Half-baked plans – Tony Wickenden

Every week sees articles in the financial press on the importance of property to the tax well that Chancellor Gordon Brown can draw from. Recently, I have read of the substantial increase in tax yielded from stamp duty and even of the possibility of year-on-year tax on development land to encourage owners to free it up for building.

As property values continue to rise, the eventual inheritance tax payable will boost Treasury coffers even more.

In reviewing the possibilities for estate planning that can be considered through one’s will, you do not have to worry about the pre-owned asset tax. Neither do you have to worry about the Poat where the disposal is made by deed of variation. This is particularly heartening since so many omit to review their will regularly, so missing out on some useful planning opportunities, especially the ability of the first of a couple to die to use their nil-rate band to make non-spousal gifts.

If each of a husband and wife leaves their share of the property under their will direct to the children on the first death, the transfer of the deceased’s share will normally be expressed to fall within the deceased’s nil-rate band. The subsequent occupation of the house by the surviving spouse should not cause the gifted share to form part of the survivor’s taxable estate because they would be occupying by virtue of their continued ownership of a half-share in the property.

The drawback with this type of planning is the loss of security of tenure to the surviving spouse. The surviving spouse will continue to own only a half interest in the house and, should relationships with the children break down, they could force a sale of the house under the Trusts of Land and Appointment of Trustees Act 1996.

Indeed, even if relationships with the children do not break down, there may be circumstances beyond the children’s control, such as bankruptcy or divorce, that result in a forced sale, meaning the surviving spouse will be left with half the proceeds of sale to find alternative accommodation.

To avoid such problems, a further option is to leave a share of the private residence to the children with an instruction that the property is not to be sold while the surviving spouse wants to remain in occupation.

A further condition might be that the surviving spouse should have the right to solely occupy the residence. Would this work? It is known that the Inland Revenue might regard a disposal on such terms as conferring an interest in possession on the surviving spouse. This would cause the children’s share to form a part of the surviving spouse’s taxable estate. As a result, no IHT advantage would arise.

The High Court decision in Lloyd’s Private Banking v IR Commissioners (1998) appears to have confirmed the Inland Revenue reasoning on the existence of an interest in possession in such cases. The dec-ision is interesting because, in this case, the deceased left her share of the house to her daughter (without a formal trust, apparently denying any possibility of arguing that the surviving spouse was a trust beneficiary) but with a provision that the surviving spouse was to be permitted to continue living in the house until his death, provided he paid all the outgoings. It was held that the effect of the provision was to confer on the widower a life interest in the half share passing on his wife’s death.

In particular, it was said that the survivor’s own rights as a tenant in common were not enough to entitle him to exclusive occupation of the whole of the property for the rest of his life. Based on this decision, it would seem that almost anything other than an outright and unconditional gift for the benefit of the children, excluding the co-owner from benefit, could fail on this point.

In Faulkner (Trustee of Rupert Charles Adams Deceased) v IR Commissioners, a house was left by will on trust for residuary beneficiaries but with directions to the trustees to permit a married couple to live in the house for as long as they wished. The trustees had no right to sell the property. It was held that the couple – and then the husband on his wife’s death – occupied the house under a direction in the will. The trustees had no discretion over this and no power to prevent it.

Thus, at the time of the husband’s death, he had a present right to present enjoyment of the house and thus an interest in possession. The residuary beneficiaries did not have a present right in the house until the death of both the husband and wife. The transfer of the wife’s interest to her husband when she died was, of course, exempt under the spouse exemption.

If an individual is to ensure that the granting of an interest in possession to a person occupying a property is avoided, it is important that the terms of the disposal must not limit in any way the full enjoyment of the property by the donee(s) to whom one wishes the gift to be made for IHT purposes.

Accordingly, transferring property into trust for beneficiaries – but where another or others occupy the property and the trustees are impeded by the terms of the trust from preventing their exclusive occupation and/or are prevented from selling the trust property without their consent – will mean the occupiers will be treated for IHT purposes as having an interest in possession in the property.

For married couples who jointly own their residence and want, on first death, to leave their share to other than the survivor – typically the children – while giving the survivor rights to exclusive occupation, these cases highlight the fact that the testator is unlikely to achieve an IHT saving if the means adopted in those cases are used. An alternative which appears to work may be the debt or IOU scheme. I will look at this in a later article.

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