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The Poat race

Having interrupted my series of articles on the use of property in inheritance tax planning to examine points of interest in the pre-Budget report, it is now time to return to my original topic.

With property representing a major part of the taxable estate of so many people, financial advisers will need to be aware of the new pre-owned assets tax and its application to property.

The first thing to consider in respect of a gift of property is whether Poat applies. The rules can come into play when a person disposes of an asset, such as a private residence, as a gift or for less than full value and continues to occupy or enjoy the asset in whole or part.

The tax is chargeable on worldwide assets where the individual is UK resident and domiciled or deemed domiciled for inheritance tax purposes. The Finance Act 2004 sets out formulae for calculating the charge, which is based on rent that the donor should have paid.

Certain transactions, while potentially caught by the rules, will not be taxable because they fall within the definition of excluded transactions. There are also a number of exemptions:Property subject to and remaining within the gift with reservation charge.

The object of the Poat rules is to catch transactions that give the donor a benefit without being caught by the GWR rules. In light of this, there should not be a double charge to IHT as a GWR and income tax as a pre-owned asset.

The Finance Act makes provision whereby an individual can elect for the gift to be assessed as a GWR and be outside the Poat charge by January 31 following the end of the initial year, being the first year for which the Poat rules apply to the individual in respect of a particular transaction.The disposal of the whole interest in any property in an arm’s length transaction with an unconnected person or as might be expected to be made between unconnected persons.

Where a transaction is not a gift, the Poat rules do not apply. This includes transactions such as might be expected to be made at arm’s length between persons not connected with each other. So, for example, a sale to a connected person, say, father to son, will not be caught if a full market price is paid.A disposal by way of gift into trust where the settlor, spouse or former spouse remains beneficially entitled to an interest in possession.

A person puts a property into trust under which he has the interest in possession. As it remains in his taxable estate, it makes sense that the Poat rules should not apply. This exclusion applies so long as that interest has not come to an end, otherwise than on death, at which stage IHT will normally become payable.The home loan scheme on death.

This utilises the IHT nil-rate band by way of a discretionary will trust taking an appropriate loan/charge on the home left to the surviving spouse. This common arrangement should remain effective because it does not involve a gift during a person’s lifetime. However, other factors need to be considered, not least whether a true trust exists and that the debt will be deductible from the taxable estate of the spouse on his/her subsequent death.The individual has ceased to own the asset or an interest in it before March 18, 1986.

The GWR provisions were introduced for IHT purposes on March 18, 1986, so it makes sense that transactions before that date should not be affected. The new Poat charge applies to all subsequent transactions.Non-residents and nondomiciliaries.

If the individual is non-UK resident for any year of assessment, no charge should arise for that year. If he or she is UK resident but non-UK domiciled for IHT, the charge should only arise in respect of UK property. If the individual was non-UK domiciled when he created a trust investing in non-UK property, the Poat charge does not apply because the trust will be excluded property for IHT.Redirection of property under a deed of variation.

Typically, this applies where a beneficiary inherits by will or on intestacy and the inheritance is varied within two years of the death. No Poat charge arises. Deeds of variation may thus be a good way to avoid the GWR and Poat provisions.

Say a widow is left an asset under her husband’s will and gifts the asset into a discretionary trust under which she is a potential beneficiary. This will be a GWR or, if it escapes those provisions for any reason, a charge will apply under the Poat rules. But if the widow creates the discretionary trust by way of a deed of variation, there will be no GWR and no charge under the Poat rules.De minimis cases.

A de minimis limit applies of 5,000 a year. If the benefit is 5,001, tax will be charged on the entire benefit. If it is 4,999, no tax charge will apply.Sharing arrangements.

A typical arrangement involves occupation and ownership of a property by donor and donee, say, where a widow transfers a share of the beneficial ownership of her home to a son or daughter and they jointly occupy the property and pay outgoings in their due proportions. Such an arrangement is not caught by the GWR rules because of section 102B (4) Finance Act 1986. Also, from April 6, 2005, this arrangement is likely to be outside the Poat charge. It is recommended that as a general guide that ownership should be on a 50/50 basis.

We must now look at those arrangements that would be caught by the Poat charge. Perhaps the best known of these is the double trust or IOU scheme. This involves a settlor establishing a trust under which he has an interest in possession. He sells his home to this trust but, rather than pay cash, the trustees give the settlor an IOU. The settlor gifts this IOU to another trust for the benefit of his family.

Thus, it is possible to transfer an amount equal to the current value of the house outside his estate after seven years but still occupy the home. Any growth in the value of the house continues to be in the settlor’s taxable estate unless interest is charged on the loan and accumulated.

It is thought that the debt would constitute an excluded liability for the purposes of paragraphs 11 (6) and 11(7) Schedule 15 Finance Act 2004. This mean that to the extent that the property value is matched by the debt, it would be subject to the Poat rules.

I will look at some of the other schemes that are available in my next column.

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