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Judgement day

How has the recent Judge case impacted on IHT planning using the private residence?

The recently reported Spec- ial Commissioner’s case of Judge and Another (Representatives of Walden Deceased) serves as a good reason to consider what can and cannot be done in connection with inheritance tax planning using the private residence.

Before doing this, how- ever, it is worth reminding ourselves of the background. The importance of residen- tial property in delivering IHT yield to the Treasury is well known among advisers. Despite the recent slowing of the growth in value of residential property generally, those who are concerned at all about IHT are likely to have a particular interest in how to plan to reduce the liability arising because of their ownership of property.

Commercial organisations are well aware of this interest and the past few years have seen a plethora of property-related IHT schemes and structures introduced to the market. These include the lease carve-out scheme (made famous in the Lady Ingram case), the prior spousal interest scheme (more recently determined in the Eversden case) and the double trust/ debt scheme that substantially triggered the new pre-owned assets tax legislation.

Currently, arrangements are emerging based on equity release, including lifetime loan and reversion-based schemes. There is also an arrangement involving equity release which facilitates the purchase of an interest in an excluded property trust. Is there no end to ingenuity?

Well, there might be. There is no current requirement under the new disclosure provisions to disclose to HM Revenue & Customs schemes or marketed arrangements whose sole or main objective is to avoid IHT. This is regardless of the fact that the scheme may be founded on or involve a financial instrument. The disclosure provisions have, to date, been focused on preventing the use of schemes that aim to make significant dents in the Government’s expected yield from PAYE on the rewards of employment, in particular, City bonus schemes.

It must be reassuring for the Government to know it can use legislation to expand the disclosure regime, if it wishes, to cover schemes aimed at avoiding IHT. The recent National Insurance Bill expands disclosure to cover NI avoidance.

I have mentioned some of the schemes that have been in use to diminish the IHT due on residential property through lifetime planning. Their number has undoubtedly been diminished by successive targeted legislation and then the Poat. Of course, the gift with reservation provisions are also in place. Where a benefit continues to be enjoyed by a donor who does not pay for that enjoyment, it is the GWR provisions that will be applied first. The Poat only applies in those circumstances where the GWR provisions do not.

It is the fact that a donor can only enjoy a benefit (and thus have their gift caught by the GWR or Poat rules) if they remain alive after the “offensive” gift has been made that makes effective IHT planning through the will more achievable. But even here it is not all plain sailing, as the Judge case referred to at the beginning of this article proves.

Broadly speaking, it remains effective to make an outright gift of an interest in property on death to one’s children, despite the fact that the donor’s spouse (usually a joint owner) continues in exclusive occupation with- out paying a market rent.

Of course, under English law, in order to facilitate this, the property in question must be held by the joint owners as tenants in common. But this can even be arranged post-death via a deed of variation. The process is not difficult.

It is worth mentioning that I have noticed pockets of misunderstanding about the effect of severing a joint tenancy to leave the holders as tenants in common. Some clearly believe that the mere creation of the tenancy in common can diminish IHT of itself. Of course, it can’t.

Much like a gift from one spouse to another (“equalisation”), it is a means to an end. It merely enables IHT planning to take place. The severance of the joint tenancy then enables the joint owners to leave their share in the property on death to other than the survivor. As joint tenants, the right of survivorship (jus accrescendi) means that the deceased joint tenant’s share passes automatically (outside the will) to the survivor.

It is fears over a surviving spouse’s security of tenure and control over sale (both concerns seemingly being in the mind of the testator in the Judge case) that has driven the development of arrangements to overcome this. Pure conditional gifts that leave a share in a property to, say, children but on condition that they shall not sell or move in (both rights that would normally pass to a joint owner) without the consent of the surviving spouse, have been held to confer an interest in possession on the surviving spouse by virtue of the resulting right of occupation. The key cases here are Lloyds Private Banking (1998), Woodall (2000) and Faulkner (2001).

These were referred to in the Judge case, which I will look at next week.

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