EXPLANATORY NOTE

1. The clause introduces changes relating to the inheritance tax provisions on lifetime gifts where the person making the gift (‘donor’) reserves or receives any material benefit in relation to the gifted asset. This is often referred to as a ‘gift with reservation’. The recent decision in the case of Ingram v CIR has shown that existing rules on gifts with reservation do not work as intended.

2. For gifts of interests in land made on or after 9 March 1999, the gift will be treated as being a gift with reservation if there is some interest, right or arrangement which enables or entitles the donor to occupy the land concerned to a material degree without paying full consideration.

3. The changes will not apply to a gift where:

4. In addition, the gift of an undivided share in land, which the donor occupies jointly with the other owner (‘donee’) will not be a gift with reservation providing the donor receives no material benefit at the donee’s expense in connection with the gift.

5. The clause amends the existing provisions on gifts with reservation by inserting new sections 102A , 102B and 102C after section 102 of the Finance Act 1986 (‘FA 1986’).

6. New section 102A provides the main new rules on gifts with reservation where property given away is an interest in land.

Subsection (1) applies the new rules to gifts of interests in land made by individuals on or after 9 March 1999.

Subsection (2) treats the gifted interest as being property subject to a reservation, and applies the provisions in 102(3) and (4) to the gift, at any time in the relevant period when the donor or his/her spouse either has a significant right or interest, or is a party to a significant arrangement, relating to the land. The effect of the provision will be that, for the purposes of the inheritance tax charge on death, the gift will effectively be deferred until the reservation ceases. If the reservation continues until the donor’s death, the gifted interest will be treated as forming part of his/her death estate. If it ceases during the donor’s lifetime, there will be a deemed potentially exempt transfer of the interest at that time.

Subsection (3) effectively restricts the operation of subsection (2) to the case where the right, interest or arrangement concerned entitles or enables the donor to occupy any of the land, or enjoy some right in relation to it, without paying full consideration.

Subsection (4) prevents a right, interest or arrangement from being a reservation under subsection (2) in two situations. These are : first, where either the donor does not and cannot enjoy the land at all, or his/her entitlement or ability to enjoy it is negligible; and second, where the donor may occupy the land or enjoy some right in relation to it only when the gifted interest comes to an end. An example of the second situation will be a gift of a leasehold interest with the donor retaining the freehold reversion which entitles him/her to re-occupy the land when the lease expires.

Subsection (5) prevents a right or interest from being a reservation under subsection (2) if it is granted or acquired more than seven years before the date of the gift. For example, a lease created and retained by a donor will not be a reservation in relation to the gift of the freehold reversion made more than seven years after the creation of the lease.

Subsection (6) deals with the situation where a donor gives away two or more interests in land, whether or not the gifts are made simultaneously or to the same donee. It provides that the new rules in section 102A will apply separately to each gifted interest.

7. New section 102B provides new rules relating to gifts of undivided shares of interests in land.

Subsection (1) applies the new rules to a gift of an undivided share of an interest in land made by an individual on or after 9 March 1999.

Subsection (2) treats the gifted share as being property subject to a reservation, and applies section 102 (3) and (4) to the gift, at any time in the relevant period except when the conditions in subsection (3) or (4) of new section 102B are met.

Subsection (3) prevents the gifted share from being property subject to a reservation if the donor either

(a) does not occupy the land; or

(b) pays full consideration for occupying it to the exclusion of the donee.

Subsection (4) prevents the gifted share from being property subject to a reservation if the donor occupies the land jointly with the donee and he/she receives either no benefit, or only a negligible benefit, at the donee’s expense for any reason connected with the gift.

8. New section 102C makes supplementary provisions in relation to new sections 102A and 102B.

Subsection (1) defines the term "the relevant period" as having the same meaning as in section 102. It means the period which ends on the date of the donor’s death and which begins seven years before that date or, if it is later, on the date of the gift concerned.

Subsection (2) excludes a gift involving land from the rules in new sections 102A(2) and 102B(2) regarding reservation if, and to the extent that, the gift qualifies for any of the exemptions mentioned in section 102(5), including transfers between spouses or to charity.

Subsection (3) provides for the donor’s occupation of the land concerned, including occupation following an arrangement, to be disregarded for the purposes of new sections 102A and 102B in the circumstances set out in Paragraph 6(1)(b) Schedule 20 FA 1986. Broadly, these cover the case where, due to some unforeseen downturn in a donor’s circumstances after a gift of land made to a relative, the donee provides for the donor’s care and maintenance by allowing him/her to occupy the land.

Subsection (4) applies the supplementary rules in Schedule 20 FA 1986, except Paragraph 6, for the purposes of new sections 102A and 102B. It also caters for the case the gifted interest in land is later replaced with another interest in land. It applies the new provisions, following the replacement, to the subsequent interest in land as they would have applied to the original interest. The rules in Schedule 20 deal, among other things, with changes (including any disposal) affecting the gifted asset and the application of the relief for agricultural or business assets.

Subsection (5) caters for the case where the gifted interest in land is later replaced with an asset other than an interest in land. For example, the donee of a gift of a freehold reversionary interest in land sells that interest for its market value and invests the proceeds in some quoted investments. Under Paragraph 2 of Schedule 20 the investments are treated as the gifted asset, instead of the freehold reversion. In this situation any question whether the gift involves a reservation will, following the replacement, be determined according to existing rules in section 102 FA 1986.

Subsection (6) removes potential overlap between section 102 and new sections 102A and 102B. A gift to which new section 102B applies will not fall within either of the other sections. This will ensure that a gift of an undivided share of an interest in land cannot be charged to tax under new section 102B as well as under the other sections.

Subsection (7) removes potential overlap between section 102 and new section 102A. A gift to which section 102 applies will not be subject to the new provision.

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9. In general, Inheritance tax (IHT) is 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 IHT once the donor survives for 7 years after the gift.

10. The main IHT exemptions include gifts between married couples, and to qualifying charities and national institutions. Transfers of qualifying agricultural or business assets can qualify for relief if certain conditions are met; the rate of relief is usually 100 per cent though in some cases it may be 50 per cent.

11. 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 IHT 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.

12. For the purposes of the IHT charge on death, a gift subject to a reservation 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 treated as being 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.

13. The GWR rules apply to a gift if:

either the donee of the gift does not take up genuine possession of the gifted asset at or before the start of the ‘relevant period’,

or at any time in that period the asset is not enjoyed to the entire, or virtually to the entire, exclusion of the donor.

The ‘relevant period’ is the period ending on the donor’s death and starting 7 years before that date or, if it is later, on the date of the gift.

14. The GWR rules cover the case where the donor is entitled to benefit from a gift whether or not any benefit is actually taken. They also apply to the case where the donor actually receives some benefit, say under some informal arrangement with the donee.

15. These rules do not apply if:

any benefit to the donor is negligible from the donee’s point of view;

the gift falls within any of the main inheritance tax exemptions (including transfers between spouses or to charity);

the donor pays full consideration for his/her occupation or enjoyment of the gifted land or chattels; or

the gift is of land which the donor is effectively forced to occupy due to unexpected hardship arising after the gift;

16. There are supplementary provisions (in Schedule 20) on tracing of property for GWR purposes where the donee ceases to possess and enjoy any of the originally gifted property before the donor’s death or, if earlier, the date on which the property ceases to be subject to a reservation.

17. Broadly, if the original property (other than a cash amount) is later sold, exchanged or otherwise disposed of by the donee, the focus of the GWR provisions shifts from that property to any benefit or consideration received for the sale etc. A disposal for less than full market value, or on the donee’s death before the donor, is effectively disregarded. Where the original property becomes comprised in a settlement, the focus generally shifts to the assets in the settlement.

18. Also, there are adaptations to the rules on agricultural and business assets relief for deciding the availability (or otherwise) of relief where property disposed of by a gift was eligible for relief in the donor’s hand and the property is subject to a reservation under the GWR provisions.

19. The 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 following the gift, did not amount to a reservation of benefit in relation to her gift of the freehold interest for the purposes of the GWR rules.

21. Subject to this, the scope of the extended rules is broadly the same as that of the existing provisions. So, for example, the exemptions set out in paragraph 15 above apply. However, the new provisions do not apply if the entitlement or ability of a donor to occupy the land is by reason of some interest or right granted more than 7 years before the date of the gift concerned.