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Replies to Queries - They owe him

24 February 2005
Issue: 3996 / Categories:

An elderly Canadian gentleman (non-UK domiciled) owns a substantial residential property portfolio in the UK, worth in the region of £3 million. To mitigate capital taxes, he is keen to gift most of these properties to his grandchildren. From a UK perspective there is no CGT liability, but an IHT liability could arise on his death within seven years. As life insurance against a possible failed potentially exempt transfer would be expensive, I am considering alternatives to a gift of the properties.

An elderly Canadian gentleman (non-UK domiciled) owns a substantial residential property portfolio in the UK, worth in the region of £3 million. To mitigate capital taxes, he is keen to gift most of these properties to his grandchildren. From a UK perspective there is no CGT liability, but an IHT liability could arise on his death within seven years. As life insurance against a possible failed potentially exempt transfer would be expensive, I am considering alternatives to a gift of the properties.
The client has previously established a Canadian-based trust for the grandchildren. My proposal is for him to sell the properties to the trustees at open market value. The consideration would be left outstanding as an 'IOU', but termed such as to qualify as a non-UK situated asset, and thus be exempt from IHT. The terms of sale would include instalment repayments of purchase price, but no interest would be charged. The trustees would fund repayments from the income generated from the property portfolio. It is accepted that a stamp duty land tax liability would arise, which would be avoided with the gift arrangement.
Do readers believe that the Revenue could challenge such an arrangement? I think the only grounds would be that the sale was a sham, but if properly structured I believe that such a challenge could be defeated. There are Canadian tax implications, but at this stage I am concerned with UK tax mitigation only. Are there alternative recommendations?
(Query T16,562) — The Tinman.


The normal method of getting round this problem would have been for the properties to be transferred to a non-UK company formed for the purpose by the current owner by way of gift from him to the company and a gift made of the shares in it shortly afterwards. There would be no potentially exempt transfer because the gift would have been of an asset outside the jurisdiction: see IHTA 1984, s 6(1). This is, however, likely to give rise to complications under recent Canadian legislation, specialist advice on which is essential.
Such an arrangement would not be attractive from the point of view of stamp duty land tax (SDLT). FA 2003, s 53 would impose a charge to that tax on the open market value of the properties, almost certainly at 4%. The same charge would, however, arise on a sale to a Canadian settlement. While SDLT might be avoided on a disposal to an offshore unit trust, UK land held by such an entity would not be within the IHTA 1984, s 48(3)(a) relieving provision.
A sale to the Canadian trust would, therefore, trigger a SDLT charge and the properties themselves would remain within the UK IHT net in the hands of the trustees. Subject, again, to Canadian considerations, this would mean that, in due course, a UK IHT charge would arise either on the death of a beneficiary with a life interest under IHTA 1984, s 49(1) or, unless conditions contained in IHTA 1984, s 71 (accumulation and maintenance trusts) were present, under the discretionary trust periodic and exit charge régimes.
In the former event, it is open to doubt whether, on the death of a beneficiary with a life interest, the IOU would be deductible. While Mr Justice Mann's judgment in Green and Mitson (Trustees of the Will of Consuelo Dowager Duchess of Manchester) v CIR [2005] EWHC 14 (Ch) suggests that it would be, the issue does not appear to have been argued before him, and in particular it is unclear whether De Freyne v CIR [1916] 2 IR 456, upon which the trustees would have to rely in relation to s 48(3)(a), is in point.
A form of trust under which the trustees were entitled to divert income to fund the IOU instalments would, however, not constitute an interest in possession and, without sales, it seems unlikely that payment in full could be achieved within the scope of the accumulation and maintenance conditions set out in s 71. Ten-yearly charges, under IHTA 1984, s 66, calculated from the date the Canadian settlement was made, would therefore appear to be in prospect.
It must follow that, from a UK point of view, a non-UK company route must be preferable to a sale to the existing Canadian settlement. Canadian advice should therefore be taken on the consequences of substituting such an arrangement. Perhaps the use of a Canadian company would have no adverse consequences?
Turning, then, to the question of whether the IOU would be UK property on the death (or earlier gift) of the current owner, the general rule is that a debt is owed where (and therefore has a situs) the debtor is resident: see Attorney-General v Bouwens (1838) 4 M & W 171 and English, Scottish and Australian Bank v CIR [1932] AC 238.
This is a rule of the general law and it is very unlikely that the courts would be willing to go behind it merely because it was being invoked for tax avoidance.
In principle the plan put forward is, therefore, likely to work if the donor fails to survive the seven-year potentially exempt transfer period. But any attempt to improve upon this situation by creating a specialty debt might well be subjected to adverse scrutiny because of the introduction of a vague marketability factor in the case of Young v Phillips [1984] STC 520.
There would be no question of a sale in return for a debt payable by instalments out of income being a sham within Lord Justice Diplock's formulation in Snook v London and West Riding Investments Ltd [1967] 2 QB 786.

Issue: 3996 / Categories:
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