INHERITANCE TAX - 20.04.2022

Using the pre-owned assets rule to save tax

Tax and gifts with reservation

Nearly 20 years ago the pre-owned assets (POA) charge became law. It attempts to stop avoidance of one tax - inheritance tax (IHT) - by charging another - income tax. The theory is that if you escape IHT unfairly you get caught for a POA tax charge. It can apply if you give away an asset and continue to get some benefit from it. This is known as “a gift with reservation of benefit ”. For example, transferring ownership of antique furniture to your family but keeping it in your own home .

Reducing your estate for IHT purposes

From a tax planning angle giving away some of your possessions to your family, e.g. children and grandchildren, instead of cash can be more effective.

Example. Jamal wants to reduce the value of his estate to cut the potential IHT bill when he dies. He therefore transfers a property, worth £300,000, to his son and his wife who occupy it with their children as their home. If Jamal survives seven years from the date he made the gift the £300,000 will cease to be subject to IHT. A corollary of this is that if the property increases in value to, say, £400,000, the £100,000 growth also escapes IHT.

Trap. Don’t give away assets that are likely to fall in value, e.g. cars. If you don’t survive seven years following the gift, the value of the assets becomes chargeable to IHT, although a special relief can reduce the value taken into account.

For detailed commentary on “fall in value relief”, visit https://www.tips-and-advice.co.uk , Download Zone, year 22, issue 14.

The pre-owned assets trap

In our example, HMRC’s view is that if Jamal visited his son he would benefit from the gift so it would be a gift with reservation of benefit . But if the benefit is minimal, i.e. Jamal doesn’t make long or frequent visits with his son HMRC accepts the gifts with reservation rules won’t apply and there cannot be a POA charge. Conversely, longer or more frequent visits could trigger the tax. At the current rates, if the POA charge applies it would be £8,000 (£400,000 x 2%) every year for the rest of Jamal’s life or until Jamal ceases to reserve a benefit from the gift of the property.

Avoiding the POA charge

Jamal knows about the POA charge and that it can be avoided if he pays his son in return for the benefit he gets from visiting. The amount he pays will reduce the charge. So, while the property remains valued at £400,000 Jamal could avoid the POA charge by paying his son £8,000 per year for the benefit he gets when he visits. The trouble is the payment counts as taxable income for his son.

Tip. Instead of giving the property to his children, he could give it to his grandchildren. If they have no income, say, because they’re still in full-time education, their tax-free personal allowances will exceed the income and there will be no tax for them to pay. This principle applies not only to the POA charge on a home but also to other gifted assets, e.g. antiques. However, remember that when you give away assets to family (apart from your spouse or civil partner) it counts as if you had sold them at their market value. There might therefore be a capital gains tax charge.