loss.
Once the charge is calculated, as long as it exceeds £5,000 it will be added to the income for the individual and declared on their annual self-assessment tax return, where tax will be due at their own personal applicable rate. If the charge is £5,000 or less, there will be no POAT charge due.
Excluded transactions
Some transactions are excluded from POAT. Arm’s length transactions are one of these excluded transactions, as are gifts to spouses or civil partners.
If the gift is already covered by the IHT exemptions for ‘small gifts’, the annual exemption or gifts for the ‘maintenance of family’ these are also excluded from the POAT charge, even if the donor can directly or indirectly benefit.
Ignore the POAT?
There are some situations where an individual may wish to ignore the POAT charge and elect instead for the GWR provisions to bite.
For example, a younger person, having gifted and still retaining benefit from an asset they previously owned would be faced with a lifetime of income tax charges through the POAT regime. They may decide it is cheaper to keep the asset in their death estate under GWR rules.
If they do wish to elect, this must be done by 31 January following the tax year in which the individual becomes first liable to the POAT charge. Different decisions may be made for different assets, but one should always bear in mind that the POAT charge is firstly only taxable if it is over £5,000; and secondly, it usually works out to be less than 2% of the cost of the asset.
The future of POAT
In January 2018, The Chancellor of the Exchequer tasked The Office of Tax Simplification (OTS) to review inheritance tax (IHT), and they responded with a two-part critique. Part one was published in late 2018, and the second in July 2019. Angela Knight CBE (the Chairman of the OTS) said the current IHT rules are ‘both unpopular and complicated’, and the process ‘complex and old fashioned’.
In particular, when discussing POAT, the OTS stated that the rules are ‘not only complex and not widely known about’ but also not well understood. The recommendation in the document was that the government should review the current rules and their interaction with other IHT anti-avoidance legislation to decide whether they are still fit for purpose as they were originally intended and moreover whether they are still necessary at all.
Although there was nothing specific in the Conservative party manifesto relating to IHT, we must watch this space carefully and see what happens on 11 March 2020 in the next Budget.
Practical tip
If you retain benefit in an asset that you have given away, there will be a tax implication. It will either be subject to the GWR rules for IHT purposes or the POAT rules for income tax purposes. Times are changing though and changes to these provisions are likely. The two may be combined in the future under one separate, less complex set of provisions, or altered and refined. They will, however, probably still be around in some form; so the ability to have one’s cake and eat it is still not likely to be allowed.
