7 - IHT: Tax Planning Flashcards
What is tax avoidance, aggressive tax avoidance, and tax evasion?
Tax avoidance: The efficient and lawful arrangement of a client’s affairs in a manner which minimises their liability to tax.
Aggressive tax avoidance: A form of tax avoidance where the taxpayer enters into complex or artificial arrangements which have the overall effect of reducing their tax liability. These schemes comply with legislation but often do not reflect the intention behind the law. It may involve exploiting loopholes or inadvertent gaps in drafting. Once HMRC become aware of a particular arrangement, ‘anti-avoidance’ legislation is often introduced to prevent further exploitation.
Tax evasion: Where a taxpayer withholds information about assets or income, or otherwise takes steps to avoid paying the tax they are liable for. This is unlawful.
What is the goal of IHT planning?
To reduce the overall IHT liability on a person’s estate. The goals of the client are often threefold:
- To minimise IHT (usually by reducing the size of their taxable estate in advance of death by making gifts or acquiring exempt assets)
- To retain sufficient assets to maintain financial security during their own lifetime
- To provide adequately for their family after their death
- This may be achieved by a person making transfers of property during their lifetime, or by dispositions in their will.
These goals often conflict. It is important to ascertain the priorities of the client and consider whether it is practical or possible for them to undertake certain tax planning measures and still maintain their own or their family’s financial security.
How can a solicitor comply with professional conduct obligations when advising on IHT planning?
When providing tax advice clients must be advised fully on the implications of taking certain steps. It is crucial to remember that:
- Actions taken to reduce IHT may result in a charge to capital gains tax (CGT) and / or result in a reduction in the client’s future income.
- Once gifts have been made to individuals, or into a trust, it is not usually possible to get the assets or cash back, unless the beneficiary consents. Any steps taken to reverse previous actions may themselves have further tax consequences.
- Anti-avoidance legislation may prevent the effectiveness of certain actions.
Provide an example of where an individual was not properly advised by a solicitor on IHT planning, re professional conduct issues.
Ten years before his death, X transferred a property to his niece, N, in an attempt to reduce Inheritance Tax (IHT). However, after gifting the property, X continued to live there rent-free until his death.
The gift was considered a Potentially Exempt Transfer (PET) and was not subject to IHT at the time. However, it was a disposal for Capital Gains Tax (CGT), meaning X may have had to pay CGT on the transfer.
X survived more than 7 years after the gift, which would typically exempt it from IHT. However, because X continued to live in the property rent-free, the gift became a Gift with Reservation of Benefit (GROB), meaning the property was treated as if it never left X’s estate. Its value at the time of death was included in his death estate, and no IHT saving was achieved due to anti-avoidance rules.
Normally, gains accrued on assets owned at the time of death are disregarded for CGT purposes. However, since X was not the legal owner at death, this benefit was lost. The increase in the property’s value over the 10 years since the gift is chargeable to CGT in N’s hands.
X was not properly advised.
How do exemptions and reliefs benefit a taxpayer?
If a transfer of value is made during a person’s lifetime this will be either a PET (which might fail) or an LCT. There are IHT consequences for both:
- A failed PET or LCT can give rise to an IHT charge in its own right. Provisions which exempt or reduce the chargeable value of the transfer result in a smaller tax bill.
- Even if the value of a PET/LCT is not high enough to trigger its own IHT charge, where the donor dies within 7 years following the transfer, the chargeable value of the transfer will ‘use up’ the NRB available for the death estate. As a result, a greater proportion of the death estate will be taxed at 40%. Steps which reduce the chargeable value of lifetime transfers leave a larger NRB and so help reduce the IHT liability on the death estate.
Which statutory exemptions and relief are available for lifetime transfers only?
Annual exemption
Family maintenance exemption
Small gifts exemption
Marriage exemption
Normal expenditure out of income exemption
Which statutory exemptions and reliefs are available for lifetime and death transfers?
Spouse exemption
Charity exemption
APR
BPR
What is the Annual Exemption and how should clients be advised to use this when IHT planning?
The Annual Exemption (‘AE’) allows individuals to make gifts of up to £3,000 each tax year free from IHT.
Any amount unused from the previous year can also be claimed to the extent it is needed.
The annual exemption is useful because without it a person is making a PET, and if they die within 7 years the gift would use up part of the nil rate band.
Clients should be advised to
- Use the AE each year to make gifts without IHT consequences, even if the client cannot give away a large amount in one go
- Appreciate that consistent giving over a number of years can enable a significant amount of money to be given away
- The AE should be used after any other available exemption or relief is applied to ensure the AE is available for later transfers.
What is the family maintenance exemption and how should clients be advised to use this when IHT planning?
This relief applies to transfer of value for the purpose of education (of the donor’s children) or maintaining dependent family members
This relief is often overlooked but, with increased education and nursing care costs, it can be very useful where applicable.
There is no upper limit to the amount that can be given away.
Clients:
- Ask the client questions to identify whether the relief applies - many high net worth clients look after elderly relatives, so you should make it clear that gifts made in this regard will be free of IHT if reasonable in the circumstances.
- If the donee is elderly and already has assets that exceed the NRB, it would be inappropriate (from an IHT perspective) to increase their estate further.
- Here, instead of claiming the relief, it may be preferable to put in place a loan arrangement, so sums received from the younger relative do not fall within the elderly relative’s estate when they die.
What is the small gifts exemption and is it useful for clients when IHT planning?
Small gifts (of up to £250 per recipient) can be made free from tax
Cannot be used with AE
Client:
- This exemption is useful where a client has a number of potential beneficiaries e.g. they have a large family and want to make gifts to a number of different children/grandchildren.
- Clients can make yearly transfers of £250 to an unlimited number of different people. The exemption is often used for Christmas or birthday presents.
What is the marriage exemption and is it useful for clients when IHT planning?
£5,000, £2,500 or £1,000 may be given tax free as a wedding gift
The amount of the relief depends on the relationship with the donee
Can be used with the AE
This exemption is not useful to all clients:
- However, when finding out about a client’s family it would be pertinent to ask about any planned marriages and, if appropriate, explain there is an opportunity to undertake tax planning / make exempt gifts that would not otherwise be possible.
What is the normal expenditure out of income exemption and how can clients use this when IHT planning?
Regular payments of spare income which do not affect the donor’s standard of living are exempt.
There is no upper limit to this exemption.
Client:
- This exemption is most useful for clients who have a large income where a significant amount is unused each month.
- It may not be appropriate for elderly clients, who are often ‘asset rich cash poor’ (have a relatively low income but have accrued or inherited potentially high value capital assets).
- For HMRC to accept a claim for this relief proof of payments will be needed. Clients should be advised to keep a log of all of the payments they make, and this can be submitted along with the death estate information where required.
- If a taxpayer pays the monthly premiums on a life policy written into trust for another person, these payments would ordinarily be treated as PETs (in favour of the beneficiary who will ultimately inherit the lump sum following death).
- However, the normal expenditure from income exemption can be claimed so these payments are instead exempt / not treated as PETs.
What is the spouse exemption and how can clients use this when IHT planning?
All transfers between spouses/civil partners are fully exempt
Where the donor is UK domiciled there is no limit to the amount that can be claimed
Clients:
It is usually beneficial for both parties to a marriage to have assets of their own so they can each carry out tax planning. Together a couple can make more exempt transfers than if one party were to hold all/most of the assets. An exempt transfer, from the richer spouse to the poorer, can be made to enable the poorer spouse to utilise exemptions.
Despite tax benefits, some clients will not wish to do this. There may be many reasons, but it is not uncommon for one person to be in control of financial affairs and not trust the other to preserve the family assets. Here, tax planning does not tie in with the client’s other goals.
The availability of spouse exemption for IHT may also provide an opportunity for CGT planning.
For CGT purposes, assets can be transferred from one spouse to another as a “no gain and no loss” transfer (the donor is treated making a disposal for an amount which results in neither a gain nor a loss).
The CGT relating to gains accrued by the donor prior to the transfer are deferred until the donee spouse disposes of the asset later (s 58 Taxation of Chargeable Gains Act 1992).
Example:
A and B are married. A uses up their CGT tax free allowance for the tax year. B has not used any of their tax free allowance. A now wants to sell an asset but the sale will result in A making a taxable gain. Instead of selling the asset, A gives the asset to B.
The gift is exempt from IHT because of spouse exemption and treated as a “no-gain no-loss” transfer by A (so no CGT is payable by A). B can then sell the asset and make use of their own CGT tax free allowance, which may otherwise be wasted, to minimise the CGT due on A’s gain.
What is the charity exemption and how should clients be advised on this when IHT planning?
All transfers to charity are fully exempt
There is no limit to the amount that can be claimed
Clients should be advised that:
They can make tax free gifts to charity. However, very large gifts are only likely to be a valid option for wealthy clients who can afford adequately to provide for their family and also make charitable gifts, or clients without family to support.
Note that if a person leaves 10% or more of their net estate to charity when they die the reduced rate of 36% IHT rather than 40% may apply to the taxable portion of their estate. A client should be advised of the circumstances in which this might apply and, in some cases, will wish to make large charitable gifts by will rather than during their lifetime in order to benefit from this IHT saving.
What is business and agricultural property relief and how should clients be advised on this when IHT planning?
Transfers of qualifying business/agricultural assets are exempt up to either 100% or 50% provided the transferor has owned the assets for the minimum qualifying period
Client:
BPR and APR are useful if the client already has property that qualifies. Advice should be given to ensure that nothing is done to compromise this. Care should be taken with regards farmhouses where surrounding land is only partly used for agriculture.
Clients could choose to invest in assets that qualify for BPR / APR e.g. if there is potential for investment in a farming partnership, or, clients could purchase AIM (Alternative Investment Market) shares, which are ‘unquoted’ for the purposes of BPR. By ‘investing’ clients are not giving anything away but are turning non-exempt cash into exempt assets.
If giving assets away, it is more efficient to give items which qualify for BPR/APR to a non-exempt beneficiary or a trust than to their spouse, where SE applies in any event.
Which assets are not subject to IHT and how should clients be advised on this?
Discretionary pension lump sum payments and life insurance policies written in trust are excluded from the taxable estate.
Clients can be advised to take out life insurance and/or pay into a pension and write the benefit of these in trust. Where clients already have insurance or a pension in place, solicitors should advise on the terms of any lump sum payments to identify whether death benefits have been nominated for a third party. If not, clients should take steps to do so.
If a life policy is written in trust after it has been set up there is a deemed PET of the redemption value of the policy at that date (usually a small amount).
If a client pays the premiums on a life policy nominated for another the client is treated as making a PET of the annual premiums (although normal expenditure from income relief can usually be claimed to mitigate this).
What are transfers of value and how can they generally be used by clients when IHT planning?
Even if no reliefs or exemptions are available, it is worth a client considering making PETs or LCTs.
It should be obvious that if a client gives away a valuable asset or a large cash lump sum, the donor’s estate after the transfer is smaller and less IHT may be due on their death as a result.
Tax planning can involve looking at whether money or assets can be given away via PETs or LCTs without triggering IHT as a result of the transfer.
You should always make sure the client has sufficient capital to make the gift as it will be impossible to recover the money once the gift is made without the beneficiary’s consent.
How can PETs (transfer of value) be used by clients when IHT planning?
Potentially Exempt Transfers (PETs) allow clients to give away significant sums of money without an immediate charge to Inheritance Tax (IHT).
Key considerations include:
If the donor survives 7 years from the date of the PET, the transfer becomes fully exempt from IHT.
The risk is that the client cannot guarantee they will survive the 7-year period.
To mitigate this risk, clients can take out fixed-term life assurance to cover the IHT liability if they die within 7 years of the transfer.
- This insurance pays a lump sum, often equivalent to the IHT liability.
- The cost of the policy depends on the client’s life expectancy and may be lower if they are young and healthy.
- The policy proceeds can be written in trust to avoid being taxed themselves.
IHT is charged based on the chargeable value of the PET at the time it was made, not the date of death. Therefore, clients should consider gifting assets likely to increase in value.
PETs usually count as disposals for Capital Gains Tax (CGT) purposes, but cash is exempt from CGT, making it ideal for PETs.
How can LCTs (transfer of value) be used by clients when IHT planning?
An LCT is a gift into trust which is immediately chargeable to IHT
Whether any IHT is payable will depend on the available nil rate band
If the donor dies within 7 years of making the LCT, it is reassessed at the death rate
Client:
Provided an LCT is for an amount equal to or less than the NRB there is no IHT payable at that time, and if the settlor survives 7 years then no IHT will be due at all.
A trust can be useful where a client can afford to make a substantial gift but wants to benefit a group of people (often family members) rather than one particular person.
If a client is wealthy enough, they can make LCTs of up to the NRB amount every 7 years (some people view this as the NRB being ‘re-set’ every 7 years) and over time can move significant value into trust from their own personal taxable estate.
Provide a summary of lifetime tax planning.
Tax planning involves advising a client on the efficient and lawful arrangement of their affairs with a view to reducing their liability to IHT. This may involve a combination of advising about available exemptions and reliefs, writing certain death benefits into trust, and the careful use of PETs and LCTs.
The IHT consequences of dying in the 7 years following a chargeable transfer can be mitigated by the purchase of life insurance.
The timing of a transfer, so that it falls within one tax year or another, may form part of tax planning.
Steps that help reduce an IHT liability may have consequences for capital gains tax or income tax.
What is tax avoidance and how is it addressed by HMRC and UK Courts?
Definition: Tax avoidance involves “bending the rules of the tax system to gain a tax advantage that Parliament never intended”, according to HMRC. This often includes taxpayers using complex, artificial arrangements to obscure their true nature and influence the tax treatment.
HMRC’s Approach: Since the 1980s, HMRC has combated such schemes by applying a purposive interpretation to tax legislation, similar to the mischief rule of statutory interpretation. This approach focuses on the purpose behind the legislation and the transaction’s substance over form—known as the Ramsay Principle.
Supplementary Measures: While the Ramsay Principle remains valid, it has been reinforced by legislative reforms, including targeted and general anti-avoidance rules, to prevent aggressive tax avoidance. These rules are essential to understand when advising on inheritance tax in the context of wills and estates.
What is the distinction between tax avoidance/tax planning/ aggressive tax avoidance/ tax evasion?
Tax Avoidance / Tax Planning:
Refers to the efficient and lawful arrangement of a client’s financial affairs to minimise tax liability.
Aggressive Tax Avoidance:
Involves complex or artificial arrangements aimed at reducing tax liability, which may exploit loopholes or drafting gaps.
- Although compliant with legislation, such schemes often do not align with legislative intent.
- HMRC response: Anti-avoidance legislation is often introduced to close exploited loopholes once HMRC identifies the arrangement.
Tax Evasion:
An unlawful act where a taxpayer withholds information about assets or income or takes deliberate steps to evade tax liability.
What are the key anti-avoidance rules relevant to inheritance tax (IHT) and other tax liabilities?
The following anti-avoidance rules are important in relation to IHT and other tax liabilities:
Restriction on Deduction of Loans for IHT: Limits the use of loans to reduce IHT liability.
Gifts with Reservation of Benefit (GROB) Rules: Prevents IHT avoidance through gifts where the donor retains a benefit.
Pre-Owned Assets Charge (POAC): An income tax charge aimed at penalising IHT avoidance by taxing benefits retained from transferred assets.
General Anti-Abuse Rule (GAAR): A broad measure to counter abusive tax arrangements across all tax areas.
Disclosure of Tax Avoidance Schemes (DOTAs): Requires certain tax avoidance schemes to be disclosed to HMRC.
Note: It is essential to understand that avoiding one type of tax (e.g., IHT) may trigger liability for another (e.g., income tax under POAC). Specialist tax advice should be sought when unsure of potential implications.
What are the anti-avoidance rules restricting the deduction of loans for inheritance tax (IHT) purposes?
When calculating the chargeable value of a deceased’s estate for IHT, deductions for the deceased’s debts and financing costs for lifetime transfers are generally allowed.
However, anti-avoidance rules restrict these deductions in the following situations:
- Loans used to acquire, maintain, or enhance assets that qualify for Business Property Relief (BPR), Agricultural Relief, or Woodlands Relief.
- Loans that are not repaid from the estate.
- Loans used to acquire, maintain, or enhance excluded property, meaning property not subject to IHT.
- Loans funding a qualifying foreign currency account.
The first two restrictions are covered in more detail, while the others are less relevant here but are important in practice.
How are loans made to acquire assets that qualify for Business Property Relief (BPR) treated for inheritance tax (IHT) purposes?
When a loan is made to acquire, maintain, or enhance assets that qualify for BPR (or agricultural/woodlands relief), there are specific restrictions on how the loan is deducted for IHT purposes:
Deduction Requirement: The cost of the loan must first be set against the value of the qualifying assets, which reduces the value of the assets that attract relief.
Excess Loan Deduction: If the loan exceeds the value of the relievable assets, any remaining amount can be deducted from the chargeable estate’s value.
Illustrative Examples:
- Loan for BPR Assets: If the loan was used to acquire BPR-qualifying shares, the loan’s cost must be deducted from those shares, thus reducing the available relief.
- Loan for Non-BPR Purpose: If the loan was used for purposes like home improvements, the loan cost is not restricted to any specific asset. Consequently, BPR can be claimed on the entire value of qualifying shares, lowering the taxable estate’s value.
How do loans and Business Property Relief (BPR) affect the taxable estate when relievable property is included?
The impact of loans on the taxable estate can vary depending on the purpose of the loan and whether it is associated with relievable property:
Example 1: A man dies. His £700,000 estate includes:
· A house worth £400,000
· Shares worth £100,000 which qualify for BPR (at 100% relief)
· Cash of £200,000
The man’s funeral expenses are £5,000. He has an outstanding debt of £25,000 from a loan used to buy the shares.
- Deduct debts / expenses: Shares reduced to £75,000. £5,000 funeral expenses deducted. Estate = £670,000
- Apply reliefs: Deduct £75,000 (BPR)
- Taxable estate: £595,000
Example 2: A man dies. His £700,000 estate includes:
· A house worth £400,000
· Shares worth £100,000 which qualify for BPR (at 100% relief)
· Cash of £200,000
The man’s funeral expenses are £5,000. He has an outstanding debt of £25,000 from a loan used for home improvements.
- Deduct debts / expenses: Total debts £30,000. Estate = £670,000
- Apply reliefs: Deduct £100,000 (BPR)
- Taxable estate: £570,000
How do unpaid loans affect the taxable value of an estate for inheritance tax purposes?
Unpaid loans impact the taxable estate based on whether they are repaid from the estate:
General Rule: Loans are only deductible from the estate’s value at death if they are actually repaid from the estate. HMRC generally assumes commercial, arm’s length loans will be repaid.
Closer Scrutiny: HMRC examines debts more closely if they involve:
- Family members, related trusts, or companies
- Loans linked to tax avoidance arrangements
- Only deducted if actually repaid.
Example:
A woman lends £200,000 to her brother, who later dies, leaving:
- Estate: £600,000 house and £50,000 cash
- £5,000 funeral expenses
- If the debt is not enforced, it cannot be deducted, resulting in a taxable estate of £645,000.
- If repayable, it would reduce the taxable estate to £445,000.
How do the Gifts with Reservation of Benefit (GROB) rules prevent inheritance tax manipulation?
The Gifts with Reservation of Benefit (GROB) rules, introduced in the Finance Act 1986, aim to prevent inheritance tax (IHT) manipulation by addressing gifts where the donor retains a benefit:
- Purpose: To stop individuals from giving away assets to reduce IHT liability while still enjoying personal use or benefit from those assets.
- Effect: Property given away but retained for personal benefit by the donor is treated as part of the donor’s estate for IHT purposes.
This ensures the property is taxed upon the donor’s death, unlike genuine gifts, which are only taxed as failed Potentially Exempt Transfers (PETs) if the donor dies within 7 years of making the gift.
Under what conditions do the Gifts with Reservation of Benefit (GROB) rules apply to a lifetime gift?
The Gifts with Reservation of Benefit (GROB) rules, as set out in s 102 of the Finance Act 1986, apply to a lifetime gift in two situations:
- Condition 1: The donee does not take “bona fide possession” of the property at or before the start of the “relevant period.”
- Condition 2: During the “relevant period,” the property is not “enjoyed to the entire exclusion, or virtually to the entire exclusion, of the donor,” meaning the donor retains some benefit, whether by contract or otherwise.
Relevant Period:
- This is the seven-year period before the donor’s death (or a shorter period if the gift was made less than seven years before death).
- Importantly, it is not simply the seven years after the gift is made; a gift may fall under GROB rules even many years later if the donor reacquires an interest in the property. This provision prevents donors from bypassing the GROB rules by temporarily giving up an interest in the property.
What does “bona fide possession” mean in the context of Gifts with Reservation of Benefit (GROB) rules?
For a donee to have bona fide possession of a gifted property under GROB rules:
- Vested Interest: They must obtain a vested, beneficial interest in the property.
- Actual Enjoyment: They need to have actual enjoyment of the property, either through physical use (e.g., living in it) or by receiving income from it.
- Timing: Possession and enjoyment must begin at the start of the relevant period.
Example:
If a donor transfers a home but lives in it rent-free while the donee lives elsewhere, the donee does not have bona fide possession. In contrast, if the donor pays market rent to stay, the donee achieves actual enjoyment.
How is “exclusion of the donor” defined under the GROB rules?
Under GROB rules, the donor must be entirely or virtually excluded from benefiting from the property:
- Definition of “Virtually”: Though not statutorily defined, HMRC interprets “virtually” as “to all intents” or “as good as”.
- De minimis Benefits: Minor benefits, like occasional social visits or brief overnight stays, may be acceptable without violating exclusion.
- Trusts: If a gift is made into a trust and the donor is a potential beneficiary, a GROB arises regardless of whether the donor actually benefits. For discretionary trusts, including the donor as a beneficiary will trigger GROB.
What is the effect of reserving a benefit under the Gifts with Reservation of Benefit (GROB) rules?
The impact of reserving a benefit under GROB rules varies based on the duration of the benefit:
- Benefit at Death: If the GROB subsists at the donor’s death, the property is treated as part of the donor’s estate for IHT, valued at the donor’s date of death.
- Benefit Ceased Before Death: If the donor ceases to retain the benefit before death, it is treated as a PET from the date the reservation ended, taxable as a failed PET if the donor dies within seven years. However, this deemed PET doesn’t qualify for the Annual Exemption.
Note: Potential double taxation can arise if both the original gift and the GROB are chargeable, but relief is available to prevent this.
What are the Capital Gains Tax (CGT) consequences of a Gift with Reservation of Benefit (GROB)?
The CGT consequences of making a GROB are as follows:
Donee’s Ownership for CGT: The property becomes the donee’s for CGT purposes, with the donor potentially paying CGT on any gains since they acquired it.
CGT on Donee’s Sale: If the donee later sells the property, CGT is calculated on the increase in value from the gift date to sale, even if the donee had limited enjoyment until the GROB ceased or the donor died.
Gift at Death: If the gift is made at death, no CGT is payable on gains accrued during the donor’s life, and the donee inherits the property at its market value at death, benefiting from a CGT-free uplift. This “free CGT uplift” can incentivise holding off on valuable property gifts until death.
What are the implications of a Gift with Reservation of Benefit (GROB) that subsists at the donor’s death?
In this scenario, a man transfers legal title to his house worth £650,000 to his daughter while continuing to live in it until his death, resulting in a GROB, At the date of death the house is valued at £750,000:
Bona Fide Possession: The daughter does not have bona fide possession as the donor continues to occupy the property.
Taxable Value at Death: The house is included in the taxable value of the estate for Inheritance Tax (IHT) purposes at the date of death value of £750,000.
Capital Gains Tax (CGT): No CGT was payable on the initial gift since it was the donor’s main residence. The daughter’s acquisition cost for CGT is £650,000.
Gain Accrued: By the time of the man’s death, the daughter has accrued a gain of £100,000, despite not benefiting from the property.
CGT Uplift: Had the gift occurred upon the man’s death, the daughter would have inherited the property at the £750,000 value, benefiting from a CGT uplift and being able to sell it without CGT liabilities.
What are the implications when a Gift with Reservation of Benefit (GROB) ceases before the donor’s death?
In this case, a man transfers legal title to his house worth £650,000 at the date of gift to his daughter but continues living in it until he moves into a care home five years before his death. At this date, the house is worth £700,000. His daughter rents out the house and receives the rental income. The house is worth £750,000 at the man’s death.
This leads to the following:
GROB Status: Initially, a GROB exists as the donor retains enjoyment of the property. This status ceases when he moves out, allowing the daughter to benefit from rental income.
Failed PET: The transfer is treated as a failed Potentially Exempt Transfer (PET) valued at £700,000 at the time he moved out. No Annual Exemption (AE) is available for this transfer.
Acquisition Cost: The daughter’s acquisition cost remains £650,000, and she does not benefit from a CGT uplift.
Rental Income: Unlike the previous example, the daughter benefits from rental income after the GROB ceases, but this income is subject to income tax. At the time of the donor’s death, the property is worth £750,000.
What is the Pre-Owned Assets Charge (POAC) and how does it prevent exploitation of the GROB rules?
The Pre-Owned Assets Charge (POAC), introduced in the Finance Act 2004 (FA 2004), is an annual income tax charge imposed on individuals who give away certain types of property but later obtain benefits from that property.
Purpose: The POAC aims to prevent individuals from exploiting loopholes in the GROB rules that allow them to remove the value of their homes from their estates for Inheritance Tax (IHT) while continuing to live in them rent-free.
Application: The POAC does not apply to property that remains within the individual’s estate for IHT purposes. Therefore, property cannot be taxed under both the GROB rules and the POAC simultaneously.
Election: Individuals can elect for property to be taxed as a GROB instead of a POAC, depending on their personal circumstances and a comparison of their income tax and IHT positions.
Terminology: Although sometimes referred to as the ‘pre-owned assets tax’ (POAT), this term is not strictly accurate as it is not a separate tax.
In what circumstances does the Pre-Owned Assets Charge (POAC) apply, and what types of property does it cover?
The Pre-Owned Assets Charge (POAC), as set out in s 84 and Sch 15 of the Finance Act 2004, applies to three different types of property:
Land: The POAC can apply to any real property transferred away while the donor continues to derive a benefit from it.
Chattels: This includes movable personal property that may be given away but from which the donor retains benefits.
Intangible Property: Specifically refers to property held in a settlor-interested trust, meaning any property that is not classified as land or chattels. Examples include:
- Cash
- Bank account credits
- Shares
The rules governing each type of property are different, and specific circumstances can lead to a transaction being excluded from the POAC. Notably, other exemptions and reliefs exist to prevent individuals from being subject to both Inheritance Tax (IHT) and the POAC. There are also de minimis and territorial exemptions, which prevent the POAC from applying to individuals who are resident or domiciled outside the UK.
What are the conditions for land to be subject to the Pre-Owned Assets Charge (POAC), and how does this apply in practice?
For land to be subject to the Pre-Owned Assets Charge (POAC), two conditions must be satisfied:
Occupation Condition: An individual occupies the land (either individually or with others). This condition is broadly interpreted, and the assessment is based on the specific facts of each case, as there is no statutory definition of “occupation.”
Disposal or Contribution Condition: Either the individual has disposed of the occupied land or has contributed (directly or indirectly) towards its acquisition without obtaining a beneficial interest.
If the POAC applies, the benefit received through occupation is treated as income. The individual pays income tax on the equivalent of the market rent they would have had to pay for occupying the land.
Example: A woman lives in her solely-owned house with her adult daughter. On her daughter’s 40th birthday, the woman transfers legal ownership of the house to her daughter, but they continue living together. In this scenario, both the occupation and disposal conditions are met. The woman must pay the POAC based on the market rent for the property, although she could elect into the GROB regime instead.
What are the conditions for chattels to be subject to the Pre-Owned Assets Charge (POAC), and what is the tax implication?
For chattels to be subject to the Pre-Owned Assets Charge (POAC), the following conditions must be satisfied:
Possession or Use Condition: The individual must be in possession of or have use of the property. Similar to land, there is no statutory definition of “possession” or “use,” making it a matter of fact for HMRC to determine.
Contribution Condition: The individual must have contributed (directly or indirectly) to the acquisition of the chattel without obtaining a beneficial interest.
If the POAC applies to a chattel, income tax is calculated by taking the market value of the chattel and multiplying it by an official rate of interest.
Example: A man gifts shares to his sister, who immediately sells them and uses the proceeds to buy a car. The man then uses this car to commute to work daily. In this case, the possession condition is satisfied since the man has use of the car. The contribution condition is also met as the car was indirectly acquired using the gifted shares. Therefore, he must pay the POAC, calculated based on the official rate of interest on the car’s market value. This situation does not allow for electing into the GROB regime.
What are the conditions for the Pre-Owned Assets Charge (POAC) to apply to settlor-interested trusts, and how is the charge calculated?
For the Pre-Owned Assets Charge (POAC) to apply to settlor-interested trusts, the following two conditions must be satisfied:
Settlor-Interested Trust Requirement: The trust must be settlor-interested, meaning that the trust property is, will, or may become payable to or for the benefit of the settlor. Examples include discretionary trusts where the settlor is an object and trusts in which the settlor has a remainder interest.
Intangible Property Requirement: The trust property must include intangible property that was settled into the trust by the individual at its creation or subsequently added by them. This property includes the invested proceeds of the original settled property and must have been settled or added after 17 March 1986.
If the POAC applies, it is calculated by reference to the official interest rate that would be payable on the settled property, with credit for any income tax or CGT paid under other anti-avoidance rules.
