IR28 9 March 1999 INHERITANCE TAX: BLOCKING TAX AVOIDANCE Loopholes which result in the avoidance of inheritance tax are to be closed, the Chancellor announced today. The changes, which confirm the Government's determination to stamp out tax avoidance, relate to what is often referred to as making a 'gift with reservation'. This is when, for example, someone gives away his/her house but continues to live in the property. The changes restore the tax position as it was understood to be prior to the House of Lords' ruling in the case of Ingram v IRC. The new provisions will apply to gifts of interests in land where: - the gift is made on or after 9 March 1999; - there is some interest, right or arrangement which enables or entitles the donor to occupy the land to a significant degree or enjoy a significant right in relation to the land without paying full consideration; - the gift is made within seven years after the interest, right or arrangement concerned is granted, acquired or entered into. DETAILS 1. Legislation (Finance Act 1986, section 102 and Schedule 20) contains special rules on the taxation of lifetime gifts where the person making the gift (the donor) reserves or receives any material benefit from the gifted asset. They are intended to prevent the avoidance of the inheritance tax charge on death through a lifetime gift aimed at reducing the value of the donor's estate for the purposes of the tax, while leaving the donor effectively in much the same position in terms of his or her continued enjoyment of the asset concerned as it was before the gift. 2. The recent decision of the House of Lords in Ingram and another v IRC [1999] STC 37 has shown that these special rules do not work as they should. 3. The Government is extending the existing provisions so that they will work as originally intended. Subject to the exceptions explained below, the new provisions will apply to gifts made on or after today where: - the asset given away is an interest in land; - the donor or his/her spouse has a significant right or interest, or is a party to an arrangement, relating to the land; - by reason of the right, interest or arrangement, the donor is entitled or able to occupy any of the land, or enjoy some right in relation it. 4. The extended provisions will not apply where: - as with the existing rules - the gift is itself covered by the main exemptions from inheritance tax, including transfers between spouses; - the retained right or interest is negligible so that the donor is virtually entirely excluded from any enjoyment of the land; - the donor pays full consideration for his/her occupation of the land; or - the occupation of the land is effectively forced on the donor by some unforeseen downturn in his/her financial circumstances; - the gift is made more than seven years after the right, interest or arrangement concerned is created or entered into; - the donor may occupy the land or enjoy some right in relation to it only on the determination of the interest that he/she has given away; for example, the donor gives away a leasehold interest and retains the freehold reversion which entitles him/her to re-occupy the land when the lease expires; or - the gift is of a share in land, which the donor then occupies jointly with the other owner (the donee) providing the donor receives no other benefit at the donee's expense in connection with the gift. NOTES FOR EDITORS 1. Inheritance tax is generally charged on assets passing on a person's death, and on gifts made by the deceased within 7 years before death. Other lifetime gifts usually count as potentially exempt transfers (PETs) at the time when they are made, so they attract no immediate tax charge. A PET becomes exempt from inheritance tax once the donor survives for 7 years after the gift. 2. Finance Act 1986 (section 102 and Schedule 20) contains special rules on the taxation of lifetime gifts where the donor reserves or receives any material benefit in relation to the gifted asset. These 'gifts with reservation' (GWR) rules are intended to prevent the avoidance of the inheritance tax charge on death through PETs aimed at reducing the value of the donor's potential death estate, while leaving the donor's continued enjoyment of the asset concerned virtually as it was before the gift. These rules are very similar to those which applied under estate duty before its abolition in 1975. 3. The GWR rules apply to a gift if: - either the recipient of the gift (donee) does not take up genuine possession of the gifted asset, - or the asset is not enjoyed to the entire, or virtually to the entire, exclusion of the donor and of any direct or indirect benefit to the donor. 4. The rules cover the case where the donor is entitled or able to benefit from the gift (whether or not any benefit is actually taken), for example, the donor of a house reserves the right to reoccupy the property. They also apply to the case where the donor actually receives some benefit, for example, the donor remains in occupation of the house by some informal arrangement with the donee. 5. The GWR rules do not apply if: - any benefit to the donor is negligible from the donee's point of view; - the gift is of land or a chattel and the donor pays full consideration for his/her occupation or enjoyment of the asset; - the gift is of land which the donor is effectively forced to occupy due to unexpected hardship arising after the gift; or - the gift falls within any of the main inheritance tax exemptions (including transfers between spouses or to charity). 6. For the purposes of the inheritance tax charge on death, a gift to which the GWR rules apply is effectively treated as made at the time when the reserved benefit finally ceases. If the benefit continues until the donor's death, the gifted asset is taxed as part of the donor's estate on death, even though the gift might have been made more than 7 years before death. Where the benefit ceases during the donor's lifetime, he/she is treated as having made a PET at that time of an amount equal to the then value of the gifted asset. 7. The recent decision of the House of Lords in Ingram and another v IRC [1999] STC 37; [1999] 2 WLR 90] has shown that the existing GWR rules do not work, as intended, where land is divided into separate interests or assets and the donor retains the interest that he/she wants to keep while giving away the other interest to the donee. Lady Ingram, the donor, created and retained for herself a rent-free lease of her freehold house and land and then gave away the freehold property, subject to the lease, to the donee. The House of Lords held that the retained lease, which enabled the donor to continue to occupy the land and house rent-free until her death, did not amount to a reservation of benefit in relation to her gift of the freehold interest for the purposes of the GWR rules. 8. If no action were taken, the decision would jeopardise a large part of the tax base. As the decision essentially affects only gifts involving land, the changes to the GWR rules are limited to such gifts. However, the operation of these rules will be closely monitored and the Government will not hesitate to act to prevent any tax avoidance through other gifts. 9. The estimated yield from inheritance tax will be around #2,000 million in 1999-2000, including about #600 million relating to land and buildings. The changes will protect the Exchequer against the potential loss of a substantial part of the latter. INLAND REVENUE PRESS OFFICE Media enquiries to: 0171 438 6692/6706/7327 (Out of hours:0860 359544) Non-media enquiries to: 0171 438 6420/6425 (Office hours only) Inland Revenue information is on the Internet: www.inlandrevenue.gov.uk # = pounds sterling