Readers' forum - A small gift

I have been wondering whether it might be beneficial to advise an elderly client to gift a small part of his house (perhaps 5%) to his children. There would be no capital gains tax implications on the gift because it would be exempt under the main private residence rules. In theory there could be a small capital gains tax liability to the children on the eventual disposal of the property, but only in relation to their small percentage share.
On death, the District Valuer would value the property for inheritance tax purposes and, because it is subject to joint ownership, it would qualify for a 10% to 15% discount.
The aim is to collect the discount on the valuation and not to gain any income tax or capital gains tax advantage. The implications of such a transfer and its effect on social security, in the event of the family having to fund nursing home costs, could also be considered.
I would be most interested in readers' views on this concept.
Query T16,663 — Planner.

Reply by Trofa e Ceuta:

On the face of it, a gift of 5% of one's home to non-resident children will be ineffective for inheritance tax purposes. Although, under pre-1997 English land law, Munro v Stamp Duties Commissioner [1934] AC 61 might have been cited in favour of the gift with reservation provisions (particularly FA 1986, s 102(1)(b)) not applying, that authority has never been regarded as safe in relation to residential situations. Had it been, FA 1986, s 102B, and the Parliamentary Statement which it replaced, would have been otiose. Furthermore, by virtue of Trusts of Land and Appointment of Trustees Act 1996, ss 12 and 13(7), it may well be that, after the gift had been made, the donor would have retained a right to occupy the whole property to the exclusion of his children, thus obtaining an interest in possession in the gifted part under IHTA 1984, s 43(2)(a). A pending Lands Tribunal appeal may throw further light on whether this problem can be got round by the payment of a rental equivalent under TLATA 1996, s 13(6)(a).
Even if there was no gift with reservation (GWR) problem, a full disposal would have been required for the pre-owned assets tax (POAT) not to apply in the alternative: see FA 2004, Sch 15 para 10(1)(a).
Both POAT (by virtue of FA 2004, Sch 15 para 11(5)(d)) and GWR (under FA 1986, Sch 20 para 6(1)(a)) could be avoided by the payment of a full rental equivalent (probably reviewed professionally every two years) for the 5% under TLATA 1996, s 13(6)(a). This would, of course, be subject to income tax in the hands of the children, without relief for their parent. The value gifted would almost certainly be below the £120,000 stamp duty land tax threshold, but, although a pre-planned payment under TLATA 1996, s 13(6)(a) should be distinguishable from a lease-back, HMRC might well consider that form SDLT 1 needs to be filed under their interpretation of FA 2003, Sch 4 para 5.
But assuming the payment of a rental equivalent is affordable, and the seven year potentially exempt transfer period has been survived, the question arises as to by how much a 95% stake in a property should be discounted for probate valuation purposes. An examination of the Lands Tribunal precedents suggests that discounts of 10 to 15% are not likely to be appropriate for 'majority' shares in land. Although there is no decision directly in point, 5% (i.e. 5% of 95%) seems likely to be the absolute maximum the District Valuer is likely to concede. The reason is that a 95% co-owner would have no difficulty at all in obtaining an Order for Sale from the court under TLATA 1996, s 15.
The downside risk in taking a chance on this is the absence of capital gains tax main residence relief for the children's 5%. Although it is presumably hoped that the gain on the 5% will be within the annual exemption, this cannot be guaranteed and, when coupled with the cost of setting up (including the preparation of SDLT 1) and continuing to monitor the level of TLATA 1996, s 13(6)(a) payments, this risk could outweigh the likely outcome of future negotiations with the District Valuer. 

Reply by Digby Bew:

As the stated aim of the proposed arrangement is to collect the discount on the valuation of the father's retained property share, one assumes that the present value of the father's estate is such as to attract a potential inheritance tax charge on death. Any discount on the valuation of the father's retained property share would serve to reduce that liability or eliminate it altogether if the adjusted estate valuation then fell below the prevailing inheritance tax nil-rate band. Of course, values (and, indeed, the nil rate band) do not remain static, so it would be sensible to continue to monitor values, and the father will also no doubt wish to review the terms of his current will and assess the impact of the gift on his devolution plans for his estate as a whole.
However, there are several fundamental difficulties.
The arrangement could compromise the father's future security of occupation. By gifting a share of the property to his children, they become joint owners of the property with him and as such acquire the corresponding rights of such co-owners under the Trusts of Land and Appointment of Trustees Act 1996 (TLATA). Whilst existing family harmony may be such that this is not thought to be an issue vis à vis the donee children, the position could be dramatically affected by the premature death, insolvency or matrimonial difficulties of a recipient child; the family could find an unwelcome third party becoming a joint owner of the property with them, with perhaps a rather less sanguine approach to rights under that Act. At the very least, the family should consider completing a TLATA trust deed which, among other things, sets out the purposes of the property trust and emphasises that the property is intended to be the father's home for the rest of his life.
Whilst currently a moot point, one view of the father's TLATA rights is that they amount to an interest in possession in the entire property. Whilst the position is by no means settled, if that is the case, then nothing has been achieved in inheritance tax terms by the gift to the children.
The father would have to appreciate that should the property be sold in the future he would not be entitled to the whole of the net proceeds of the sale; this might have some bearing on his plans for the purchase of a new property in the future.
If the authorities find that the father's gift of the property share was undertaken with the intention of defeating a means-testing assessment for relative state benefits, the effect of the gift would be ignored and the father treated as if he owned the gifted asset. As with the previous point, he is then made reliant upon his children in making their gifted value available to their father, which, in turn, has potential capital tax consequences for the children.
The gift by the father will be of an undivided share in land; accordingly FA 1986, s 102B will prima facie apply. The interest gifted will be property subject to a reservation unless one of three defences can be made out, none of which seems likely to be in point on the facts given. The 5% gifted share would thus be treated as property to which the father was beneficially entitled at the date of his death, resulting in, among other things, loss of the valuation discount for joint ownership. However, no capital gains tax-free uplift would apply to the value of the gifted share on the father's death in these circumstances. Thus, nothing has been achieved in inheritance tax terms by the gift of the 5% share, but with a greater potential capital gains tax exposure for the children on the gifted share on eventual sale of the property after their father's death.
Might an alternative be to consider a gift of the whole property to the children followed in due course by an unrelated settlement by the donee children back on their father on reverter to settlor terms?

Reply by Lacuna:

It is implicit in the query that the intended donees do not occupy the property and so the proposed gift would be caught by the provisions of FA 1986, s 102B as a gift with reservation of benefit. The result would be that the part gifted would be regarded as part of the estate on death in view of FA 1986, s 102(3) and the effect of IHTA 1984, s 5 would be that the house would be valued as a whole without any discount. As a gift with reservation there would be no question of an income tax charge under the pre-owned assets provisions.
In the case of land, the reservation of benefit provisions can be avoided if, following the gift, the donor pays open market consideration: IHTA 1984, Sch 20 para 6(1)(a). The open market rent for such a small fractional share is likely to be minimal.
It should be recognised, however, that the corollary of the discount on death afforded to the retained share is the size of the lifetime gift on the 'before and after' principle in IHTA 1984, s 3(1); the donor will need to survive for seven years to achieve any worthwhile saving.
So far as possible future care fees are concerned, the fact that the house was not in sole ownership would make the local authority's task more difficult if it wanted to seek an order for sale, but it would be more likely to seek the imposition of a charge over the property. And if care were needed shortly after the gift it would be voidable in any event.

Reply by Hodgy:

Planner has given some thought to capital gains tax in coming up with this proposal. He has also considered what the inheritance tax implications of such a transfer of value might be. The basic problem is that the gift will not be a transfer of value, because the subject matter of the gift is part of the house in which the client lives. As a consequence, the gift is subject to a reservation of benefit and so this means that there is no transfer of value. Therefore on the client's death the house will be treated for inheritance tax as being owned entirely by the client. The fact that the children have legal title to, say, 5% of the house will be ignored and no discount will be given.
A way round the reservation of benefit issue could be for the client to pay a market rent for his right to occupy the 5% of his house owned by the children. However, I would not like to hazard a guess as to how you would calculate such a rent. In addition, the rent may be beyond the means of the client and it will be taxed on the children. Therefore this option is not likely to be viable.
Pre-owned asset tax will not be a problem, because if there is a reservation of benefit, the occupation of the house is not caught by the pre-owned assets legislation. Similarly, there is an exemption if the taxpayer pays a market rent for the occupation.
Given that any transfer of the house is not likely, the funding of care costs has not been considered.

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