IHT Gifts With Reservation – Share And Share Alike!

Mark McLaughlin looks at some important exceptions to the ‘gifts with reservation’ anti-avoidance rules for inheritance tax purposes, in the context of gifts of an interest in the family home.

Many taxpayers (and their advisers) will be aware of the inheritance tax (IHT) anti-avoidance rules dealing with ‘gifts with reservation’ (GWR).

In broad terms, the GWR provisions (in FA 1986, ss 102-102C; Sch 20) are designed to prevent ‘cake and eat it’ situations, whereby an individual seeks to reduce their exposure to IHT by making a lifetime gift (which they hope to survive by at least seven years) whilst continuing to have the use or enjoyment of the gifted asset.

If the GWR provisions apply, the gifted (or in some cases, substituted) property is generally treated as remaining part of the donor’s estate for IHT purposes.

The GWR legislation was originally introduced with effect from 18 March 1986. Additional legislation was added from 9 March 1999, to counter certain IHT planning arrangements involving land and property, which were popular at that time.

This extension of the GWR rules covers (among other things) gifts of an undivided share of an interest in land, such as where the sole owner gifts a half interest to another individual (FA 1986, s 102B). The share disposed of is generally a GWR (within s 102).

Do you have a reservation?

There are various exceptions and exclusions to the general rule that gifts otherwise caught by the GWR rules are treated as remaining part of the donor’s estate for IHT purposes.

Perhaps the most well-known exclusion from GWR is the ‘full consideration’ let-out. In the case of gifted land or chattels, the retention of a benefit (i.e. where the donor has actual occupation or enjoyment) is disregarded if he pays full consideration in money or money's worth (FA 1986, Sch 20, para 6(1)(a)).

There are further possible exceptions from a GWR for gifts of shares of interests in land (FA 1986, s 102B(3), (4)).

For example, if a parent (say, father) gifts an equal interest in a property to his adult daughter (i.e. so that they become joint owners), there is no gift with reservation broadly if the following conditions are satisfied:

(a) Father does not occupy the property – This exception potentially applies (for example) to the gift of an interest in an investment property, but would not help if the property was father’s home, and he continued living there.

(b) Father occupies the property to his daughter’s exclusion, for full consideration in money or money’s worth – Thus if daughter lives in another property (and not in the gifted property), there should be no GWR if father pays his daughter a full market rent for his continued occupation of the gifted share of the property (s 102B(3)).

(c) Father and daughter both occupy the property, and father receives no (or negligible) benefit for the gifted share – ‘Benefit’ in this context can include household expenses (see below) (s 102B(4)).

As indicated above, exceptions (b) and (c) are particularly relevant to the gift of a share in father’s home to his daughter. In addition, the gift of an interest in land is not a GWR to the extent that certain IHT exemptions apply (FA 1986, s 102C), such as gift in consideration of a marriage (see s 102(5)).

There is a further exclusion from the GWR provisions involving the elderly or infirmed, which can apply following unfortunate changes in circumstances (see below).

Share and share alike

The ‘sharing’ exception from a GWR (see (c) above) is illustrated below.

Example 1: Good while it lasted

Jane owns the freehold of her home. Her adult son Robert also lives there. Jane could give Robert 50% of her interest in the freehold of her home. The gift will be a potentially exempt transfer by Jane; it becomes exempt if Jane survives at least seven years. The GWR provisions for the gift of the share of an interest in land (FA 1986, s 102B) will apply, but there is no GWR because of the joint occupation exclusion (see (c) above), assuming that Robert does not contribute in any way to his mother’s share of the property upkeep and expenses.

However, what if Robert moved out? Jane could pay a full market rent for her continued occupation of the whole property (see (b) above). However, this is not an ideal scenario (e.g. Robert will be liable to income tax on the rental income). Sharing arrangements of this kind are therefore more suitable if it seems likely that occupation will be long-term.

A condition of the joint occupation exclusion is that the donor (Jane in the above example) does not receive any benefit (other than a negligible one) from the donee (Robert) for any reason connected with the gift. ‘Benefit’ in this context includes (for example) Robert paying Jane’s all or part of share of the household upkeep and expenses. However, there is nothing to prevent Jane continuing to pay all the running costs of the property. This would therefore seem to be the safest option.

In the above example, Jane gifted a 50% share of the house to her son. The legislation in FA 1986, s 102B does not contain an explicit requirement to gift an equal share. The donor may therefore wish to consider giving away more than a 50% interest. However, HMRC could contend that, if two individuals occupy a property jointly, the most that can be given away is 50%. HMRC’s Inheritance Tax manual indicates that any case in which the donor takes less than an equal share will be referred to its Technical Group (IHTM14332).

For income tax purposes, there is also an exemption from the ‘pre-owned assets’ (POA) income tax charge (which can broadly apply to benefits received by the former owner of certain assets, including land) where the sharing exception from GWR in (c) above applies (FA 2004, Sch 15, para 11(5)(c)).

Circumstances can change

As indicated above, there is a further important, but perhaps less well known, exception to the GWR provisions in respect of the gift of land, or the share of an interest in it (FA 1986, s 102C(3)). This special relieving provision broadly applies if the donor occupies the land (or there is an arrangement enabling him to do so), where the occupation (or arrangement) would be disregarded for GWR purposes in the following circumstances (Sch 20, para 6(1)(b)):

it results from an unforeseen change of circumstances; and
the donor has become unable to maintain himself through old age, infirmity, etc; and
it represents a reasonable provision by the donee for the care and maintenance of the donor; and
the donee is a relative of the donor or his spouse (or civil partner).

There is also an exception from the POA income tax charge if the above conditions are satisfied (FA 2004, Sch 11, para 11(5)(d)).

Note that all of the conditions must be satisfied (i.e. the requirements are cumulative). In addition, in practice it may be difficult to determine what constitutes a ‘reasonable’ provision by the donee for the donor’s care and maintenance. However, whilst the conditions are fairly onerous, the relaxation in the GWR provisions can be helpful in some unfortunate situations.

Example 2: Moving back ‘home’ due to ill health

In April 2010, Edward was aged 78 and in good health. He decided to move out of his five bedroomed detached home (‘Woodlands’), because the property was too large following his wife's death and his three adult children had all moved out.

Edward decided to buy a small bungalow, which was more suited to his needs. He moved out of Woodlands and gifted it to Frank, his eldest son. Frank subsequently lived in the property with his wife and children.

In June 2014, Edward unfortunately suffered a serious stroke (he had not previously suffered any serious health problems). Edward’s stroke left him needing constant care. He moved back to Woodlands, where Frank looked after him. Sadly, Edward’s health continued to deteriorate, and he died a few months later.

HM Revenue and Customs (HMRC) accept that, in the case of an unforeseen serious illness, where the donor cannot maintain himself, occupation represents reasonable provision for his care and maintenance (see the example in HMRC’s Inheritance Tax manual at IHTM14342).

However, in the example above, suppose that Edward made a full recovery a few months after moving back to Woodlands. In those circumstances, the exception from a GWR would probably only be available until Edward sufficiently recovered, and was able to move back to his bungalow and look after himself again (unless he paid a full market rent for his continued occupation of the property).

Practical points

If it becomes necessary for the donor to pay rent for the continued occupation of the property for any reason (e.g. the recipient moves out so that the ‘sharing’ exception is no longer met), make sure that it is a full market rent. HMRC guidance suggests that the rent should be calculated on an ‘arm’s length’ commercial basis, and that the parties should seek independent advice. In addition, the rent should be subject to regular reviews, to ensure that ‘full consideration’ continues to be paid throughout the period of occupation (IHTM14341).
Remember to consider any non-IHT (and non-POA) implications of sharing arrangements, such as income tax for the recipient of any rents, and capital gains tax implications in respect of the gifted land or property for the donor (and the donee, on a subsequent disposal). Aside from any tax implications, donors should think very carefully before making gifts, particularly the gift of an interest in the home.