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When the Poat comes in

John’s Eversden scheme – resulting from a legislative anomaly exposed in CIR v Eversden (2003) – allowed a gift of the interest represented in the value of his home to be transferred to his children.

This was done in such a way that John could remain living in the home without it being deemed to be a reservation of benefit, which would make his gift ineffective for inheritance tax purposes.

However, he will now be caught by the pre-owned asset tax, which was created by Schedule 15 of the Finance Act 2004 and was designed to close this loophole.

John could now face a tax charge based on the value of the benefit he receives by living in the property. The annual value is calculated in accordance with guidelines set out in paragraph 5(2) of Schedule 15.

In essence, the annual value equates to what the property would cost him to live in if it was being rented rather than owned. As the property is worth 400,000, the value will be 20,000 a year, assuming a 5 per cent yield.

John has two choices. He can pay the tax and, hence, keep intact the IHT benefits he has created. Alternatively, he can make an election which states that his home continues to be a gift, albeit with reservation. This means that while he will not have to pay the tax, he will lose the inheritance tax savings.

He must make his decision by January 31, 2007. When the decision is made, he cannot later change his mind after that same date.

It is necessary to compare the cost of the tax against the IHT savings in order to advise him. Assuming that John is a 40 per cent taxpayer, he will pay 8,000 in Poat. On the other hand, as he has assets other than his home in excess of the IHT threshold of 275,000, additional IHT of 160,000 will be payable if he elects not to pay the Poat.

So, at first glance, John will have to continue living in his home for 20 years before the new tax charge becomes more than the IHT saving. Of course, this ignores increases in property and rental values, as well as potential changes in income and inheritance tax, but at least provides a good starting point.

The situation needs care- ful thought. The sum of 8,000 is a lot of money to find from the income of a retired person, albeit one who has income sufficient to cause 40 per cent taxation.

John and his family need to consider just how important is it for them to save IHT on the house. Is it important enough to warrant an 8,000 tax bill? What is his financial lifestyle like? Does he require every penny of his current income? If he does and the 8,000 would have to be taken from assets rather than income, this makes the situation even more complex.

Another approach would be to closely examine John’s overall financial position in order to ensure effectiveness both in terms of creating income and incurring tax. Being more efficient elsewhere within the budget could find some of the extra expenditure needed to pay the Poat.

For example, John may well be creating income from building society and bank deposits which is taxed at 40 per cent. By moving at least some of this capital to an investment bond wrapper (with no need to change the risk profile) he could make use of 5 per cent tax deferral on withdrawals, increasing his net income gain.

Finally, thinking out of the box, John could elect to maintain his home as a gift with reservation. As stated above, the gift is then ineffective for IHT but he escapes the Poat. He could then arrange a whole-of- life policy to generate the amount needed to pay the IHT on the home. For a man of John’s age, this pol- icy could be bought for around 430 a month (source: The Exchange).

This would be on a maximum basis, where little money goes towards actual investment and premiums increase in years to come. However, this is clearly a cheaper option than saving the IHT by opt- ing to pay the Poat.

So, John gains the best of both worlds – the IHT is paid and the Poat avoided. Even better, John would have the satisfaction of knowing that while some additional expenditure would be required, at least the money goes to someone other than the taxman.

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