Gift With Reservation of Benefit
If the asset concerned is a property or holiday home, I am often asked if it would be a good plan to give it away during lifetime, but have an arrangement with the donee that continuing use could still be made of the property on an informal basis. If there is no lease or tenancy back to the donor, surely that would be an effective gift?
The answer is that the inheritance tax rules were amended as long ago as 1986 to make sure that any benefit of any sort which is received back by virtue of gift effectively makes the gift non effective for inheritance tax purposes. It does not matter that the benefit is freely given by the donee. Obviously therefore it is very important to avoid this trap which is known as the ‘gift with reservation of benefit’ rule.
Scenario One: Property Sharing
A straightforward exclusion from the reservation of benefit rule relates to property sharing arrangements. If a share in a property is given away to, say, members of the family and then both the donor and the donees all make use of the property on equal terms, there will be no gift with reservation of benefit. This can apply to a person’s main residence if, for example, it is a situation where a person is elderly and children come to live with a parent on a long term basis to help care for him or her. Equally, this rule can apply to a holiday home where all members of the family make use of the property from time to time.
Scenario Two: A Useful Loophole
Another exception from the gift with reservation of benefit rule relates to let properties. The legislation states that if a share in a let property is given away, this will in all cases be outside the reservation of benefit rule.
This is a most useful loophole!
What it means, in practice, is that a substantial interest in a let property, say a flat which is tenanted, can be transferred into a family trust in which the donor and other members of the family are all discretionary beneficiaries. The income can then continue to go to the donor/settlor but the share of the property held in the trust is outside his or her estate for inheritance tax purposes. However when the property is transferred into the trust, the gain to date over its base cost is realised for capital gains tax purposes and so there may be a capital gains tax liability.
Scenario Three: Main Residence
My third IHT opportunity relates to a person’s main residence. Subject to the specific circumstances of the case concerned, it is possible to give away a long lease over one’s home which is set to commence at around the time of the death of the donor, the lease being given away to one’s children. Whilst this may save a substantial amount of IHT, there are two significant downsides.
The first is that the continued occupation of the home by the donor is treated as a taxable benefit for income tax purposes under what is known as the ‘pre-owned asset’ rules. So the scheme creates income tax liability.
Second, the base cost of the reversionary lease in the hands of the donees will be very small and so what one effectively does is to convert the inheritance tax liability into a capital gains tax liability payable by the donees. In some circumstances, however, neither of these tax charges is any great problem.
Practical Tip
There are various exceptions and exclusions for very small benefits but property owners should take care as they can be playing with fire. Careful advice is necessary. All in all, there are ways of reducing IHT without simply giving everything away, but various complications will follow. Tax planning is not necessarily for those who want a simple life!
Malcolm Gunn
