UK Government Closes IHT 'Gifts With Reservation' Loophole

by Robert Lee, Tax-News.com, London

24 June 2003

UK Paymaster General Dawn Primarolo announced last week that a well known loophole in the Inheritance Tax law that allowed the spouse of a deceased homeowner to gift the estate to a trust, thus avoiding IHT, whilst still materially benefiting from the property, will be closed with immediate effect.

The Inland Revenue set out the changes in a recently published statement:

1. Finance Act 1986, section 102 and Schedule 20, contains special rules on the taxation of lifetime gifts where the person making the gift (the donor) reserves or receives any material benefit from the gifted asset. These rules are intended to prevent the avoidance of the IHT charge on death through a lifetime gift aimed at reducing the value of the donor's estate for the purposes of the tax, without the donor having to give up enjoyment of the asset concerned. In its recent decision in the case of CIR v Eversden [2003] EWCA Civ 668 and [2003] STC 822 the Court of Appeal held that these special rules do not work when gifts by a married person are routed through a trust for their spouse.

2. The Government is amending the existing provisions so that they will apply in these circumstances. The new provisions will disapply the current exception from section 102, Finance Act 1986 for gifts to a spouse where gifts are made on or after today, and

- the property becomes settled property by virtue of the gift;

- the trusts of the settlement give an interest in possession to the donor's spouse, so that the gift is exempt from IHT by reason of the exemption for transfers between spouses and the rule which treats an interest in possession as equivalent to outright ownership;

- between the date of the gift and the donor's death the interest in possession comes to an end;

- when that interest in possession comes to an end, the beneficiary does not become beneficially entitled to the settled property, or another interest in possession in it.

3. In applying section 102 in these circumstances, the original disposal by way of a gift will be treated, where relevant, as having been made immediately after the beneficiary's interest in possession ends, so that the circumstances before that time will not be considered in determining whether the gifted property is "property subject to a reservation" for IHT purposes.

In addition, Ms Primarolo announced the shutting of a loophole in the corporate taxation law pertaining to companies' intangible assets:

1. New rules for the taxation of companies' intangible assets were introduced in Schedule 29 of the Finance Act 2002. These rules give companies tax relief on their intangible assets, such as patents or trademarks, either in line with the treatment of assets in their accounts or, as an alternative, a deduction of 4 per cent of the value of an asset each year until it is fully written down. The new rules generally apply only to assets created, or acquired from unrelated parties, after 31 March 2002.

2. There is evidence that companies are entering into schemes that seek to bring other assets (those already in existence on 31 March 2002) into the new regime, to enable them to receive the 4 per cent relief per year. If successful, this would allow companies to transfer assets within a group (without capital gains consequences) but the same parties would still be unrelated for intangibles purposes - so the transaction would bring the assets into the intangibles regime. These schemes are intended to enable a company to continue to receive tax relief for a period of 25 years.

3. To put it beyond doubt that the intangibles assets rules work as originally intended, the Government has announced today (June 20) that amendments to these rules will be introduced in a New Clause in the Finance Bill at Report Stage. The New Clause will:

- amend the definition of a "related person" under the intangibles rules to include the case where two companies are members of the same group, and

- widen the anti-avoidance power already in paragraph 111 of Schedule 29 Finance Act 2002 to cover the whole of the Schedule.

4. The changes will deny relief in all future accounting periods, regardless of when transactions took place. They will not revisit past periods in which companies may have claimed relief. For companies' accounting periods which began before today and end after today, any relief that may be due under the law prior to its amendment will be apportioned across the period.

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