Avoiding a gift with reservation of benefit
Gifts with reservation
If an individual makes a lifetime gift of an asset, even in excess of available inheritance tax (IHT) exemptions, there is generally no immediate charge to IHT on the transfer of value. If the donor no longer enjoys the subject of the gift and has no rights to do so, the value of their estate is reduced by the potentially exempt transfer (PET).
If the donor survives for the next seven years, the PET is disregarded on their eventual death. However, if they die within that period, the “failed PET” becomes chargeable to IHT at the death rates - subject to taper relief if the gift was made more than three years before death.
Not unfettered
If, however, the gift is made with strings attached, it will generally be caught by the gift with reservation of benefit (GROB) anti-avoidance provisions (for HMRC guidance see Follow up ).
Thus where the donor retains possession or enjoyment of the asset gifted, this GROB is brought back into their estate on death (whenever that occurs) as though it had never been made. If, after making the gift, they retain possession or enjoyment for a time and then lose the right to do so, the GROB rules would cease to apply and the seven-year “survival” window would start running from that date.
Example. Bethany gifts the legal interest in a very rare pocketwatch to her daughter on 6 April 2017 but keeps the watch until 6 April 2021 when she finally agrees to physically hand it over. Bethany dies on 6 April 2027 - ten years after transferring the legal interest. Because of the GROB rules, she is treated as making a PET on 6 April 2021 - and therefore did not survive seven years from the effective date. The value of the watch will have to be included in her estate, although taper relief will apply to any tax due on it.
Pro advice. Even though a gift may be brought back into the estate on death for IHT purposes, other tax implications of the original gift (such as a capital gains tax on the disposal) are not cancelled out.
Here we are looking specifically at chattels - that is, items of tangible moveable property such as paintings or articles of furniture. For other assets (for example, interests in land), broadly similar considerations may apply but the tax rules and practical implications may differ.
Have your cake and eat it
In helping to minimise your clients’ IHT liabilities, you may try to ensure that lifetime gifts are not caught by the GROB rules. In simple terms this requires that the donee assumes bona fide possession and enjoyment of a chattel gifted, and that the donor doesn’t continue to benefit from the chattel after it has been gifted.
Life isn’t always this straightforward. In some cases the donor may want to continue to enjoy the chattel while passing its value to the next generation.
In other cases there may be pressing reasons why it should remain in the donor’s home. For example, a parent may have the space and security measures to facilitate keeping a bulky or valuable item in the family home, while their children may lack such facilities.
This was examined in the First-tier Tribunal case of Scott v HMRC (2015) TC04455 (see Follow up ), which looked at the question of whether the GROB rules applied to a gift of some paintings which remained in the donor’s house due to practical issues with their removal.
Pro advice. Always remember that outright gifts may involve non-tax risks. For example, chattels gifted may be lost to a family on divorce or bankruptcy of the donee. In some cases the use of a trust might be considered instead.
A potential solution…
One way a donor may avoid a GROB is by paying a full value market rent for continuing use and enjoyment of the chattel gifted. Where this approach is adopted, HMRC is unlikely to accept anything short of a formal lease agreement negotiated at arm’s length between donor and donee.
To substantiate this, each party should be advised independently by professional valuers, whose task it would be to agree the value of the chattel, and to negotiate the level of rent and other terms of the lease. Typically, valuers might regard a chattel rent based on 1% of capital value as full value and HMRC might accept this, but this could vary according to circumstances.
The terms of the lease should include rent reviews, insurance arrangements and termination provisions. In addition to paying the rent, the donor would normally be expected to meet costs such as storage, security and insurance.
Pro advice 1. Clients may be reluctant to pay rent in order to enjoy what they have always regarded as their own chattels. However, failure to pay adequate rent for valuable assets would probably bring the original gift within the scope of the GROB rules.
Pro advice 2. Once a chattel lease has been entered into, any failure to honour its terms might immediately trigger the GROB rules. Payments of rent should always be made on time - preferably by bank standing order so that the obligation is not inadvertently overlooked, perhaps in the event of illness. Rent review clauses should be carefully observed.
…but watch the trap!
Any arrangement which seeks to ensure that gifts will escape the GROB rules may fall foul of further anti-avoidance provisions, meaning pre-owned assets tax (POAT) may be payable. If a donor, either alone or with other persons, continues to benefit from an asset they previously owned and the GROB rules don’t apply, the POAT rules may impose an annual income tax charge (for HMRC guidance see Follow up ).
The POAT charge (where it applies) amounts to income tax on the benefit enjoyed. This is calculated as “notional” interest at HMRC’s prescribed rate (3% since April 2016) on the value of the chattel at a specified valuation date, minus any rent paid by the donor. In most cases there is no POAT charge where the donor’s disposal of the pre-owned asset was at arm’s length, was made to their spouse or civil partner, or is covered by the IHT annual or small gifts exemption. There is also no charge in a year in which the overall net POAT benefit (after deducting any rent paid) does not exceed £5,000.
Pro advice. Where a client falls within POAT but doesn’t want to pay the income tax, one option is to elect back into the GROB rules. This avoids an early income tax liability, at the cost of losing the longer term IHT advantage that had been sought. An election must be made on the prescribed form by 31 January following the end of the first year in which the POAT charge would otherwise arise (see Follow up ).
Is it worthwhile?
Passing valuable chattels down to a younger generation may be a significant feature in a family’s strategy to minimise IHT liabilities. However, circumventing both GROB and POAT provisions may not be a trivial task, and HMRC is likely to examine any arrangements closely, so you need to proceed with caution.
A word of warning
While it may be attractive for a client to avoid a prospective IHT charge on chattels on eventual death, the cash flow implications of falling straight into an immediate and recurring POAT income tax charge could outweigh any advantage. The professional costs should also be considered, since entering into a chattel lease is likely to incur fees from valuers and solicitors, as well as your own fees for the extra work undertaken.
HMRC guidance: gifts with reservation of benefit
Scott v HMRC [2015] TC04455
HMRC guidance: pre-owned asset tax
Form IHT500
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