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Don&#39t look gift horse in mouth

Advisers active in the inheritance tax planning market will doubtless be aware of the gift-with-reservation provisions as set out in S.102 and Schedule 20 of the Finance Act 1986.

Generally speaking, if a gift is made, whether outright or via a trust, and some benefit is retained by the donor, the full value of the gifted property is deemed to still form part of the donor&#39s estate on death. However, a recent case in the High Court has highlighted a loophole in the legislation which could lead to business opportunities, albeit probably for a very limited period.

The case in question is CIR •Eversden, where judgment was delivered on July 10. The facts were briefly that, in December 1988, the settlor, a Mrs Greenstock, created an interest-in-possession trust initially for the benefit of her husband. On her husband&#39s death, the capital and income were to be held in a discretionary trust under which Mrs Greenstock herself was to be one of the potential beneficiaries. Mrs Greenstock then conveyed her private residence to the trustees to hold on trust, 5 per cent for herself absolutely and 95 per cent under the terms of the trust. Both she and her husband then continued to occupy this property.

Her husband died in February 1992. The next year, the trustees sold the property and out of the proceeds (5 per cent of which belonged to Mrs Greenstock) purchased another residence and an investment bond. Mrs Greenstock then had a 5 per cent interest in this new residence, of which she was the sole occupier until her death in October 1998, and a 5 per cent interest in the bond, from which she received no benefit.

There were several issues before the court. First, the Inland Revenue contended that, as Mrs Greenstock was a beneficiary under a discretionary trust that she had created, this constituted a gift with reservation and thus the value of the trust fund (over £320,000) should be included in her estate on her death. Second, it contended that, as Mrs Greenstock enjoyed sole occupation of the new property purchased in 1993, this conferred a benefit on her which was also effectively a gift with reservation.

The executors of her will, on the other hand, argued that the initial gift by Mrs Greenstock was to her husband and thus was an exempt transfer and, therefore, S.102(5)(a) of the Finance Act 1986 would apply to prevent any charge operating under the general gift-with-reservation rules. This states that, where the original gift was an exempt gift between UK-domiciled spouses, the gift-with-reservation rules cannot operate at all.

The decision in the High Court was a victory for Mrs Greenstock&#39s executors. The court held that the fact that the original gift into trust was to her husband and was thus exempt overrode the other two issues and meant that, in the circumstances, the gift-with-reservation rules could not apply.

This ruling is very significant in that it appears to drive a coach and horses through the gift-with-reservation legislation. It now appears that the gift-with-reservation problem can be overcome if the initial gift is to the spouse and a subsequent appointment of benefits is made to, typically, the children.

Some life offices have for some time been recommending the use of a similar type of arrangement involving investment bonds and doubtless more providers will jump on the bandwagon following the Eversden decision.

Ideally, there should be some considerable time delay between the effecting of the bond and the appointment away. Also, the spouse should actually derive some benefit (say, enjoyment of the 5 per cent withdrawals for a period), otherwise the Revenue may be able to attack the planning on Furniss •Dawson grounds, namely, that the initial interest given to the spouse had no value and was simply a step inserted into the arrangement to derive a tax benefit.

In any event, this potential bonanza will almost certainly be short-lived. The Revenue has announced that it will appeal against the decision although many commentators see this as merely a delaying tactic to give it time to perhaps introduce amending legislation which could be announced in the pre-Budget report in November.

Remember the Revenue&#39s reaction to the last high-profile IHT case it lost – the Lady Ingram case. The law was changed at the first opportunity.

It is unlikely, however, that any action will have retrospective effect, so there does appear to be a small window for this type of planning before the rules inevitably change.


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