Presented by
Robert W Maas, FCA, FTII, FIIT, TEP
of Blackstone Franks LLP

Income tax charge by reference to enjoyment of property previously owned (Cl 84 & Sch 15)

1. Applies from 2005/06 onwards.

2. It imposes an income tax charge where in the tax year

a) an individual occupies any land, whether alone or together with other persons,
b) at some time after 17 March 1986 that individual owned an interest in either
i) the relevant land, or
ii) other property, the proceeds of disposal of which were (directly or indirectly) applied by another person towards the acquisition of an interest in the relevant land, and
c) the individual has disposed of all or part of his interest in the relevant land (or other property) other than by an excluded transaction.

3. The tax charge will also apply if

a) the individual occupies the land in the tax year, and
b) the individual has directly or directly provided any of the consideration given by another person for the acquisition of either
i) an interest in the relevant land, or
ii) an interest in other property the proceeds of disposal of which were (directly or indirectly) applied by another person (not necessarily the same person) towards an acquisition of an interest in the relevant land, and
c) that provision of consideration was other than by an excluded transaction.

4. The chargeable amount is:

The appropriate rental value minus any payments in respect of the occupation made in pursuance of a legal obligation by the individual to the owner of the land.

5. The appropriate rental value is:

value at the relevant date of the interest in the relevant land that was disposed of by the individual (or can be attributed to the property disposed of)
rental value x ___________________________________
value of the relevant land at the valuation date.

6. The rental value is the rent (on the basis that the only amounts that can be deducted in respect of services provided by the landlord are the costs of providing services other than the repair, insurance or maintenance of the premises) which would have been payable for the period if the property had been let to the individual at an annual rent equal to the annual value, i.e. the rent which might reasonably be expected to be obtained on a letting from year to year if the tenant undertook to pay all taxes, rates and charges usually paid by a tenant and the landlord undertook to bear the costs of the repairs, insurance and other expenses (if any) necessary for maintaining the property in a state to command the rent.

7. The Revenue have power by Regulation to provide for either a valuation of the relevant land or the rental value of the land to be determined by reference to an earlier valuation date or tax year subject to any prescribed adjustments.

8. The excluded transactions are where:

a) the original disposal by the individual was a disposal of his whole interest in the property (except for any right expressly reserved by him over the property) by a transaction such as might be expected to be made at arm's length between unconnected persons,
b) the original disposal was a gift into settlement and the individual has an interest in possession in the settlement,
c) the original disposal was to the individual's spouse (or under an order of a court to his former spouse), or
d) by virtue of the original disposal the land become settled property in which the individual's spouse or former spouse has an interest in possession (or had such an interest which come to an end on her death).

9. There are also a number of exemptions

a) if the relevant land is subject to a reservation of benefit by the individual for IHT purposes (or would have been subject to a reservation but for IHTA 1986, s 102(5)(d)-(i), s 102B(4) (and as if that provision has applied prior to 9 March 1999) or Sch 20, para 6),
b) if the individual is not resident in the UK during the tax year,
c) if the individual is not domiciled in the UK during the tax year (but is resident here) and the property is situated outside the UK,
d) at the time of the original disposal the individual was domiciled outside the UK (even if the property was situated in the UK),
e) if the appropriate rental value (plus the value of any chattels or intangible property caught by the provision) does not exceed £2,500,
f) the Treasury have power by Regulation to grant further exemptions - the budget papers indicated that the provision would not
i) affect parents or grandparents who have helped their children or grandchildren onto the property ladder, or
ii) apply where the benefit is incidental, including cases where a gift comes to benefit the donor following a change in circumstances,
g) if an individual would be caught by the provision for 2005/06 (or would be if he occupied the land in that year) he can elect (for as long as he continues to occupy the relevant land or any substituted property) to treat the property for IHT purposes as being subject to a reservation
- such an election must be made by 31 January 2007 and cannot be withdrawn after that date.

10. If the individual is taxable under the provision both in respect of land (or chattels) and in respect of intangible property which derives its value from the land he is not taxed twice

- but is taxed on whichever head produces the greatest charge.

11. If the individual is taxable on a benefit in kind in respect of the property the employment income charge takes priority

- but if the charge under Sch 15 is higher the excess remains taxable under Sch 15.

12. The IHT not the income tax definitions of land, interest in land, property, settlements and settled property apply. In deciding whether a person is a connected person s 839, ICTA 1988 applies but as if "relative" included an uncle, aunt, nephew and niece and as if settlement and settlor had the same meanings as in IHTA 1984.

Restrictions on CGT gifts relief (Cl 111 & Sch 21)

13. Hold over relief under CGTA 1992, ss 165(4) and 260(3) cannot apply on a disposal to a trust after 10 December 2003 if either

a) there is a settlor who has an interest in the settlement (or an arrangement exists under which such an interest will or may be acquired by the settlor), or
b) a chargeable gain arises to the transferor on the relevant disposal, in computing that gain the allowable expenditure falls to be reduced by an earlier claim by an individual under ss 165 or 260 (including one before 10 December 2003), and immediately after the relevant disposal that individual has an interest in the settlement (or arrangements exist under which such an interest will or may be acquired).

14. If neither of the above conditions apply at the time of the disposal to the settlement but come to apply at any time in the six years after the disposal to the settlement, a hold-over claim cannot be made once the appropriate condition becomes satisfied. If a claim has already been made the satisfaction of the condition triggers a chargeable gain on the transferor equal to the held-over gain. This claw-back of the relief does not apply if the transferor was an individual who has died before the trigger event occurs. Where this claw-back applies the settlement (or any person deriving title to any property from it) is treated as if hold-over relief had never applied.

15. If the hold-over relief claim is revoked it is treated for the above purposes as if it had never been made.

16. A person is a settlor in relation to a settlement for this purpose if he is an individual and the settled property includes property originating from him (directly or indirectly).

17. A settlor has an interest in the settlement if either

a) any property which may at any time be comprised in the settlement (or any derived property) is (or will or may become) payable to or applicable for the benefit of the settlor or his spouse in any circumstances whatsoever, or
b) the settlor or his spouse enjoys a benefit deriving directly or indirectly from any property comprised in the settlement (or any derived property).

18. For this purpose reference to an individual's spouse does not include his widow or widower or a spouse from which he is separated under a court order, a separation agreement, or in circumstances that the separation is likely to be permanent. A settlor does not have an interest in a settlement if the only circumstance in which amounts can be applicable for his benefit is either in the case of a marriage settlement in the event of the death of both parties to the marriage and of all or any of their children, or on the death of a child of the settlor after that child had become beneficially entitled to the settled property (or any derived property) at or before age 25.

19. There are exceptions where

a) the trustees have elected under ICTA 1988, s 691(2) (maintenance funds for historic buildings) for the income not to be income of the settlor, or
b) the settled property is held in trust for a disabled person which ensure that during his lifetime at least half of the income must be (and actually is) applied for that person's benefit, no such income can be applied for the benefit of any other person (including the settlor's spouse) and no interest in possession subsists in the settled property
- if there is more than one settlor with an interest in the settlement each of them must qualify as disabled persons.

20. If a chargeable gain arises under 14 (claw-back of hold-over relief) the tax can be paid by instalments if the tax on the original transfer could have been paid by instalments had the hold-over relief claim never been made.

21. If the tax is not paid by the transferor it can be recovered from the trustees.

CGT Private Residence relief where CGTA 1992, s 260 applies (Cl 112 & Sch 22(6))

22. CGT private residence relief cannot be claimed on a disposal after 9 December 2003 if a hold-over election under s 260 was made on any earlier disposal as a result of which the deductible expenditure on the later disposal would fall to be reduced.

23. If the s 260 election is made after the later disposal PRR must be treated as never having been due

- but if the election is revoked it is treated as if it had never been made.

24. If the earlier disposal (or all such disposals if there were more than one) was made before 10 December 2003 PRR is not lost completely. Instead the dwelling-house is treated as not qualifying for PRR from 10 December 2003

- and the last three years of ownership can be treated as qualifying for PRR only to the extent that such period falls prior to 10 December 2003.

Example

John owned a rental property up to 15 March 1998. He then gifted the property to a discretionary settlement and made a s 260 election to hold over the gain of £40,000. The trustees allowed the house to be occupied by John's daughter, Jane, from the time of their acquisition to 15 March 2000 after which they let the house at arm's length. The trustees sold the house on 15 July 2004 for £400,000. It was worth £280,000 when it was settled.

The trustees gain is
Proceeds £400,000
Less cost £(280,000-40,000) 240,000
£160,000

Period for which the property was
Jane's main residence
15.3.1998 - 15.3.2000 2 years
last three years of ownership
3 years to 15.7.2004 but limited to 2 years 5 months
16.7.2001 - 10.12.2003
4 years 5 months

Period of ownership by trustees
15.3.1998 - 15.7.2004 6 years 4 months
PRR
160,000 x 53/76 £111,579
Taxable 48,421

25. There is an exception where the trustees have elected under ICTA 1988, s 691(2) (maintenance funds for historic buildings) for the income not to be income of the settlor.

Inheritance Tax

26. Is IHT planning for the family home still possible?

27. It is still sensible for the home to be held jointly by the parents and for each to leave his share - or at least the first £263,000 worth of it - to the children

- it is not a pre-owned asset as the surviving spouse will not have had an interest in the half share going to the children.

28. For most people the private residence forms their major asset
- but it is the most difficult one to give away because of the reservation of benefit rules.

29. When one spouse dies the other usually wants the surviving spouse to be able to live in the house for as long as she wishes.

30. It is normally best for husband and wife to hold the property as tenants in common

- i.e. so that the deceased's half does not automatically pass to the surviving spouse
- this enables part of the value to pass to the children on the first death
- but remember the rule in Saunders v Vautier
- if all of the beneficiaries of a trust are of full age and capacity they can bring the trust to an end.

31. Where property is held as tenants in common this is in law a trust for sale

- so any of the joint owners can go to the court and ask it to enforce the sale.

32. Is there a risk that the children will gang up and force a sale against mum's wishes?

- you bet!

33. How can you protect mum from a sale?

a) Give her a right to live in the property during her lifetime
- this won't work
- it creates a life interest in her favour (CIR v Lloyds - Private Banking Ltd.)
- and a life tenant is deemed for IHT purposes to own the property.

b) Put the husband's share in trust for the children and grandchildren
- this should work if you pick trustees that can be relied upon to protect the wife
- could the wife be a trustee and the trustees be required to act unanimously?
- there must be enough grandchildren to ensure that there is always a minor beneficiary
- could include the great-grandchildren.

c) Give all or any of the spouse, the children, the grandchildren and the great-grandchildren the right to live in the property
- the wife will have an interest in possession
- but so will all the other beneficiaries
- so if there are say 10 beneficiaries in all the wife will have a life interest in 10% of the husband's 50% of the house
- but the wife is at risk that the children and their kids may all move in.

34. Might it still be possible to give an interest in the house to the children and continue to occupy it?

can you manage to live for another 14 years?
- if so the Ingram scheme will probably work
i.e. transfer the property to a nominee, let the nominee grant a lease to you, wait seven years and then gift the reversion to the children
- s 102A(2) treats the gift as a gift with reservation if the donee or his spouse enjoys a significant right in relation to the land (such as a right to live there)
- but s 102A(5) says that a right is not significant if it was acquired or granted over 7 years before the gift
- the lease retained by the donee should satisfy this requirement
- there are some problems though
a) how long should the lease be?
- the longer it is the less the value that will have been given away
- but you don't want it to expire during the client's lifetime
b) there must be no reservation of benefit in the reversion itself
- which probably means that the lease needs to be at a nil rent and to require the tenant to pay all outgoings.

c) Sch 25 will apply but the amount may be fairly low (and covered by the £2,500 de minimis limit) as it is the proportion of the rental value that the value of the reversionary interest bears to the value of the house.

35. Other possible strategies.

a) Reversionary lease; grant to the children a lease to take effect in say 30 years time - there is no gift with reservation as the donor has no interest in the lease - but how do you determine when the lease should start.
- again the Sch 25 charge may be fairly low.

b) Split between a lease and reversion on purchase e.g. at the time the house is bought the parents buy say a 60 year lease from the vendor and the children buy the reversionary interest from the vendor (the two together making up the agreed purchase price)
- there is no gift with reservation as there is no gift
- there is no Sch 25 charge (unless the parents give the children the funds to buy the reversion) as there is no disposal of any part of the interest acquired by the parents.
- but this needs the co-operation of the vendor
- and the "marriage value" probably ought to be wholly paid for by the children so that no value can be said to pass to them from the parents.

c) The parents could gift cash to the children and the children use the cash to buy a house for their parents to live in
- the gift with reservation rules does not apply to an absolute gift of cash (IHTA 1984, Sch 20, para 2(2))
- unless the associated operation rules apply
- a gift of cash, which must be used to buy the house, would be caught
- a gift not specifically tied to the purchase may not be (but IHTA 1984, s 268 is very wide).
- this will trigger a Sch 25 charge though.

d) The children could buy a new house for their parents to live in and the parents could gift the proceeds of sale of the old house to the children on its subsequent sale
- the associated operation rules probably don't apply as the transfer of value is made only by the second of them (the gift of cash).
- Sch 25 may well not apply (unless the Revenue can show an arrangement) as it is hard to see how the proceeds of sale of the old house could be said to form part of the consideration for the acquisition of the new house.

e) There is no problem in gifting an interest in the house to someone who will occupy it jointly with the donor
- but the Revenue say that the donee must pay his appropriate share of the costs.
- and s 102B(4) and Sch 15, para 11(1)(c) appear to give protection from the Sch 25 charge.

f) The donee could pay full consideration for the occupation of the land
- this is not attractive for the main residence as creating taxable income in the form of rent will probably wipe out the IHT benefit
- although the payment of the rent of course brings about a further reduction in the donor's estate
- but it could be attractive for a second residence that the donee does not use a lot or for a holiday home.
- and it will eliminate the Sch 25 charge unless the rent paid is less than the rental value.

g) It may be possible to gift part of the land if the donee does not occupy it all
- defining the part gifted may need care
e.g. suppose a widow has a large house with 10 rooms of which she only occupies 5. A gift of the part she does not use (assuming it can be segregated) would not be a gift with reservation but would only give away half the value
- but if she does not drive the part retained could be given access by foot only, which might significantly reduce its value and increase the value of the part given away.
- there cannot be a Sch 25 charge as the donee will not occupy the part gifted.

Capital Gains Tax

36. There are two separate exemptions

for the dwelling house, and
for land which the owner has for his own occupation and enjoyment with the house as its garden or grounds up to the permitted area of 0.5 hectare (inclusive of the site of the house)
- the dwelling house can include outbuildings and the land in between - which might well exceed 0.5 hectare.

37. What is a residence is a question of fact

- the determining factor is quality of occupation not length of stay
- in Goodwin v Curtis (1998 STC 475) the General Commissioners held that two properties one occupied for two months and the other for three had been used as mere temporary accommodation and not as a residence
- but a property that was bought as a residence but never occupied cannot qualify
- and remember that income tax takes precedence over capital gains tax and the fact that a person lives in his dealing stock does not take it out of the scope of income tax.

38. The Revenue contend that if land is separated from a house by a wall or fence it is not garden or grounds for occupation with the residence

- this is probably a rebuttable inference.

39. The test as to whether land qualifies for exemption is applied at the time of disposal
- so if the house is sold before the garden the latter cannot attract relief (Varty v Lynes 51 TC 419).

40. If the garden is sold and the house retained this may create an inference that the garden is not owned "for enjoyment with the house"

- but this was accepted in Batey v Wakefield (55 TC 550).

41. Where it is claimed that more than a half acre is needed for enjoyment with the house the Revenue will instruct the District Valuer to negotiate the part

- it is sensible for the taxpayer to instruct a surveyor
- the test is an objective one, i.e. it is not does the owner need the land but does any owner of the property need it? (Longson v Baker 2000 STC (SCD) 244)
- an alternative strategy might be to reduce the value to 0.5 hectare by carving off less valuable parts of the land to a company or a different family member.

42. The Revenue regard two contiguous flats occupied together as a family home as a single dwelling house

- but not normally in other circumstances.

43. The election where a person has two or more residences

a) the election must be made within two years from it becoming necessary to determine what is the main residence (e.g. from the purchase of the second)
- but it can be varied at any time
- and the right to elect can be revived by buying a third residence, transferring one to a trust or letting one - or getting married or separated.

b) elect that every residence is the main one for at least part of the period of ownership
- as that exempts the last three years of ownership as well
- and attracts the £40,000 bonus relief for let properties.

c) remember that a person can have two residences without owning them both e.g. he could rent one.

d) if no election is made it becomes a question of fact which is the main residence
- as the Inspector's right to choose must be exercised judicially.

e) remember that the permitted periods of absence in s 223(3) are dependent on
i) the house being the main residence both at some time before and sometime after the period of absence, and

ii) the person having no residence or main residence eligible for relief under s 223 (a house owned overseas during a period of non-residence is probably not one so eligible for relief).

44. Where a residence is the main residence for part only of the period of ownership the gain is time apportioned

- but only by reference to use after 31 March 1982 (s 223(7))
- time apportionment could be avoided by transferring the property to a trust
- but this would lose the bonus relief if the property will then be let.

45. The relief is restricted where part of the house is used exclusively for business purposes

- but the Revenue take a relaxed attitude to "exclusively".

46. The relief is also restricted if any expenditure is incurred wholly or partly for the purpose of realising a gain from the disposal of the property
- e.g. buying an extension to a lease
- but the Revenue say that obtaining planning permission for redevelopment is OK.

47. There is no longer relief for a house occupied by a dependant relative (unless it has been occupied continuously since 5 April 1988)

- but the exemption can be obtained by owning the property through a settlement
- provided it is the only or main residence of the beneficiary
- the exemption seems to apply even if the beneficiary is charged rent.

48. ESC D5 (private residence held by personal representatives) has been given statutory effect (as TCGA 1992, s 225A) from 10 December 2003

- both immediately before and immediately after the death the property must have been the only or main residence of one or more individuals, the entitlements of which together amount to at least 75% of the net proceeds of disposal.

Non-UK domiciliaries

49. There is really no ideal structure for owning the house. The options are as follows:

(a) Own it personally and accept there will be UK IHT at some stage (assuming the house is worth more than £250,000).

(b) Own the house personally and take out term life cover for the value of the house - or, for those who are clever/mean, up to the excess of the value of the house over £250,000. For a person who is genuinely likely to be living in the UK for a few years only and could manage with a 5 to 10 year term insurance, that is probably the best bet.

(c) Have the house owned by an offshore company which in turn is owned by an overseas trust and make sure there is a resolution of the trustees that says that they will procure that the beneficiary can reside in the house rent free. The problem with the house being owned by an overseas company is that there is a benefit in kind risk. The Revenue will contend that the occupant of the house is a shadow director of the overseas company and therefore taxable on a benefit in relation to the occupation of the house. That is obviously a question of fact. If the occupant makes all the decisions in relation to the house he is very vulnerable to attack. Documentation is very important in these circumstances. For example, if he is given a formal lease at a peppercorn rent and the lease imposes on him an obligation to keep the house in good repair to a very high standard and provides that he can carry out improvements but only at his own cost and with the consent of the landlord, then it may well be that all of the decisions that he has to make in relation to the house are decisions that he needs to make as occupier. It should not be difficult to ensure that the lease is clearly granted by the overseas directors. I think it would be difficult for the Revenue to show that a person is a shadow director of a company if no decisions actually have to be made in relation to the company after he goes into occupation of the house. Full documentation is absolutely essential. This probably ought to include a letter from you expressing the opinion that you do not believe that the individual is a shadow director of the company on the basis of what you have been told and in the circumstances do not believe he has a liability to UK tax in relation to the occupation of the property. It would then be hard for the Revenue to seek penalties should they attack the situation at some stage (obviously you need to take care in what you write, so that it is clear you are expressing an opinion on what you have been told and taking no more responsibility than that).

(d) Own it personally but acquire it with an interest free loan from an offshore trust secured by a charge on the property. A mortgage is deducted from the asset on which it is secured for IHT purposes. However, there is an anti-avoidance provision that prohibits the deduction of a debt if it consisted of either:
(i) property derived from the deceased
(ii) consideration given by a person who was at any time entitled to any property derived from the deceased.
(FA 1996, s103)
Also a charge given for no consideration would not give rise to deduction. This means that a loan from the occupant himself or from a trust or settlement created by the occupant may not work. It also of course means that whilst a person could take out a 100% mortgage to eliminate the initial value of the property for IHT purposes it is hard to cover the future growth in value.

e) Register the house in the name of an overseas company as nominee for the individual
- the asset owned by the individual is probably his claim against the nominee, which is a non-UK asset.

50. The Sch 25 position is unclear. Sch 25, para 12 is badly worded.

Should you put your house in your Company?

51. Not if the cost significantly exceeds £75,000 because the benefit is horrendous

- but it is arguable that no benefit can arise if the house is owned jointly with the company
- bear in mind the loss of the CGT exemption.

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April 2004