Income tax and pre-owned assets guidance section 4
Contents
4 HMRC's approach to certain issues
This section of the guidance looks at the HMRC's approach to certain practical issues regarding the pre-owned assets charge under this Schedule.
Examples of how we view particular situations
can be found in Appendix
1 to the guidance material.
4.1 Domicile/residence issues
Schedule 15 does not apply to a person who is not resident for Income Tax in the United Kingdom in the year of assessment. To be regarded as resident in the UK you must normally be physically present in the country at some time in the tax year. You will always be resident if you are here for 183 days or more in the tax year. If you are here for less than 183 days, you may still be regarded as resident for the year under other tests. If you consider that residency is an issue for you, and one that has not been previously agreed with HMRC, you may wish to consult leaflet IR20(PDF 640K), which discusses the position in more detail. The person's domicile in this case is immaterial.
A person's domicile becomes material if that person is resident for Income Tax purposes in the United Kingdom for any year of assessment. If the person is resident in, but domiciled outside, the United Kingdom, only relevant property situated in the United Kingdom will be subject to the charge. As the treatment of domicile for the charge is the same as that for Inheritance Tax, a person's domicile under section 267 Inheritance Tax Act 1984 as well as that under general law is relevant.
A person is deemed domiciled in the United Kingdom under this section if
- they were domiciled on or after 10 December 1974 in the United Kingdom and within the three years immediately preceding the relevant time, or
- they were resident for income tax purposes in the United Kingdom in not less than seventeen of the twenty years of assessment ending with the year of assessment in which the relevant time falls.
The relevant time for the purposes of the charge will be the first day of the year of assessment in question.
Paragraph 12(3) of the schedule provides that if any property situated outside the United Kingdom became comprised in a settlement when the person settling the property was domiciled outside the United Kingdom it will not be subject to the charge. Even if that person becomes domiciled in the United Kingdom at a later date this property will remain excluded from the charge.
Paragraph 12(3) provides that a charge under this Schedule shall not arise in relation to property regarded as excluded by virtue of section 48(3) IHTA'84. We do not regard this provision as having an impact on paragraph 11 in determining whether there is derived property in the taxpayer's estate, or GWR property in relation to him (see foreign domiciliary example in appendix).
If the person adds property, wherever situated, to the settlement after they became domiciled in the United Kingdom the additional property would be subject to the charge if it falls within the provisions of paragraphs 3, 6 or 8 of the schedule. If applicable the general exclusions and exemptions would still be available, as they would be for any United Kingdom situated property where the person is domiciled outside the United Kingdom.
4.2 Tracing and contributions
An absolute gift of cash is not subject to the inheritance tax reservation of benefit provisions unless the donor retains a benefit in the cash itself. For example, A, who is a partner in a business, withdraws capital from his capital account and gifts this to B, who then lends the partnership an equivalent cash sum. That sum is still on loan to the partnership when A dies. The cash sum is treated as a gift with reservation under section 102(3) Finance Act 1986. But the provisions in paragraph 2 Schedule 20 FA 1986 that enable the reservation of benefit provisions to apply to property that is substituted for the original gift do not apply where the original gift is of cash (para 2(2)(b)).
Thus, where an absolute gift of cash may later be used by the recipient to purchase property occupied or enjoyed by the donor for example, the application of the reservation of benefit rules to this property is precluded, unless the transaction can be shown to be a gift with reservation of benefit, by associated operations, of the purchased property.
These 'tracing' rules do not apply to the application of the income tax charge under this schedule. The arrangement referred to above would satisfy the contribution condition of paragraph 3(3) of this schedule if the contribution was made on or after 18 March 1986. The income tax charge would then apply unless the provision of consideration was an excluded transaction (paragraph 10(3)(2)) or it fell within one of the exemptions from the charge in paragraph 11. For the purposes of the latter paragraph and more particularly sub-paragraphs 11(5)(b), (c) and (d) the restriction on the tracing of cash gifts normally imposed for inheritance tax purposes does not apply when considering whether there is an exemption from the income tax charge (paragraph 11(8) Sch 15).
4.2.1 House sharing
Where people enter into an arrangement whereby they contribute to a shared property (land & buildings) owning venture and whereby they intend to and do in fact share the occupation of and the expenses arising from the occupation of the property broadly equally, it is not the intention of Sch 15 FA 2004 to levy an income tax charge on any part of that arrangement. Such circumstances are generally covered by section 102 B (4) FA 1986, which is made applicable to Sch15 by para.11(5)(c). However, if the situation is that the contribution made by each person is not commensurate with their respective enjoyment of the property and / or the expenses were shared unequally, the circumstances may fall to be scrutinised in the context of Sch 15 FA 2004. In such circumstances, a charge to income tax may well result.
4.3 Reasonable attribution
Paragraphs 3(2)(a)(ii) and 3(3) relating to land and 6(2)(a)(ii) and 6(3) relating to chattels apply where the chargeable person has either disposed of property and the proceeds of this disposal were used to acquire the relevant property, or where the chargeable person has contributed any of the consideration (directly or indirectly) to acquire the relevant property. Where these provisions apply it is necessary to calculate the proportion of the value of the relevant property that can be reasonably attributed to the property originally disposed of or to the consideration provided. How should this proportion be calculated?
Each case will turn on its own facts and the value of the land disposed of and its ultimate sale price, the consideration provided and the independent financial resources of the recipient will all have to be taken into account when making a reasoned judgement as to the value reasonably attributable.
For example, the disposal condition in paragraph 3(2)(a)(ii) would be met if the chargeable person transferred land to another ("X"), who later sold the land and used the proceeds to purchase a second property which the chargeable person occupies. If the land was valued at £100,000 at the date of transfer, sold for £300,000 and the new property purchased for £150,000, we would consider it reasonable to treat the whole value of the new property to be attributable to the property originally disposed of. If the value of the new property exceeds the proceeds received from the sale of the original property the proportion of the value reasonably attributable to the original property will be reduced. The value reasonably attributable to the new property cannot exceed the final value of the property originally disposed of.
If in the above example X used the sale proceeds to buy another property (Blackacre) which the chargeable person did not occupy but also used his own resources to buy a house (Whiteacre) which the chargeable person did occupy then we will not treat the value of Whiteacre as attributable to the property originally disposed of unless X had borrowed on the security of Blackacre.
If X purchases Whiteacre for £200,000 and half the purchase price (say £100,000) comes from the sale proceeds of the original land given to him and half comes from his own resources we would argue that half the value of Whiteacre was attributable to the property originally disposed of. Note that the reasonable attribution is not limited to the £100,000 originally put into Whiteacre but is half the value of Whiteacre at the relevant valuation date.
4.4 Full or part consideration
If the chargeable person's occupation of the relevant land, or enjoyment of the relevant chattel, is for full consideration in money or money's worth, i.e. a full market rent is paid by them for their continued occupation/enjoyment, their occupation/enjoyment is not a reservation of benefit for inheritance tax purposes (para 6(1)(a) Sch 20 Finance Act 1986). This treatment is extended to the income tax charge under this schedule by virtue of paragraph 11(5)(d). Any arrangement or transaction entered into on or after 18 March 1986 where the chargeable person pays full consideration for their enjoyment or occupation of the relevant asset will not be subject to the income tax charge.
If the consideration paid by the chargeable person is less than full consideration, or if they initially pay a full consideration but, over time, this falls below market rates, the asset in question will be treated as subject to a reservation of benefit from the date the chargeable person ceased to pay full consideration. There will be no income tax charge under this schedule provided that the provisions of paragraph 11(5)(a) apply.
4.5 Sales at undervalue
The application of paragraph 4(4) in respect of land to which the disposal conditions of paragraph 3(2) applies by virtue of a 'non-exempt sale' is restricted to sales of the whole interest in the property. If there is a sale of part only of the chargeable person's interest in the relevant land, no account can be taken of the consideration actually paid by the purchaser. (for an example see 2.1 above)
As the consideration must be paid in sterling or another currency this sub-paragraph will not apply if the consideration took another form, i.e. if one item of land was exchanged for another. Example: X exchanges his house valued at £800,000, for Y's property valued at £200,000 (Y's property in this example could be taken to mean land, a business, a right, in fact any property other than cash). X continues to live in his former property. Under the provisions of paragraph 4(4) the value of Y's property is not regarded as consideration to be taken into account, and X will be subject to a POA charge on £200,000. On X's death there will be a GWR in respect of a ¾ share of his former property, and his estate for IHT purposes will include the £200,000 from Y.
4.6 Occupation/Possession
Land
Paragraph 3 of the schedule applies where the chargeable person occupies any land that they had either both previously owned and disposed of, or contributed to its acquisition. In this context 'occupation' is construed quite widely. For example, the chargeable person would be regarded as in occupation not only if they were resident in the relevant property but also if they used it for storage or had sole possession of the means of access and used the property from time to time (see Appendix 1) . The chargeable person would not be regarded as occupying a property from which they receive rental payments from the person(s) actually in occupation.
If the person's occupation or use of the property is only very limited in its nature or duration it may not come within the provisions of paragraph 3. Each case will ultimately be decided on the facts and circumstances relating to it. However, in line with the HMRC's Interpretation of inheritance tax and gifts with reservation – RI 55 (November 1993) – some examples can be given of limited occupation that will not bring the chargeable person within paragraph 3. These include
- a house which is the owner's residence but where the chargeable person subsequently stays with the other person for less than one month each year or, in their absence, stays for not more than two weeks each year,
- social visits, excluding overnight stays by the chargeable person as a guest of the owner. The extent of the social visits should be no greater than the visits that may be otherwise be expected if the chargeable person had never previously owned the property, or made a contribution to its acquisition,
- a temporary stay for some short term purpose, for example, while the chargeable person convalesces after medical treatment, or they look after the owner while they are convalescing, or while the chargeable person's own home is being redecorated,
- visits to a house for domestic reasons, for example baby-sitting by the chargeable person for the owner's children,
- a house together with a library of books which the chargeable person visits less than five times in any year to consult or borrow a book,
- land which the chargeable person uses to walk their dogs or for horse riding provided this does not restrict the owner's use of the land.
More significant use of the property may bring the chargeable person within the scope of paragraph 3. Examples are
- a house in which the chargeable person stays most weekends or for more than a month each year,
- a second home or holiday home which the chargeable person and the owner both then use on an occasional basis,
- a house with a library in which the chargeable person continues to keep their own books, or which they use on a regular basis, for example because it is necessary for their work.
Chattels
Similar considerations apply to the possession or use of previously owned chattels when the application of paragraph 6 is contemplated. Very limited or occasional use of the chattel in question will not incur an income tax charge under this schedule.
For example, a car used to give occasional lifts (i.e. less than three times a month) to the chargeable person will not be liable to the charge. But if the chargeable person is taken to work every day in the car it is likely an income tax charge will be incurred.
4.7 "Substantially less"
Where any relevant property is included in the chargeable person's estate for inheritance tax purposes, or is subject to the inheritance tax reservation of benefit provisions, the value of that property is exempt from the charge (see 1.3.2). If other property that derives its value from the relevant property is included in the estate or is subject to a reservation of benefit the charge will not apply either. However, if the value of that derived property that can be reasonably attributed to the relevant property is "substantially less" than the value of the relevant property, only that proportion of the value of the relevant property that can be reasonably said to be included in the estate is exempted from the charge.
The term "substantially less" is not defined by the legislation but by analogy with the Capital Gains Tax taper relief rules we would regard a reduction of value of less than 20% as not substantially less for the purposes of this Schedule. If the circumstances of a particular case suggest that the "substantially less" provision should be triggered by a reduction of more or less than 20%, it will be judged on its individual merits.
Where the value of the property in the estate is substantially less than the value of the relevant property the appropriate rental value of any land, and the appropriate chargeable amounts relating to chattels or intangible property, for the purposes of this Schedule will be reduced by a reasonable proportion to take into account the property in the estate.
4.8 Double charges
The regulations relating to the income tax charge (SI 2005 No. 724) include provisions to avoid a double charge to inheritance tax where the chargeable person elects that the gift with reservation provisions apply to the relevant property. A double charge may arise where the chargeable person makes a gift of property that is a potentially exempt transfer for inheritance tax. If that property is then liable to the income tax charge they may decide to make an election that the property is subject to the inheritance tax reservation of benefit provisions. If they then die within 7 years of the original gift a double charge to inheritance tax will arise – firstly on the original transfer that must now be aggregated with the death estate and secondly on the property subject to the reservation.
The provisions to avoid double charges effectively retain the charge on the transfer that produces the higher overall amount of inheritance tax and reduce the other transfer to nil. The application of these provisions may best be illustrated using an example.
Mr G entered into a lifetime loan scheme (or double trust scheme as it may be known) in June 2003. He sold his house to a trust fund of which he is the life tenant for £500,000. The trustees do not pay the purchase price but give Mr G an IOU instead. Mr G then makes a gift of the IOU (the outstanding purchase price) to a second trust for the benefit of his children. He remains in occupation of the property and, as the outstanding debt reduces the value of the house for inheritance tax purposes to nil (see 1.5.2 and 'excluded liability'), he is liable to the income tax charge from 6 April 2005. To avoid paying the charge he makes an election under paragraph 21 of Schedule 15 that the house is subject to the gift with reservation provisions. Mr G dies in July 2007 and the house is valued at £750,000 at that date.
As the death occurred less than 7 years after the original gift of the IOU it must be aggregated with Mr G's estate when calculating the inheritance tax liability. But the house is also chargeable on the death as a gift with reservation following the election. A double charge to inheritance tax would arise but for the double charges provisions which apply in this instance, as the gifted property (the IOU) represents the proceeds of the disposal of the relevant property (the house). The two potential charges should be considered in isolation. In these examples Mr G's estate is valued at £500,000 and the inheritance tax threshold at the time of writing of £285,000 is used.
Gift now
taxable |
£500,000 | |
|---|---|---|
Estate |
£500,000 | |
Aggregate
chargeable transfer |
£1,000,000 | |
Taxable gift |
£500,000 | |
Less nil-rate
band |
-£285,000 | |
Excess |
£215,000 | |
Tax @ 40% |
£86,000 | |
Taper relief
due @ 40% |
(£34,400) | |
Tax payable |
£51,600 | |
Taxable estate |
£500,000 | |
Nil-rate
band used against gift |
£0 | |
Tax @ 40% |
£200,000 | |
Total inheritance
tax payable |
£251,600 | |
| Charge to
tax using gift with reservation |
||
Estate |
£500,000 | |
Gift with
reservation |
£750,000 | |
Aggregate
chargeable transfer |
£1,250,000 | |
Less nil-rate
band |
-£285,000 | |
Excess |
£965,000 | |
Total inheritance
tax payable @ 40% |
£386,000 | |
(apportioned
between estate and gift with reservation) |
||
In this scenario the charge to tax using the gift with reservation will be used and the charge using the original gift will be reduced to nil by the double charges provisions and disregarded.
Further regulations were made SI 2005 No.3441 to deal with the double charges that may arise where the taxpayer decides to dismantle a "double trust scheme" and return to the position they were in prior to that arrangement.
Example:
Mrs X sells her house to a trust in which she has an interest in possession in exchange for an IOU from the trustees, which she then gifts to a second trust for the benefit of her children. The gift of the IOU is a potentially exempt transfer for IHT purposes and its value will be chargeable if the taxpayer dies within seven years of making it. The "double trust" arrangement is then dismantled e.g. by the cancellation of the IOU, so that the full value of the house will return to her estate and also be subject to IHT on her death. There is therefore the potential for a double charge.
Statutory Instrument 2005, No. 3441, therefore extended the previous regulations by introducing The Inheritance Tax (Double Charges) Regulations 2005, to provide relief from the double charge that would otherwise arise in the above example. As in the previous example, tax is calculated on the basis of the failed PET, and again with the house as an asset of the death estate. Inheritance Tax is then charged on whichever transfer produces the greater tax, and the other transfer is reduced to nil.
It should be noted that the double charges provisions will not always apply when a perceived double charge arises. In particular, if an election is made in respect of property subject to an 'Eversden' type arrangement with the result that the life tenant has made a potentially exempt transfer and the settlor's estate includes property subject to a reservation, both charges to tax are unaffected by the double charges provisions. The provisions only apply where there is a double charge in respect of the same individual.
4.9 Insurance policies
There may be certain instances where schemes involving insurance policies fall within the scope of paragraph 8 of the schedule. However, the majority of the more common schemes should not be affected. Examples of those that might be caught can be found in Appendix 1.
Where a charge to tax under this Schedule arises, paragraph 15 of this Schedule requires that the open market value of the policy at the relevant time should be used in establishing the chargeable amount determined under paragraph 9 (see 4.10 below).
4.10 Valuation
Paragraph 15 of this Schedule is taken from the wording of section 160 Inheritance Tax Act 1984. This provides that "Except as otherwise provided by this Schedule, the value of any property shall for the purposes of this Schedule be the price which the property might reasonably be expected to fetch if sold in the open market at that time; but that price shall not be assumed to be reduced on the ground that the whole property is to be placed on the market at one and the same time".
