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MALCOLM GUNN FTII, TEP details a case where some inheritance tax planning needed further tinkering.
MALCOLM GUNN FTII, TEP details a case where some inheritance tax planning needed further tinkering.
MRS EATMORE IS a relatively wealthy lady owning a property in which she lives and also a share portfolio. When she was about 80, we looked at what could be done to help save the potential inheritance tax liability on her estate. She had already made substantial gifts out of her portfolio of investments and did not wish to reduce it any further. Another big problem was the fact that all the base costs in the investments dated back to 1982 and so any sale or gift would give rise to prohibitive capital gains tax liability. This single aspect has consistently militated against proper management of her portfolio and no doubt does in many other cases as well.
The home
The property in which she lives was also bought many years ago and what we decided to do therefore was to grant her son, Will, a reversionary lease over the property. As she was 80 years old, we thought that a very long lease to commence in about 15 years time would be suitable. Obviously she will need to pay a full market rent to her son, if and when she attains the age of 95 and wants to continue to live at the property, but there cannot be many people of such great age who live on their own and so by that time we thought that this was a problem which we could manage if it ever arose.
A drawback
Will Eatmore would acquire the reversionary lease at a very small capital gains tax base cost and so there will often be a worry about saving inheritance tax and simply replacing it with a capital gains tax liability. Eventually nearly all the value in the property will be transferred into the leasehold interest held by Will, and so on his sale of the property at some future date, the likelihood is that nearly all the sale proceeds would be liable to 40 per cent capital gains tax, less some taper relief.
This will be slightly better than the 40 per cent inheritance tax liability which the scheme avoids, but this small saving would hardly be worth all the trouble of going through the scheme. Moving into the property and electing for it to be main residence might chip away a little more at the capital gains tax problem, but it is much better to see if there is an alternative way out.
There is a complex solution involving a trust to hold the freehold and the reversionary lease in different funds, but we did not go down that route.
Lucky Will!
Will Eatmore was in fact not troubled at all by capital gains tax. He had lost a considerable amount of money on an investment in a private company and had very substantial capital gains tax losses brought forward which we thought would cover the prospective gain on the lease.
In itself, this was lucky enough, but as we all know, luck changes. In fact, with the passing years, Will managed to realise some capital gains and slowly the brought forward losses started to disappear. They are now down to about £40,000. So it is back to the drawing board with the reversionary lease idea.
Another escape route
As someone kindly reminded me at a function some time ago, the answer to this problem is provided by one of my own articles! In Taxation
, 12 October 2000 I examined tax planning with reverter to settlor exemptions and some of the ideas in that article can be put to good use by Will.
What he must do is to transfer his reversionary lease into a trust in which Mrs Eatmore has an interest in possession. This will of course be a disposal of the lease for capital gains tax purposes and we will need to see whether the remaining £40,000 of capital losses brought forward will be sufficient to eliminate the capital gain to date on the reversionary lease. This also gives rise to a potentially exempt transfer for inheritance tax purposes, but Will is young enough and in good health and so we shall hope that this transfer does not get him out of the frying pan and into the fire.
While the lease is in the trust, and before it becomes operative on its due date, it would seem that it cannot benefit from the principal private residence exemption for main residences held in trust (section 225, Taxation of Chargeable Gains Act 1992) because it does not provide any rights of residence to the life tenant. Once the lease comes into possession, there will be perhaps an argument that there is only one residence and so the two interests in it, freehold and leasehold, are both within the exemption, but we will not need to explore this as there is an alternative method of securing the position.
Terminating the trust
On the death of Mrs Eatmore, the trust assets should revert to her son Will for an interest in possession with power for the trustees to appoint them out at their discretion. In this way, on the death of Mrs Eatmore, section 54, Inheritance Tax Act 1984 will apply to allow exemption from inheritance tax on the funds in the trust, that is the leasehold interest. The section sets out an exemption in revertor to settlor cases.
There will be no capital gains tax payable on the death of Mrs Eatmore because section 72, Taxation of Chargeable Gains Act 1992 will apply, as it does on the death of any other life tenant. The fund will be uplifted to market value tax free. The trustees can then appoint the assets out of the trust under their power at some convenient later stage and there should be little or no capital gains tax position because of the new market value base cost.
Other points
This arrangement not only deals with the future capital gains tax problem but also with any risk there may be that Mrs Eatmore attains the age of 95 and then has to start paying rent on her own property. There are of course associated operations provisions for inheritance tax purposes, but they cannot have any impact here, because nothing of this sort was ever envisaged when the reversionary lease was first granted.
If the available losses are insufficient to cover the gain on making the trust, it might be possible to deal with this by starting off with holdover relief to a discretionary trust which later converts to an interest in possession trust, but in the long term this held-over gain will still materialise because on the death of a life tenant such part of any gain is not then covered by exemption (see section 74, Taxation of Chargeable Gains Act 1992). However, a tax deferred is no doubt a tax saved, although it would be an all or nothing hold over so that the losses could not be utilised.
More tinkering needed
Perhaps the story illustrates a wider principle that even basic tax planning can never be filed away and forgotten. Some periodic reviews of how it is going are often advisable.
