Giving away your assets to the next generation before your death can be an effective means of minimising Inheritance Tax (IHT) liabilities. However, as one tribunal case showed, such gifts have to be absolute and bring you no personal benefit in order to achieve the tax savings desired. Where a gift is made and the person making it (the donor) retains any benefit from whatever is given away, this is called a ‘gift with reservation of benefit’. Such gifts are ineffective for IHT and are treated by HM Revenue and Customs (HMRC) as remaining in the donor’s estate.
The case involved a woman who owned a long lease on a valuable house. She had, with the permission of her landlord, sublet it to her three sons. There was no dispute that that represented a disposal of property by way of gift and that possession and enjoyment of the property had been assumed bona fide by the sons to the entire exclusion of their mother.
On her death, however, HMRC took the view that the gift of the subleases had been subject to a reservation of a benefit within the meaning of Section 102 of the Finance Act 1986. On that basis, HMRC argued that the subleases fell to be treated as property to which the woman was beneficially entitled immediately before her death.
Their value was thus subject to IHT. Why did HMRC take that view? Because the subleases granted to her sons contained covenants to maintain and repair the property.
A challenge to that decision, brought by the executor of the woman’s estate, was rejected by the First-tier Tribunal, which accepted that the mother had retained a benefit because by taking on the repair obligations, the sons had relieved their mother of her duties under the head lease to perform them herself.
In rejecting the executor’s appeal against that ruling, the Upper Tribunal found that the sons’ obligations under the subleases were for the ‘better enjoyment’ by their mother of her retained interest in the head lease. The covenants they entered into, which mirrored those in the head lease, gave her greater protection than she would have enjoyed had she simply remained subject to her own covenants without imposing any corresponding obligations on her subtenants. That was a benefit she had reserved and the value of the subleases therefore remained in her estate.