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STUBB LEGAL AUDIO RECORDING SCRIPT
Subscription Area: Property
Month of Production: December 2009

This audio recording will concentrate on Inheritance Tax.
Quotations from judgments of the House of Lords are the copyright of the United Kingdom Parliament and from other judgments are Crown copyright. Quotations from statutory legislation are Crown copyright.


PART ONE - THE NIL-RATE BAND

1 Finance Act 2008

Everyone wishes to pay as little inheritance tax as possible. The most commonly available tax break is the nil-rate band. The nil-rate band is currently £325,000. Each Finance Act increases the nil-rate band, although this is not a rigid rule.
Thus when a man dies, his personal representatives must aggregate the value of all the assets to see if the gross estate exceeds £325,000. Valuations of chattels for inheritance tax purposes are dealt with in Forms D10 and D35. Here the personal representatives supply the Revenue with valuations of household and personal goods. The Inland Revenue Capital Taxes Office must be satisfied that the inheritance tax account constitutes a complete return of the household and personal goods owned by the deceased, and that the value of the goods have been ascertained in accordance with the correct statutory principle. The Revenue notes that there are several areas which commonly cause difficulty. For example, where there is a property situated abroad but no mention of any contents. Where assets are jointly owned, the Revenue will ask for detailed information on how joint ownership was established, and where chattels are given at a nil value, a full explanation of the circumstances must be given. Where a valuer gives a range of values, the Revenue expects the probate value to be in the middle of the range. The Revenue can request further information and open an enquiry if it believes a valuation is inadequate. Penalties will be considered where it is contended that the account has been negligent.
The valuation of land also causes difficulties, such as experienced in the recent case of Arkwright v IRC {[2004] EWHC 1720 (Ch)}. A husband and wife owned a property as tenants in common, until the death of the husband. His half-interest passed to his daughters, and the issue was the value of his half-share. The deceased died owning a beneficial 50% share in the matrimonial home as tenant in common with his spouse. The issue in question was whether the value of the deceased's interest in the property was one half of the vacant possession value or a lower value, given the surviving spouse's right to occupy the house and the fact that the deceased could not have sold it without her consent. The whole property was valued at £550,000, and the Inland Revenue valued his half at £275,000 - a direct mathematical proportion. However, the daughters considered that the value of their father’s interest was less than half of the whole, because immediately before his death, their mother had the right to occupy the house and it could not have been sold without her consent.
The Special Commissioner decided that the value of their father’s share should be discounted to take into account the rights of occupation of his wife, because any purchaser would know that his wife was in occupation that was likely to continue. The special commissioner held that the value of the deceased's interest was less than one half because of the surviving spouse's rights of occupation and that the decrease in value of the deceased's share as a result of death had to be taken into account in valuing his interest before death. It was also agreed that the surviving spouse's interest in the property was related property within section 161 of the Inheritance Tax Act 1984.
The Revenue appealed on the question of whether the commissioners were right. The appeal was allowed on the basis that the Lands Tribunal should decide such questions. As a result, the commissioners' conclusion that the correct measure of value is less than a one half share cannot be relied upon. Issues of law as to the construction and effect of sections 160 and 161 of the Inheritance Act 1984 Act are for the special commissioner to decide; but the dispute as to the interest in property was for valuation by the Lands Tribunal. The result of Inland Revenue Commissioners v Arkwright was that the Revenue's appeal was allowed on the ground that valuation issues should properly be referred to the Lands Tribunal for determination.
Intangible property must also be given a market valuation. For the purpose of market value, it is necessary to proceed on the basis of a hypothetical vendor and a hypothetical purchaser and that the transaction is attended by various assumptions. We know from Gray v IRC {[1994] STC 360} that the hypothetical vendor is a prudent man of business and although there is no express direction in respect of purchasers, we can reasonably assume that the hypothetical prudent prospective purchaser is also a prudent man of business. In the recent case of Bower deceased v HMRC {SpC 665}, the special commissioner came up with a novel basis of valuation being the price that a willing speculator would be prepared to pay for the relevant asset. The High Court has concluded, however, that this was wrong. The asset in question was the right to a life annuity under a discounted gift bond - not an easy thing to value at the best of times. Some principles emerged from the case which seem to be uncontroversial. The property should be assumed to have been capable of sale in the open market even if it was inherently unassignable or subject to restrictions on sale. The question was what a purchaser in the open market would have paid to enjoy whatever rights attached to the property at the relevant date. The High Court thought that the special commissioner may not have appreciated that the hypothetical sale took place in the real world. There had to be an assumed buyer to satisfy the statutory hypothesis and although the special commissioner had been entitled to consider possible purchasers, he was not entitled to invent them. The High Court observed that the special commissioner's method of calculation had not been put forward by either of the parties nor any of the witnesses. This was considered to be a breach of natural justice and it was certainly not based on the evidence before him. It had flowed from his erroneous conclusion that he had been required or entitled to populate the real market in which the hypothetical sale took place with hypothetical speculators who had not shared the characteristics of real buyers.

One of the most common tasks for any private client solicitor is to advise a testator who wishes to provide for: (i) his wife; and (ii) his children. Assume for the time being that our client, the testator, has a total estate which is worth £550,000, but that this includes his home worth £200,000, which he shares with his wife. Probably the commonest solution is for the will to provide for the children to be given "the maximum amount of cash which I can give without incurring any liability to Inheritance Tax", ie the nil-rate band, and for the wife or partner to be given the residuary estate - which includes the testator's interest in the matrimonial home. A gift by will to one's spouse will normally be fully exempt from inheritance tax {see the Inheritance Tax Act 1984, section 18}. There is an exception where the transferee spouse is not resident in the UK. In the example, it is assumed, the spouse is resident in the UK. Therefore, the interest of the testator in the house and the rest of the residuary estate will be exempt from inheritance tax. Use of the nil-rate band and the gift to the widow will combine to result in no inheritance tax being due.
A civil partner under the Civil Partnership Act 2004 will be in the same position as a spouse. This may be a substantial point on the facts of the case. Since the coming into force of the Civil Partnership Act 2004 in the UK, a homosexual couple now also has the choice to enter into a legal relationship designed by Parliament to correspond as far as possible to marriage.
Entitlement to the nil-rate band legacy may be in fixed proportions or the subject of a discretionary trust for named beneficiaries. If the latter, it may be useful for the wife to be included among the class of discretionary beneficiaries.
A common difficulty arises if the estate does not contain sufficient assets to pay the whole of the nil-rate band legacy without entrenching upon the house. Everything depends upon the wording of the will.
If a will gives the house to the widow then the gift of the house takes priority and there will be an insufficiency of assets for the legacy to the children and an "abatement" in respect of it. However, if priority is given to the nil-rate band legacy and the house is contained in residue, the priority will be given to the legacy.
Assume, in the latter case, that the widow wishes to have the house vested in her. After the death of the testator and grant of probate, what if the nil-rate band legacy impinges upon the house? The personal representatives can execute an assent to the widow. If she doesn't pay off the legatees immediately, the personal representatives can also execute a charge on the house. Alternatively, they can make the assent subject to a covenant by the widow to pay the overlapping amount to the disappointed beneficiaries.
Parties normally expect that the burden of any covenant or charge will be a debt or encumbrance such as to depress the value of the widow's estate for inheritance tax purposes on her future death. But inheritance tax is never that simple. Not all debts are deductible.
Deductibility of debts and encumbrances internal to the estate has long been limited. The current rule springs from section 103 of the Finance Act 1986. In determining the value of a person's estate immediately before death, a debt incurred by that person or an encumbrance created by him shall be non-deductible to the extent that "the consideration given for the debt or the encumbrance ... consisted of property derived from the deceased".
An instructive example of the working of section 103 of the Finance Act 1986, is Phizackerley v Revenue and Customs Commissioners {[2007] STC (SCD) 328}. This was a case where both husband and wife had died. The couple acquired their house in 1992 as beneficial joint tenants. Until retiring in 1992, Dr Phizackerley, an Oxford University academic, lived with his wife in accommodation provided by Balliol College. They then bought a house for £150,000 as joint tenants. Apparently Mrs Phizackerley had not worked since their marriage and made no financial contribution to the purchase price. In 1996, some financial planning took place. The house was put into a beneficial tenancy in common in equal shares. Almost immediately afterwards the couple made wills. Probably both included discretionary nil rate band trusts with any residue going to the surviving spouse; Mrs Phizackerley's certainly did.
In 2000, she died. Her estate, consisting almost entirely of her share in the family home, was within the nil rate band and under the terms of her will passed into the discretionary trust created by her will. But Dr Phizackerley agreed with the trustees of her nil rate band will trust that instead of transferring her share of the home to them he would transfer it to himself and instead give them an index-linked IOU for £150,000, the then value of her share. Dr Phizackerley died in 2002, leaving an estate which now included the entire value of the home and before deduction of the outstanding IOU debt amounted to nearly £530,000. HM Revenue & Customs refused to allow the debt to be deducted in the inheritance tax calculation. The commissioner ruled that it was right to do so.
The short reasoning was that: the husband had owned the house; he had disposed of a beneficial half share to the wife; and such beneficial half share was consideration for the husband's covenant. The personal representatives argued that the conferment of such beneficial half share was by way of maintenance and thus within section 11 of the Inheritance Tax Act 1984, and not a transfer of value. Although the special commissioner accepted that a half share in a house could constitute maintenance in an appropriate case, he held that in the present case it was not shown to be such. He made the point that ordinarily maintenance connoted a flavour of meeting recurring expenses, which a transfer of a beneficial half share in a house was not. One rather obvious difficulty was that both the husband and the wife were dead and thus their live testimony was not available.
It seems to be plain that had the husband died before the wife, the result would have been different. A debt scheme operates well where the house provider is the first to die.
If instead of a debt scheme, a charge scheme is implemented, it is difficult to see that the result for deductibility is any different. The popular press inveighed against the Phizackerley decision as being against discretionary trusts. This is wide of the mark. The real point is one of deductibility. The practical point is that one can still draft a will using the concept of a nil-rate band legacy and a residue, possibly giving priority to the house over the nil-rate band legacy and even using a life interest.
If the house or interest has never been disposed of by the widow at some time in the past {on or after the 18th March 1986}, the debt is fully deductible for inheritance tax purposes. Section 103 is not engaged. If it has been so disposed of, it is not sufficient to prove that such disposition was a transfer of value. Each of parts (a) and (b) of section 103 must be shown not to apply.
The first test is to attempt to show that the disposition was not a "transfer of value" as defined in section 3 of the Inheritance Tax Act 1984. Care is needed here. Beware of assuming that a transfer between spouses is not a transfer of value. Such a transfer is a transfer of value but is "exempt" if the transferee spouse is UK resident, and partially exempt if not so resident; see above. Sections 10-17 of the Inheritance Tax Act 1984 comprise a part entitled: "Dispositions that are not transfers of value." It is here that we must look. Probably the only section to be pondered over is section 11, which deals with dispositions for maintenance of family.
Normally a debt incurred by a person and still outstanding on death is deducted from the estate in calculating inheritance tax. But section 103 of the Finance Act 1986, prohibits this to the extent that consideration for a "debt or incumbrance" incurred by the deceased was "property derived from the deceased". That expression includes property previously the subject of a disposition by the deceased, and property derived from that property, unless the original disposition was not a transfer of value.
The Revenue argued, and the special commissioner agreed, that in funding the property purchase in joint names, Dr Phizackerley made a gift to his wife of either half the purchase price or half the value of the property; it was not necessary to decide which. The wife not having earned during the marriage made this difficult to challenge and there was no serious attempt to do so on behalf of the taxpayer.
The share of the home which she owned on her death, and which was then reacquired by Dr Phizackerley in return for his IOU, was therefore property derived from him within section 103. It followed that when he in turn died, section 103 disallowed deduction of the IOU debt in calculating the inheritance tax liability. The response put forward for the taxpayer was that the original gift of half the home by Dr Phizackerley to his wife was a disposition for her maintenance and therefore, by virtue of section 11 of the Finance Act 1986, not a transfer of value. There was considerable argument about the precise meaning of maintenance, but the commissioner ruled that it must be either income or a capital payment made to satisfy an income liability. In this case the presumed intention was to provide the wife with security, not maintenance.
Dr Phizackerley's taxable estate included the entire value of the home but the IOU debt could not be deducted for inheritance tax purposes. The overall result was broadly what it would have been if the 1996 financial planning had never taken place and the property had remained in his sole ownership throughout. The intention behind the financial planning, to offset both nil rate bands against the couple's joint assets, was largely frustrated. Mrs Phizackerley's nil rate band was used up to the value of her estate when her assets passed into her discretionary nil rate band trust in 2000. But over £150,000 of Dr Phizackerley's nil rate band was wiped out by his inability to deduct his IOU debt, which had become an asset of his wife's nil rate band trust, from the value of his own estate which at his death included the whole value of the family home.
The unfortunate outcome resulted from a combination of factors which will not be found together in the majority of cases. First, the couple died in the wrong order. The section 103 argument could not have been used if Dr Phizackerley had died first. Second, Mrs Phizackerley had never earned during the marriage. Consequently when she died, Mrs Phizackerley's only significant asset was her share of the property. Had her estate contained sufficient other assets to satisfy the nil rate bequest, her share in the home need never have fallen into the will trust and the problems which flowed from that would not have arisen.
There was nothing inherently unsound in the concept of using discretionary nil rate band will trusts to enable both nil rate bands to be used, or in severing the joint tenancy of the family home to provide an asset to go into the will trust on first death. That the couple might die in the wrong order was foreseeable but not preventable. The size of Dr Phizackerley's estate when he died does not suggest there was scope to transfer sufficient other assets to his wife during her lifetime to fund the nil rate band trust coming into effect under her will. So it was also unavoidable that after Mrs Phizackerley's death her share of the home would by default fall into the nil rate band trust, and that an equivalent asset would have to be created for that purpose if it was intended instead to pass that share of the home back to her surviving spouse. That is where after her death things could have been organised differently and to better effect, assuming the terms of her will so permitted. In this case, the alternative asset created was an IOU given by Dr Phizackerley. The generally acknowledged safer route is for the executors to impose a legal charge over the property in favour of the trustees of the will trust, securing the indexed value of the half share, before the property is transferred back to the surviving spouse. If that is done, the incumbrance is created by the executors, not the surviving spouse, and for no consideration. Section 103 of the Finance Act 1986 does not then add the debt back into the estate of the surviving spouse on death.
Some commentators have suggested that for additional safety the surviving spouse should not act as executor, or certainly sole executor, on first death, as they would then be making the "disposition", albeit in an executor rather than personal capacity.
Nothing in this case undermines the validity of properly carried out inheritance tax planning based on mutual discretionary nil rate band will trusts. There is no problem if both partners have sufficient other assets to satisfy the nil rate band legacy without recourse to the value of a share in the family home. In that case there is no need for the survivor to give the deceased's executors an IOU as happened in Phizackerley; the survivor is beneficially entitled to the deceased's half share as part of the residue of the estate. Even if a share in the family home has to go into the discretionary will trust for want of other assets, there is only a potential problem if it can be shown that there was a substantial inequality between the couple's financial contributions towards the cost of the family homes which they successively occupied. The Phizackerleys' example was an extreme and fairly obvious one. And even where a couple's contributions to the cost of a family home are manifestly unequal and it is necessary for a share of its value to be placed in the nil rate band trust, there is still no problem as long as the executors achieve that by taking a legal charge over the property rather than an IOU from the surviving partner.
The Finance Act 2008 has had a big impact on this area of the law. Schedule 4 introduces a transferable nil rate band. This means a married couple or civil partners can now offset both their nil rate bands against their joint estate for inheritance tax purposes without the sort of financial planning undertaken by the Phizackerleys in 1996. This is something to bear in mind when revisiting the wills of living couples, especially those who have discretionary nil rate band trusts in their existing wills.

Those who worry about negligence claims from their tax planning advice can take some comfort from the fact that it is very difficult to claim damages for negligent tax planning. The main reason for this is that there is no clear claimant. Is the claimant the deceased, the personal representatives or the beneficiaries? The question of whether a solicitor owes duties of care to beneficiaries when advising a client was considered in the House of Lords' decision in White v Jones {[1995] 2 AC 207}. A solicitor provided negligent advice to a testator in connection with the preparation of a will, causing a beneficiary to suffer loss. There was no contractual relationship between that beneficiary and the solicitor. Nevertheless, in a decision underpinned by social justice considerations, the House of Lords held that the solicitor did owe a duty of care to the beneficiary, principally because the absence of any other remedy against the solicitor gave rise to an undesirable lacuna in the law.
Claimants have since sought to apply the principles laid down in White v Jones to different circumstances, such as where a solicitor provides negligent advice on inheritance tax planning matters. The question of who can bring a claim against the solicitor in such circumstances has given rise to difficulties, as is apparent in the decision of the court in Rind v Theodore Goddard {[2008] EWHC 459 (Ch)}. The claimant's mother, Mrs Rind, instructed solicitors to provide inheritance tax planning advice with a view to minimising the value of her estate for inheritance tax purposes. However, Mrs Rind unintentionally reserved a benefit in certain assets, which therefore remained part of her estate for inheritance tax purposes. Following her death, a claim was brought against the solicitors by the claimant, a beneficiary under Mrs Rind's will, in respect of the estate's increased inheritance tax liability.
In seeking summarily to dismiss the claim, the solicitors argued they had owed no duty of care to the claimant as a beneficiary since they had been retained by Mrs Rind, not the claimant. The solicitors also argued that the claimant could not rely upon White v Jones, partly on the basis that the sufferance of loss by the claimant had not been foreseeable on the facts, but also because there was no undesirable lacuna. The additional inheritance tax liability had been incurred by Mrs Rind's estate, and the estate therefore possessed a cause of action against the solicitors. On an application of White v Jones, therefore, there was no need to extend a duty of care to the claimant as a beneficiary.
The solicitors' arguments appear perfectly logical. The key question in identifying the existence of an undesirable lacuna was whether the estate had a cause of action against the solicitors. This would require a combination of: (i) a breach of a duty owed to Mrs Rind during her lifetime; with (ii) a loss suffered by Mrs Rind's estate after her death.
The Court of Appeal had previously held that a testator could vest a cause of action in his estate in this way. Indeed, to hold otherwise would effectively be to draw an artificial legal distinction between the testator and his estate.
However, the solicitors' arguments were unsuccessful, because the court was forced to recognise the decision of the appeal court in Daniels v Thompson {[2004] PNLR 638}. The facts of Daniels were similar to those in Rind. Through reliance upon Daniels, the claimant was able to argue that Mrs Rind's estate did not have any cause of action against the solicitors in respect of the inheritance tax liability, with the extension of a duty of care to the claimant as a beneficiary therefore being justified on the basis of White v Jones.
The court was unable to rule out the existence of a lacuna, and therefore rejected the solicitors' application. In doing so, however, the court said that "if Daniels v Thompson were to be considered again by the Court of Appeal...I am not able to predict what the outcome might be".
The law governing the circumstances in which beneficiaries of an estate are entitled to bring an action against the testator's former solicitors in respect of inheritance tax liabilities suffered by that estate is in need of further consideration. The social policy considerations evident in the decision in White v Jones are arguably less compelling where a beneficiary seeks to recoup the consequences of an estate's failed tax avoidance scheme. However, the disabling of the estate's ability to bring such claims itself may have opened the door for beneficiaries to do so. The sufferance of loss by the beneficiary still needs to have been reasonably foreseeable at the time of the solicitor's alleged breach of duty. Nevertheless, at least until this area of law is revisited by the appeal court, solicitors who advise on matters which could impact upon the value of a client's estate after death need to pay careful attention to the interests of that estate's beneficiaries.


PART TWO - KEEPING AN INTEREST

2 Finance Act 2009

Whilst negligence claims may be unlikely, penalties from the Revenue are a distinct possibility. Section 247 of the Inheritance Act 1984 provides that anyone who fraudulently or negligently submits an incorrect account, information or document to the Revenue shall be liable to a penalty.
In Robertson v IRC {[2002] STC (SCD) 182} one of the special commissioners quashed the imposition of a penalty on a Scottish solicitor, awarding costs against the Revenue. The same commissioner has upset another penalty in Cairns v HMRC {[2009] UKFTT 00008 (TC)}. The commissioner had two grounds for dismissing the penalty. First, the summons issued by the Revenue was insufficiently specific. Apart from attaching extracts from the relevant legislation, the summons, which the commissioner described as having ‘the flavour of a summary criminal complaint’, contained no further specification whatsoever of how or in what respect Mr Cairns had acted fraudulently or negligently. The account or document to which these allegations related was not even identified. It was irrelevant that the notice had been preceded by lengthy correspondence. An initiating document, be it summons, summary complaint or indictment, must set out the parameters of the enquiry, and the essential facts and basis in law on which a public authority relies. If it does not do so, there is bound to be significant risk prejudice. It cannot be determined where the enquiry will begin or end. Second, the commissioner said that he would in any event have dismissed the case on its merits. An individual who later died was not capable of managing his own property and affairs. He was residing in Roslynlee Hospital, but was anxious to return home to Stonefield, which he owned. Mr Cairns was asked by Midlothian Council to act as the individual’s guardian. He obtained a valuation of Stonefield in January 2004 of £400,000 but this was stated to be an ‘arbitrary figure pending investigations as to costs involved in upgrading’. The property was in a terrible condition, suffering from wet rot, dry rot, rising damp and structural defects in the roof. Mr Cairns spent some money making one room habitable, and the owner did return home but died in October 2004. Mr Cairns submitted a form inheritance tax 200 in which he valued Stonefield at £400,000 and paid the tax due at that point. He was uncertain of the true value of Stonefield but considered that the sale price would probably be agreed, in due course, with the district valuer, to be the date of death value. He considered it unnecessary to go to the expense of obtaining a further valuation, which would probably be heavily qualified and not necessarily any more accurate than the existing valuation. There was no evidence of any significant increase in the value of properties in the locality between January and October 2004. He did not describe the value attributed to Stonefield as a ‘provisional estimate’, something which the commissioner described as ‘in the circumstances, careless’. There were difficulties selling the property and the Revenue was informed, responding that the district valuer ‘must still consider the date-of-death value... regardless of any subsequent sales. But he will of course take the (sale) into account when considering his values’. Stonefield was subsequently sold for £600,000. Mr Cairns sent a cheque for the tax, based on an the Revenue estimate of the tax due. There was still some doubt as to the full extent of the deceased’s estate and, in the event, some tax was refunded. The Revenue argued that Mr Cairns should have obtained another professional valuation. However, the commissioner described this is bare assertion. The mere failure to obtain another valuation, when it had not been established that a second valuation would have led to a different figure being inserted in the statutory form, did not constitute negligent delivery of an incorrect account. It could not be suggested that a prudent personal representative, or even a solicitor acting as such, should have foreseen when completing the statutory form that Stonefield was likely to sell for £600,000. The commissioner said: ‘Negligent conduct amounts to more than just being wrong or taking a different view from the Revenue.’ The only respect in which it could be said that the account had been negligently furnished was the failure to describe the value as a provisional estimate. Omitting to do so was a careless error. However, the commissioner said that it was ‘minor, technical and of no consequence whatsoever’. It had no effect on the dealings between the Revenue and Mr Cairns as executor. Stonefield was sold. the Revenue was kept informed. In effect, the Revenue reserved its position as to whether it would regard the sale price as the date-of-death value. The tax was duly paid, indeed overpaid, and a refund eventually paid to the deceased’s estate.

A new tax penalty regime came into force on the 1st April 2008 and the Revenue has issued a statement and some frequently asked questions explaining how it works. Most of it is reasonably predictable but it does contain the interesting and novel idea that the taxpayer can make an innocent error for which he should not be penalised. There is no penalty for a person who rakes reasonable care but submits an incorrect return. However if they later discover the error but do not take reasonable steps to tell us about it, the inaccuracy will he treated as careless.
Each person has a responsibility to take reasonable care. But what is necessary for each person to meet that responsibility has to be viewed in the light of their abilities and circumstances. For example, we would not expect the same level of knowledge or expertise from a self employed unrepresented individual as from a large multinational company. Every person is expected to make and keep sufficient records for them to provide a complete and accurate return. A person with simple straight forward tax affairs needs to keep a simple system of records which are followed and regularly updated. A person with larger and more complex tax affairs will need to put in place more sophisticated systems and maintain them equally carefully. We believe it is reasonable to expect a person who encounters a transaction or other event with which they are not familiar to make sure to check the correct tax treatment or to seek suitable advice. This does not actually say what reasonable care is, but the principle is clear enough - and I suppose there is enough authority in other areas of the law for us to have a good idea of what it means.
Where the taxpayer does not take reasonable care, there is obviously a high probability of him being negligent and a more conventional penalty regime will apply - but with the Revenue saving its real ire for those who go in for deliberate concealment.
In a similar vein to the introduction of a single penalty regime, the Revenue has introduced a common interest rate regime that will apply across all taxes and duties. The legislation is contained in Schedules 53 & 54 of the Finance Act 2009 and the Taxes and Duties (Interest Rate) (Amendment) Regulations {SI 2009/2032} came into effect on 12 August 2009. The effect of the regulations is that the current Inheritance Tax interest rate of 0 per cent for both charging and repaying interest will remain in place until new rates are set by reference to the September meeting of the Bank of England’s Monetary Policy Committee. With effect from September, the current single rate of interest for Inheritance Tax, Capital Transfer Tax & Estate Duty will be replaced by one rate for charging interest on unpaid tax and another, lower, rate for the repayment interest supplement that is added to repayments. The regulations stipulate that the rate for charging interest on unpaid tax will be the Bank of England base rate + 2.5 per cent. The rate of interest that will be paid on repayments of tax and interest will be the Bank of England base rate - 1 per cent, although the rate for the repayment interest supplement is subject to a floor of 0.5 per cent.

Private client lawyers are always anxious not to create an inadvertent interest in possession. The problem is particularly acute in connection with the occupation of properties held wholly or partly on discretionary trusts. The most recent decision is Judge (Personal Representatives of Walden deceased) v HM Revenue & Customs {[2005] WTLR 1311, SpC 506}. The case of Judge is an exciting development in the long running debate over whether occupation of a property under a discretionary trust represents an interest in possession for inheritance tax purposes.
The proposition is comparatively simple. One party to a marriage dies leaving the matrimonial home on discretionary trust for the benefit of the family, with various powers to allow the surviving spouse to remain in occupation. The Revenue considers that this represents an interest in possession and its view is set out clearly in Statement of Practice SP 10/79.
This statement of practice is highly controversial and has been the subject of much adverse comment over the years. However, the decision in IRC v Lloyds Private Banking Limited {(1998) STC 559; [1998] 2 FCR 41} did give the Revenue a degree of support for its view. In that case the testatrix left a half share in a property to trustees to hold on discretionary trusts, subject to the proviso that they should not make any objection to the husband residing there as long as he wanted. The High Court concluded that in such circumstances, an interest in possession was created with the result that the settled property formed part of the estate of the surviving spouse and was liable to inheritance tax on his death.
It is well established that an interest in possession arises where there is a present right to the present enjoyment of the settled property. The High Court in Lloyds Private Banking construed the proviso as giving the widow a present right of present enjoyment and therefore an interest in possession.
In Judge the Special Commissioners were able to reach a quite different conclusion and it remains to be seen whether it stands up on appeal - for an appeal must be inevitable given the enormous significance of the point involved.
On Mr Walden’s death, his personal representatives had administered his estate on the basis that his widow had been given an interest in possession in the matrimonial home. The residue had been left on discretionary trusts. Mrs Walden died three years after her husband, and her personal representatives contended that the clause in Mr Walden’s will dealing with the matrimonial home had created a discretionary trust, so the value of the home was not to be included in Mrs Walden’s estate. The special commissioner reviewed the recent case law on interests in possession. She quoted the dictum of Lord Reid in Gartside v IRC {[1968] AC 553} – ‘In possession must mean that your interest enables you to claim now whatever may be the subject of the interest… a right to require trustees to consider whether they will pay you something does not enable you to claim anything’ – and that of Viscount Dilhorne in Pearson v IRC {[1980] STC 318}: ‘For there to be an interest in possession, there must be a present right to present enjoyment of something.’ It was agreed by all parties that clause 3 of Mr Walden’s will was unclear. Applying the rules of construction, the Special Commissioner found that the house was left to trustees, who could not sell it without the consent of the deceased’s widow. However, pending the sale, any rents were to be held on the discretionary trusts applying to the residue of the estate. The clause went on to declare: ‘My trustees during the lifetime of my wife may permit her to have the use and enjoyment of the said property for such period or periods as they shall in their absolute discretion think fit.’ In the Special Commissioner’s view, it was clear that Mrs Walden had no right to occupy the property. The trustees had a discretion as to whether or not to permit her to reside, and this was incompatible with the will giving her a right of occupation. This decision is helpful to taxpayers in reinforcing the fact that an individual must be given a right before they can have an interest in possession. However, it gives no guidance on the issue of what actions on the part of trustees in exercise of a discretion might confer an interest in possession. The trustees had believed that the widow already had an interest in possession and had, therefore, taken no steps to exercise their discretion to give her an interest.
It was obviously necessary for the Special Commissioners to distinguish this case from Lloyds Private Banking and the key distinction was the lack of any enforceable right to reside in the property. Mr Walden’s will provided no such right for his widow because although the property was held on trust for the widow to have the use and enjoyment of the property, it was only for such period as the trustees in their absolute discretion thought fit. If Mrs Walden had no right to occupy the property, no interest in possession could exist.
The matter was complicated by the fact that it was clearly the intention of all parties that the widow should continue to occupy the property as long as she wished; those who drafted the will thought that the widow had an interest in possession and had advised on a number of occasions that this was the case. Furthermore, for the property to pass into discretion meant that the spouse exemption did not apply and this was unlikely to have been intended by the deceased. However, despite these indications, Special Commissioners said that the terms of the will were clear and unambiguous and did not confer on the widow the right necessary to create an interest in possession. This case will be a serious blow to the Revenue stance on this whole subject because SP 10/79 includes the proposition that an interest in possession will arise “if the power to permit a beneficiary to occupy a property forming part of trust property is drawn in terms wide enough to cover the creation of an exclusive or joint residence, albeit revocable, for a definite of indefinite period and is exercised with the intention of providing a particular beneficiary with a permanent home”. It is no exaggeration to say that if Walden stands, SP 10/79 goes out of the window. Some will say not before time.
When advising clients in relation to the matrimonial home either before death or in the context of a post-death variation, practitioners should not underestimate the lengths that the Revenue will go to in an attempt to argue that the entire value of the property remains in the surviving spouse’s estate. Therefore, they should make sure that they have advised clients of the possible risks, and looked at all the alternatives.
Not only has the Revenue waged a war on lifetime tax planning with the introduction of the pre-owned assets tax regime, but now it is also taking an unhealthy interest in a surviving spouse’s occupation of the matrimonial home where a share has already been passed down to the next generation by way of deed of variation, or otherwise. What was once innocent and straightforward tax planning is now being treated as devious tax avoidance by the Revenue, which is requesting unprecedented amounts of detail to justify the occupation. The Revenue's letter goes on to ask them to justify various things, including:
Whether their mother was the only person who had any right to occupy the property having regard to sections 12 and 13 of the Trusts of Land and Appointment of Trustees Act 1996; Whether the children could disturb their mother’s right to occupy the property and turn their interest in land to account during her lifetime; Whether in fact the children held their share of the property on trust for their mother for life;
Was the mother in exclusive occupation of the property between her husband’s death and her death? What explanation was given to all parties about the deed of variation and, in particular, their rights and obligations in relation to the property? What is more, the frequent absence of anything to back up the surviving spouse’s occupation of the property is being used by the Revenue as evidence of something far more sinister, like an implied trust. What should the practitioner do if faced with a similar list of questions from the Revenue, and how does one avoid running up an enormous bill for clients? The first thing is not to panic. Many of the questions can be dealt with simply. Look at each question in turn and decide whether the Revenue is entitled to ask for a reply, or whether the question is simply ‘fishing’ for further information that the client is under no obligation to disclose. It is important to be conscious that any answer given to the Revenue may provoke further questions. There may be no right answer – it is often down to being able to persuade the Revenue, on the facts in question, that the surviving spouse did not have an interest in possession. It is the client’s word against the Revenue’s.

We mentioned pre-owned assets tax, and it is extremely relevant in the context of a widow wishing to occupy the family home, while transferring it into the names her children. This sort of arrangement might fall foul of pre-owned assets tax. The Finance Act 2004 created a new form of tax which has great relevance to inheritance tax, namely pre-owned assets tax. Pre-owned assets tax retrospectively covers transactions entered into at any time since 17 March 1986. It imposes an annual income tax charge on those who continue to benefit from an asset they formerly owned or to which they contributed, and will catch property owners who have side-stepped liability to inheritance tax by gifting significant assets, such as a family home, to family members and then continued to use them. Tens of thousands of taxpayers are potentially affected. In many cases it will be obvious that they are caught, but there will be other situations in which a liability will be unexpected. Pre-owned assets tax is a bit of a mouthful, but everyone who advises private clients will have spent many hours grappling with it. Though it came into effect on 6th April 2005, Pre-owned Assets Tax was first announced in December 2003. This new scheme tackles inheritance tax avoidance by imposing an income tax charge. There is to be a freestanding income tax charge under Schedule D on the benefit received by the former owner of the property. Property includes land, chattels and other intangibles.
The purpose of Pre-owned Assets Tax is to bolster the inheritance tax gift with reservation of benefit provisions by imposing an annual income tax charge on those who continue to benefit from an asset they formerly owned or to which they contributed. This means that, in general, there is either a liability to Pre-owned Assets Tax or potentially to inheritance tax in respect of an asset, but not to both. There are exceptions, but it is useful to bear this principle in mind when analysing what is and what is not caught. The Pre-owned Assets Tax legislation is to be found in Schedule 15 to the Finance Act 2004. The legislation is complex and reference should always be made to the exact wording.
Schedule 15 is divided into three parts: land; chattels and intangibles. There are different specific rules for each category, but also some general rules that apply to all three. One general rule is that taxpayers are only liable to Pre-owned Assets Tax if they are UK resident during the tax year in question.
As regards land, an individual is liable in respect of land if: (a) he occupies it; and (b) he satisfies either the disposal condition or the contribution condition. “Occupies” is not defined. It includes living in the property, whether on a permanent or occasional basis, but not receiving the rent from it. In other words, let properties are not caught by Pre-owned Assets Tax. To satisfy the disposal or contribution condition, the taxpayer must have disposed of the land or provided consideration given by another to acquire it.
The regime for chattels is similar to that for land. The test is whether the individual is in possession of, or has the use of, the chattel and has either disposed of it or contributed to it, other than by an excluded transaction. There are several excluded transactions defined by the Act. The most important is transfers between spouses.
The regime for intangibles is more limited. Intangibles can only give rise to a liability to Pre-owned Assets Tax if: (i) they are held in a settlement; and (ii) under the terms of the settlement, the settlor is liable for income tax under section 660A of the Taxes Act 1988.
There are some exemptions which apply to all three regimes, land, chattels and intangibles. Consistent with the overall approach that assets that will be liable to inheritance tax are not caught by Pre-owned Assets Tax, the most important exemptions apply where the asset concerned is part of the taxpayer’s estate for inheritance tax. So, if your elderly grandmother places her house in a life interest trust for herself, the house still forms part of her estate for inheritance tax, and the Pre-owned Assets Tax exemption applies. Another important exemption from the whole scheme is where the cash value of the benefit retained is below the de minimis threshold set at £2,500.
The next question is what is the rate of this tax charge. The rate is 5% and is applied to the amount of benefit retained. The benefit retained is to be calculated by looking at the open market rent where the asset is land and imputed percentages of capital value for chattels or intangible assets. Pre-owned Assets Tax is calculated in different ways for the three regimes. For land, the taxpayer is treated as having the rental value of the land added to his annual income. So, broadly speaking, a higher rate taxpayer would pay Pre-owned Assets Tax of £20,000 on a house with a rental value of £50,000 per annum. In the case of chattels, the Pre-owned Assets Tax is calculated by reference to the official rate of interest, as defined in section 181 of the Income Tax (Earnings and Pensions) Act 2003, which currently stands at 5%. Intangibles are taxed by reference to the same rate of interest, with credit being given for certain taxes paid by the settlor.
The charge itself is to be calculated according to the nature of the asset. The chargeable amount for land will, in general terms, be the market rent that would be regarded as appropriate in the circumstances. Thus, on a notional 5% rent, the chargeable amount in respect of a property worth £400,000 would be roughly £20,000. Specific rules apply to the computations to be made in respect of both chattels and intangible property. It is not difficult to see the arguments that are going to arise with regard to determining the chargeable amount.
Some taxpayers will be prepared to pay Pre-owned Assets Tax to preserve the inheritance tax savings. This may be appropriate for those who have a limited life expectancy or who, perhaps, are intending to give up use of the asset in the medium term. But they will need to bear in mind the possibility of rental values rising dramatically in the future, increasing the amount of Pre-owned Assets Tax, or indeed income tax rates generally being raised.
The legislation is retrospective, so it is difficult to avoid it. However, some transitional relief has been given. Provided the taxpayer makes an election by 31 January 2007, he can opt for the asset in question to remain part of his estate for inheritance tax purposes. This allows taxpayers who set up gifts with reservation of benefit to cancel the gifts for tax purposes. The taxpayer will have to decide whether or not he wishes to bear the new income tax charge regardless, on the basis that this is still likely to be more beneficial than the loss of the inheritance tax saving, or he can pay a full market rent for his continued use of the asset.
Dismantling is not an option, as the new tax will have bitten already. The best way of avoiding Pre-owned Assets Tax, is to make an election. The legislation allows the taxpayer to elect that the asset in question is liable to inheritance tax on his death. In return, there is no liability to Pre-owned Assets Tax. An election must be made by the 31st January in the year following that in which the liability to Pre-owned Assets Tax first arose. An election is designed to negate any inheritance tax saving that may have been achieved. But this area contains surprises, mostly unpleasant. Some of these are mentioned below.
Sometimes it is possible to adjust matters so that the taxpayer is not caught by Pre-owned Assets Tax and so that all or part of the inheritance tax savings are preserved. Some arrangements for the family home can be restructured so that the former owner pays the market rent. This in itself can be inheritance tax-efficient, as the rental payments are immediately outside the estate. Furthermore, the income tax on the rent can be reduced by using up the younger generation’s personal allowances and lower tax bands. In other situations, a more sophisticated route may be available, and each case will need to be examined individually.
There is one saving grace in the £5,000 annual exemption, rather like the Capital Gains Tax exemption. If the total tax payable in any year of assessment under the Pre-owned Assets Tax regime does not exceed £5,000 it is exempt. The effect of this, on the basis of a notional 5% return, is that this exemption will take out of the charge a property worth up to £100,000. However, once the £5,000 exemption is exceeded, the exemption is lost altogether.


NOTE TO LAWYERS
If you intend to quote one of these cases to a judge, first you must obtain a full copy of the judgment. Use "The Law Reports Index" or "Current Law Case Citator". Judges are entitled to insist upon sight of a full copy of the judgment, before they take notice. When citing a case reference, however, always use the neutral citation.


MULTIPLE CHOICE TEST
Subscription Area: Property
Title of Recording: Inheritance Tax (Dec 2009)


NAME OF LAWYER...............................................................................................

RING THE CORRECT ANSWER

PART ONE - The Nil-Rate Band
Question 1: Brian & Janet are planning the disposal of their estate and have consulted you with a view to drawing up their wills. They want to minimise their exposure to IHT, mainly for the sake of their son Darren. They own their home as beneficial tenants in common. Brian also has shares in a FTSE tracker worth £300,000. They ask you what the current nil-rate band is?
A £300,000
B £315,000
C £325,000

Question 2: They make identical wills. Each will states that there should be a legacy to Darren up to the maximum of the nil-rate band, while the residue goes to the other spouse. Their home is subject to an outstanding mortgage of £30,000. The house on the right was sold for £330,000, but the house on the left was repossessed for £300,000. What value would the Revenue attribute to their home?
A £330,000
B £300,000
C £270,000

Question 3: Which part of the Finance Act 2008 allows the nil-rate band to be transferred between spouses?
A section 103
B schedule 4
C section 247

PART TWO - Keeping an Interest
Question 4: Brian dies leaving his share of the home to Janet. Darren receives the nil-rate band legacy. Janet decides to make sure that no inheritance tax can be charged on the home, by transferring it into Darren's name, and relying on a private agreement to continue living their until her death. Why might this fail?
A because it amounts to a settlement
B because it is a gift with reservation of benefit
C because it gives rise to a discretionary trust

Question 5: If she falls foul of pre-owned assets tax, what rate of tax if payable?
A none
B the same rate as income tax
C 5%

Question 6: Upon Janet's death, you make a mistake in completing form IHT 200. In which of the following circumstances can the Revenue impose a penalty on you?
A if you have acted negligently
B only if you have acted fraudulently
C the client would be liable to a penalty but not the solicitor

 

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