Income tax and pre-owned assets guidance section 5

Appendix 1

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Land – straightforward gift or sale of whole

As previously mentioned at 1.3.1 of this guidance, a disposal of property is an excluded transaction "if it was a disposal of his whole interest in property", coming within the provisions of paragraph 10. As this wording makes clear, "his whole interest" is precisely that, and can for example be a half share, or a quarter share of the whole land if that share is all that he owns.

In 2000 Mr A conveyed his house to his daughter Miss B. He continues to live there.

  • While Mr A remains in occupation the property is subject to a gift with reservation for inheritance tax, whether or not Miss B also lives there. . The income tax charge will not apply by virtue of paragraph 11(5)(a) of this schedule.
  • If Mr A pays a full market rent to Miss B for his occupation the property will not be subject to a reservation by virtue of paragraph 6(1)(a) Schedule 20 Finance Act 1986 and the income tax charge will not apply by virtue of paragraph 11(5)(d) of this schedule.
  • If the conveyance to Miss B was not a gift but a sale at full market value there will be no transfer of value for inheritance tax. The transaction is a disposal for the purposes of paragraph 3(2) of this schedule but it is an excluded transaction by virtue of paragraph 10(1)(a). An income tax charge will not arise under this schedule.
  • If Mr A had carved out a lease of his property for himself, and sold the freehold reversion to Miss B, that disposal will be an excluded transaction by virtue of paragraph 10(1)(a), provided that the sale was a transaction such as might be expected to be made at arms length between persons not connected with each other. If this provision has been met an income tax charge under this Schedule will not arise. The reversion is regarded as a distinct item of property, and the sale was of the entire interest in it. Mr A continued to occupy the house by virtue of his leasehold interest, which is a separate item of property. There is of course a "marriage" value for the two interests and a truly arms length transaction must take account of this along with any other factors.

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Land – straightforward gift or sale of part share

In 2001 Mr A conveyed his house into the joint names of himself and his daughter Miss B. He continues to live there.

  • If Miss B does not occupy the property the half-share gifted by Mr A is subject to a gift with reservation for inheritance tax. The income tax charge will not apply by virtue of paragraph 11(5)(a) of this schedule.
  • If Miss B does not occupy the property but Mr A pays Miss B a full market rent for his occupation of her half-share, the half-share will not be subject to a reservation by virtue of paragraph 6(1)(a) Schedule 20 Finance Act 1986 and the income tax charge will not apply by virtue of paragraph 11(5)(d) of this schedule.
  • If Miss B does occupy the property with Mr A and they share the running costs of the property in the same proportion, the half-share will not be subject to a reservation by virtue of section 102B(4) Finance Act 1986 and the income tax charge will not apply by virtue of paragraph 11(5)(c) of this schedule.
  • If the conveyance to Miss B was not a gift but a sale at full market value there will be no transfer of value for inheritance tax. The transaction is, though, a disposal for the purposes of paragraph 3(2) of this schedule. Furthermore, the transaction is not an excluded transaction under paragraph 10(1). However, the Regulations provide that, as the sale took place before 7 March 2005, the income tax charge under this schedule will not apply. If the sale had taken place on or after 7 March 2005 Mr A’s occupation of the half-share would be subject to an income tax charge if the appropriate rental value exceeds the de minimis limit in paragraph 13. There is a further exception that may apply if the sale was for a consideration not in the form of money or an asset readily convertible into money (see following examples).
  • If the sale of a part share had been to a commercial provider of equity release schemes the income tax charge will not apply. This is so whether or not such a sale takes place on or after 7 March 2005.

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Land – equitable interests

If Miss B acquired her interest in the property by way of an equitable arrangement rather than for cash – for example, she had given up work to care for Mr A on the understanding that she would receive a share of the property in return – the income tax charge will not apply. Regulation 5

In considering whether the conditions were satisfied, we would need information about how the essential elements of the transaction had been arrived at. We do recognise that there is a substantial body of case law dealing with the circumstances in which an interest in a house is acquired in consequence of a person acting to his detriment. The Ministerial Statement had these sorts of situations in mind and we would interpret Regulation 5 accordingly. In particular, we accept that the requirement that "the disposal was by a transaction such as might be expected to be made at arm’s length between persons not connected with each other" would be interpreted with such cases in mind. Where the parties had sought separate advice and acted upon it or had obtained a court order confirming the property entitlement, that would reinforce the claim that the conditions were satisfied. But we would not expect parties to such an arrangement to have done this. We recognise that detriment that the acquirer can demonstrate he has suffered can provide consideration for the acquisition of the interest and prevent the transaction from being gratuitous.

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Partnership interests

The treatment of a share of a partnership interest for Schedule 15 purposes follows that applied for IHT purposes. In other words, we do not regard the partnership interest as transparent, and the disposal of a share is unlikely to give rise to a Schedule 15 charge in any circumstances.

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Land – lease carve out (Ingram scheme)

Mr R transfers title to his property to a nominee who then grants Mr R a 20-year lease of the property at a peppercorn rent. The encumbered freehold reversion is then gifted to his son. Mr R continues to occupy the property.

If the transfer was effected on or after 9 March 1999 the property will be subject to a reservation of benefit for inheritance tax by virtue of section 102A Finance Act 1986. No charge to income tax will then arise under this schedule.

If the transfer was effected before 9 March 1999 the arrangement is not caught by section 102A Finance Act 1986 and will be subject to the income tax charge under paragraph 3(2) of this schedule. The value subject to the charge will be the value attributable to the property actually disposed of, calculated in accordance with the formula in paragraph 4(2).

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Chattels – lease carve out

The provisions of section 102A Finance Act 1986 only apply to interests in land. If the subject matter of the scheme referred to above is chattels rather than land, therefore, the provisions of this section do not bite. The property will not be subject to a reservation for inheritance tax regardless of when the scheme was actually effected.

It does, however, represent a disposal by the chargeable person who will be subject to an income tax charge under paragraph 6(2) of this schedule. The value subject to the charge will be the value attributable to the property actually disposed of, calculated in accordance with the formula in paragraph 7(2).

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Land – settlement on interest in possession trust (Eversden scheme)

Mrs T transfers 95% of her property to a settlement for the benefit of her husband for his life. On his death the property passes to a discretionary trust, of which she is one of the potential beneficiaries. She remains in occupation of the property.

If the transfer was effected on or after 20 June 2003 the property will be subject to a reservation of benefit by Mrs T for inheritance tax by virtue of section 102(5A) Finance Act 1986 and the income tax charge will not apply.

If the transfer was effected before 20 June 2003 the property will not be subject to a reservation of benefit. If the interest in possession of Mrs T’s husband continued until his death the property will not be subject to the income tax charge because, although the disposal condition in paragraph 3(2) is met, the transaction is an excluded transaction by virtue of paragraph 10(1)(c).

However if her husband’s interest in possession ended during his lifetime the transaction will not be excluded because of paragraph 10(3) and the property disposed of will be subject to the income tax charge. The value of the property will be determined by the formula in paragraph 4(2).

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Intangible property – Eversden scheme

Intangible property may also be settled on Eversden-type scheme, i.e. the chargeable person settles cash on interest in possession trusts for their spouse or civil partner, which the trustees then invest in a bond. If the terms of the settlement fall within the definition in paragraph 8 of this schedule similar results to the scheme involving land referred to above apply.

For example, if the spouse or civil partner’s interest in possession ends during their lifetime and the property is now held on discretionary trusts of which the settlor is one of the potential beneficiaries, the income tax charge will apply under paragraph 8 if the settlement was effected before 20 June 2003. The charge will be calculated with reference to paragraph 9 of this schedule.

It should be noted that the excluded transaction provisions have no application with regard to intangible property so paragraph 10(1)(c), which may have a bearing in respect of certain Eversden-type schemes involving land, has no relevance here.

If the settlement was effected on or after 20 June 2003 the property is subject to a reservation of benefit for inheritance tax by virtue of section 102(5A) Finance Act 1986 and the income tax charge will not apply.

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Land – reversionary lease scheme

A reversionary lease scheme, typically, is an arrangement where a donor grants a long lease of his property for say 999 years to the proposed donee, and the lease does not take effect until some future date. An example of this would be where Mr V, who has owned his house since 1990, grants a 999-year lease to his daughter in 1998 but not to take effect until 2018. Mr V continues to occupy the property.

Such schemes entered into before 9 March 1999 are not gifts with reservation of benefit so long as the lease contains no terms that are beneficial to the donor (see example below), and the income tax charge will apply.

For reversionary lease schemes entered into on or after 9 March 1999 HMRC had previously held the view that section 102A Finance Act 1986 would apply to them because the donor’s occupation would be a “significant right in relation to the land”. If that analysis were correct, the reservation of benefit rules would apply and there would be no income tax charge. However, HMRC now consider that where the freehold interest was acquired more than 7 years before the gift, the continued occupation by the donor would not be a significant right, and therefore, contrary to its previously held view, section 102A cannot apply to the gift because of section 102A(5). If the donor grants a reversionary lease within 7 years of acquiring the freehold interest, section 102A may apply to the gift depending on how the remaining provisions of that section apply in relation to the circumstances of the case.

Bear in mind, however, that, whenever the freehold interest was acquired, a gift may be a gift with reservation of benefit under section 102 Finance Act 1986 if the lease contains terms beneficial to the donor. An example of this may be where the lessee covenants to pay the costs of maintaining the property.

Where the GWR provisions do not apply it will nevertheless be regarded as a disposal of an interest in the relevant land under paragraph 3(2) of Schedule 15, and the charge to income tax will apply, calculated in accordance with the formula in paragraph 4(2), unless the donor elects into the reservation of benefit provisions.


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Land – death scheme involving a loan

Mr and Mrs S own a house in equal shares as tenants in common. Under the Will of Mr S, assets not exceeding the ‘nil-rate band’ for inheritance tax pass into a discretionary trust, of which Mrs S is one of the potential beneficiaries. The remainder of his estate passes to Mrs S. Following the death of Mr S in June 2005 his executors transferred his half share of the property to Mrs S and, in return, she executed a loan agreement equivalent to the value of the half-share. No inheritance tax is payable.

The income tax charge under this schedule will not apply here. As Mrs S did not own her husband’s share at the relevant time and did not dispose of it the disposal conditions in paragraph 3(2) do not apply. If she did not provide Mr S with any of the consideration given by him for the purchase of his half share the contribution condition in paragraph 3(3) will not apply either. Even if she had provided him with some or all of the consideration the condition will still not apply as it would have been an excluded transaction under paragraph 10(2)(a). In the final scenario, however, the debt would not be allowable for inheritance tax on the death of Mrs S by virtue of section 103 Finance Act 1986.

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Land – lifetime scheme involving a loan (double trust or home loan scheme)

There are a number of variants of this scheme – one of the more straightforward types is referred to in the Double Charges section of this guidance (see 4.8) – and the income tax charge under this Schedule will apply. (Guidance on whether the loan may be chargeable under the IHT reservation of benefit provisions is given at the end of this section).

As the chargeable person is usually still occupying the house as the life tenant of an interest in possession trust the exemption in paragraph 11(1) of this Schedule would appear to prevent the charge from applying. However, the value of the property in the estate will be reduced by the debt now owned by the trustees of the second trust in the scheme. For example if the house is valued at £500,000 and the debt is valued at £400,000, only the net value of £100,000 is chargeable to inheritance tax. In this scenario the concept of excluded liabilities will apply – paragraphs 11(6) and 11(7) of this Schedule (see 1.3.2). The exemption in paragraph 11(1) is restricted to the value of the relevant property that exceeds the amount of the excluded liability – in this example £100,000. The remaining part of the house will be subject to the charge – in this example four-fifths of the appropriate rental value.
If, in the above example, the debt is expressed as a percentage of the value of the house, the income tax charge would be payable on the same percentage of the rental value.

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Reservation of benefit in the loan – HMRC’s view.

The essence of many of these schemes involves the chargeable person(s) (the vendors) selling their home for full value to a newly formed trust (trust 1) with the sale proceeds left outstanding on loan. An IOU for the loan is gifted to a second trust (trust 2) for the benefit of the vendor’s family. The vendor(s) continue to occupy the property under the terms of trust 1, and the loan is repayable to trust 2 on demand. HMRC’s view on this is that since the loan was repayable on demand, there will be a GWR in respect of it, until such time as the trustees call in the loan. The reason for this is that if trust 2 had called in the loan, trust 1 would have been forced either to sell the home to repay the debt, or to seek finance from elsewhere. If the house were sold, then the vendor(s) would have been unable to occupy it under the terms of trust 1. In order to avoid the need for a sale, trust 1 would have had to find a third party willing to lend 100% of the value of the property on the basis of a covenant by the trustees, and security over the house. Even if such borrowing could be obtained, which must be extremely doubtful, it would be prohibitively expensive. Trust 1 could only justify taking on such borrowing if they were financed by the vendor(s) (the life tenants) who would be benefiting from the property by residing in it. On the foregoing basis it is considered that the trustees of trust 2, in not calling in the loan, have enabled the vendor(s) to retain a significant benefit in it, and therefore that the debt was not enjoyed to the entire exclusion of any benefit to the vendor(s) by contract or otherwise.
A variant of the scheme described above is where the terms of the loan provide that the debt is only repayable at a time after the death of the life tenant. Since, unlike the position with loans repayable on demand, the loan can not be called in by the loan trustees, it is generally thought that these schemes will not be caught as gifts with reservation.

If the loan is subject to a reservation of benefit this does not mean the vendor can avoid paying income tax. The reservation of benefit is in the loan not the house and he has still made a relevant disposal of the house which is subject to an excluded liability and which therefore reduces his estate. Reserved benefit property does not form part of someone’s estate while he is alive. (see ss102(3)(4) FA 1986). In these circumstances if A does not wish to pay the income tax charge the debt should either be appointed back to him or written off (in which case the excluded liability ceases to reduce the value of his estate and there is no income tax charge from the date the debt is written off or appointed back to him) or he should elect (in which case there is no income tax charge at all).

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Insurance policies

  • The settlor effects a discounted gift scheme comprising a gift into settlement with certain "rights" being retained by them. The retained rights may, for instance, be a series of single premium policies maturing (usually) on successive anniversaries of the initial investment or on survival, reverting to the settlor, if they are alive on the maturity date, or the settlor carves out the right to receive future capital payments if they are alive at each prospective payment date. The gift with reservation provisions do not apply.

In the straightforward case where the settlor has retained a right to an annual income or to a reversion under arrangements, that right is not property within paragraph 8 as the trustees hold it on bare trust for the settlor. A bare trust is not a settlement for inheritance tax purposes. The settlor is excluded from other benefits under the policy and so this schedule does not apply.

There may be more complex cases where the settlor’s retained rights or interests are themselves held on trust. But that would normally be construed as being a separate trust of those benefits in which the settlor had an interest in possession, and no charge to tax will arise under this schedule by virtue of paragraph 11(1).

Even if, in less common cases, the paragraph 11 provisions did not apply so as to exempt the case from charge completely, any charge under this schedule would apply by reference to the value of the rights held on trust for the settlor, not by reference to the value of the underlying life policy.

  • The settlor effects a policy and settles it on trust for the benefit of others. He then makes a substantial interest free loan to the trustees, repayable on demand. The trustees use the loan to purchase more policies, and make partial surrenders each year to pay off part of the loan.

This arrangement is not a gift with reservation for inheritance tax. The settlor is not a beneficiary of the trust itself and the making of the loan does not constitute a settlement for the purposes of inheritance tax. No charge to tax will arise under this schedule.

  • Pension Policies

Pension policies may typically provide pension and lifetime benefits for the scheme member, and other benefits that are payable on death at the discretion of the scheme trustees. It is considered that the pension and other lifetime benefits would either represent unsettled property or a trust separate from that on which the death benefits are held. In the arrangement described, both parts can be treated as mutually exclusive and therefore provided the scheme member could not benefit from the trusts governing the death benefits, a charge under this schedule will not arise.

A charge under Schedule 15 will not arise in relation to approved pension arrangements or, from 6 April 2006, pension arrangements under registered schemes. Neither are such arrangements caught as GWR’s, as HMRC’s statement of practice 10/86 makes clear. Non-registered schemes do not fall within the statement of practice, and so may well come within Finance Act 1986, in which event, the same dispositions would not come within Schedule 15.

  • Business trusts (or partnership policies)

In some cases, policies are taken out on each partner's life solely for the purposes of providing funds to enable their fellow partners to purchase his/her share from the partner's beneficiaries on their death. The partner is not a potential beneficiary of his/her "own" policy. In such circumstances, a charge to tax under paragraph 8 of this schedule will not arise.

However, in many cases, the partner retains a benefit for themselves, for example they can cash in the policy during their lifetime for their own benefit. In such cases, even if the arrangement is on commercial terms so that it is not a gift with reservation for inheritance tax, the trust is a settlement for inheritance tax purposes and a charge to tax under paragraph 8 will arise.

The valuation of a partner’s, or settlor’s, interest in a policy for the purposes of paragraph 8 of Schedule 15 should be his share of its open market value as at 6 April each year. That valuation will be relevant for determining the amount of charge for that year of assessment.

Where the policies are term assurances, in the vast majority of cases the policyholder will be in normal health, and therefore it is likely that the chargeable amount, as calculated under paragraph 9 of Schedule 15, will have little marketable value and will fall below the de minimis exemption in paragraph 13. Therefore, a policyholder in normal health at the valuation date may assume that he will survive beyond the term of the assurance, and complete his tax return accordingly. However, in circumstances where the policyholder has been advised that their state of health is such that it casts doubt on their survival to the end of the term of assurance (i.e. there becomes a realistic prospect of the policy paying out and therefore having a material market value), then consideration should be given to obtaining actuarial advice about the value of the policy.

  • Pre 18 March 1986 Policies settled on trusts.

A charge under Schedule 15 does not arise where, before 18th March 1986, a life policy has been contracted and settled on trusts from which the settlor can benefit, even where premiums are paid after this date.

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Land – Occupation.

Example 1: Mr A gives his house to his daughter in 1987. The disposal condition of paragraph 3(2) has been met. He occupies the property along with his daughter, and later when she moves out, on his own. This was ‘relevant land’ at all times since 1987, for the purposes of paragraph 3(1), of Schedule 15. It is protected from POAT throughout because it is subject to a reservation of benefit.

Example 2: Mr A sells his house and makes a cash gift to his daughter, who uses the money towards the purchase of a house of her own also using some of her own money. The contribution condition of paragraph 3(3) is met. Within 7 years of this gift he moves in with his daughter and occupies a self-contained part of the house, and has the means of access to the remainder of the property, and actually uses it from time to time. E.g. storing furniture there. In these circumstances, the whole property is considered to be "relevant land" for the purposes of paragraph 3(1). However, while he occupies with his daughter there is no POAT charge due to para 11(8). Had Mr A moved into occupation more than 7 years after the cash gift, the provision of that consideration will be an excluded transaction, coming within paragraph 10(2)(c) of Schedule 15.


Example 3: The scenario is that of example 2, however Mr A does not have means of access to the rest of the house, and his access to the self-contained part is via an external door. He visits the rest of the house only when invited e.g. for Sunday lunch. He stores no furniture there. In this example, only the self-contained part is "relevant land" for the purposes of paragraph 3(1).

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Post-death variations of an estate.

Mrs W is bequeathed a house, which she occupies, under her husband’s Will. She completes a deed of variation within two years of her husband’s death altering the terms of the Will so that the house passes to her son instead. The deed of variation is effective for inheritance tax purposes as the provisions of section 142(1) Inheritance Tax Act 1984 apply. Although she continues to occupy the house the income tax charge will not apply by virtue of paragraph 16 of this Schedule.

The provisions of paragraph 16 will also apply if the deed of variation referred to above had merely changed Mrs W’s absolute interest in the property to a life interest in possession, with her son as remainderman. If her life interest is terminated during her lifetime (but more than two years after her husband’s death) and she continues to occupy the property the income tax charge will not apply provided that the deed of variation satisfied the provisions of section 142(1) Inheritance Tax Act 1984. In any event, if her life interest was terminated after 21 March 2006 and she continues to occupy the property the reservation of benefit provisions will apply. (S102ZA FA 1986 as amended by Finance Bill 2006).

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Foreign Domiciliaries – excluded property.

An arrangement that is not uncommon is where a foreign domiciliary settles a trust which owns a UK house through a foreign registered company. The shares in this company (and any loan made to it) are excluded property, coming within the provisions of section 48(3) IHTA ’84. Paragraph 12(3) provides that Schedule 15 will have no application to such assets. However in considering the application of paragraph 11 in respect of the house he occupies, the operation of paragraph 12(3) does not mean that the shares (or any loan made to the company) are automatically disregarded in determining whether, for the purposes of paragraph 11, there is derived property which is in the taxpayer’s estate or GWR property in relation to him. In these circumstances we would accept that the exemptions in paragraph 11 can apply to the foreign domiciliary.

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Reverter-to-settlor trusts

Legislation introduced in the 2006 Finance Bill will, from the 5th December 2005, prevent property gifted by the donor but still enjoyed by him as a beneficiary of a reverter-to-settlor trust from escaping an income tax charge under Schedule 15.

Previously the donor could gift property that would then be settled back on him on trusts which allowed him to continue to enjoy the property, but which on his death would revert back to the settlor (the original donee). The property was (for trusts established pre Budget 2006) treated as part of the donor’s estate for IHT purposes, but on his death was excluded from a charge to IHT under sections 53 and 54 IHTA’84, as it reverted back to the settlor (the original donee). A charge under Schedule 15 would also not arise because the property was still regarded as part of the donor’s estate for IHT purposes.

The new legislation will allow a Schedule 15 charge to apply in situations where the former owner of an asset (or a person who contributed to its acquisition) enjoys the asset under the terms of a trust, and the trust property reverts to the settlor – or to the spouse or civil partner, widow, widower or surviving civil partner of the settlor.