Anyone who has any dealings with estates, be they an accountant, lawyer or financial advisor, needs a working knowledge of UK inheritance tax (IHT). IHT was originally intended to catch the wealthy, but the increase in house prices, particularly in the south-east of England, has seen increasing numbers of people caught within the IHT net. Consequently, more people are taking tax-planning steps with a view to avoiding IHT. Those steps are then met with measures designed to prevent the taxpayer from escaping the reach of IHT. From time to time, tax-planning arrangements come before the higher courts and the rules are further clarified. This was the case in Buzzoni v HMRC [2013] EWCA Civ 1684.
Introduced in 1986, the reservation of benefit provision sparked an elaborate game of cat and mouse between HMRC and the taxpayer, with many arrangements entered into by the taxpayer receiving the endorsement of the higher courts...The taxpayer's success has continued with the decision in Buzzoni
One of the longest-standing IHT anti-avoidance provisions is to be found in s102 Finance Act 1986 (FA 1986), which deals with reservation of benefit. Since its enactment, s102 seems to have caused nothing but trouble for HMRC. Introduced in 1986, it sparked an elaborate game of cat and mouse between HMRC and the taxpayer, with many arrangements entered into by the taxpayer receiving the endorsement of the higher courts. HMRC made legislative attempts to close the perceived loopholes, notably by the introduction of sections 102A-C FA 1986, only to be frustrated in its aim by the introduction of further schemes, ultimately leading to the introduction of the pre-owned asset tax (POAT) with a view to discouraging taxpayers from entering into popular arrangements. The taxpayer’s success in relation to reservation of benefit has continued with the decision of the Court of Appeal in Buzzoni, which clarifies the meaning of s102(1)(b) FA 1986.
Statutory context
The reservation of benefit provisions are designed to prevent a taxpayer from having their cake and eating it. In broad outline, when a person dies, inheritance tax is payable on the property comprised in their estate at the date of death, or that they have given away to individuals in the previous seven years. In addition, IHT is payable during a person’s lifetime on certain lifetime transfers – generally transfers into trusts – so long as the aggregate of gifts in the previous seven years is above the nil-rate band – currently GBP325,000. At first sight, it would seem a person could avoid IHT by simply giving their house away to their son or daughter, but continuing to live there, provided of course that they survived for seven years after making the gift. This simple avoidance tactic is prevented by the reservation of benefit provisions, which were introduced at the same time as the concept of the potentially exempt transfer. Property caught by those provisions is treated as if it still forms part of the donor’s estate at the date of the donor’s death. Being caught by reservation of benefit rules can give rise to the worst of all possible worlds: the donor still has to pay IHT on the value of the asset but loses any capital gains tax advantages, such as the tax-free uplift on death or principal private residence relief.
Property is treated as ‘property subject to a reservation’ and so treated as forming part of the donor’s estate if it falls within either of the paragraphs of s102(1) FA 1986, which provides as follows:
‘Subject to subsections (5) and (6) below, this section applies where, on or after 18 March 1986, an individual disposes of any property by way of gift and either –
- (a) possession and enjoyment of the property is not bona fide assumed by the donee at or before the beginning of the relevant period; or
- (b) at any time in the relevant period the property is not enjoyed to the entire exclusion, or virtually to the entire exclusion, of the donor and of any benefit to him by contract or otherwise; and in this section “the relevant period” means a period ending on the date of the donor’s death and beginning seven years before that date or, if it is later, on the date of the gift.’
These provisions are not new. There had been almost identical provisions in the estate duty legislation and they brought with them a raft of authorities on their meaning.
Paragraph (a) is relatively easy to understand. Subsection (1)(b) is more difficult. Although not immediately apparent, there are two limbs to subsection (1)(b). The property that is given away must be enjoyed to the entire (or virtually the entire) exclusion of the donor (limb one) and to the entire (or virtually the entire) exclusion of any benefit to the donor by contract or otherwise (limb two). This is not simply a matter of semantics: the division of the provision into two limbs has practical consequences. It is important to keep the two limbs distinct, as different considerations apply to each. In a limb-one case, the only question is whether the donor is as a matter of fact excluded from the property they have given away: anything else (such as whether the donee in fact derives a benefit from the donor’s non-exclusion) is irrelevant.1
The approach to a limb-two case, where what the court is concerned with is whether the donor is excluded from benefit, is more subtle. As is made clear by the Court of Appeal’s decision in Buzzoni, not every benefit to the donor causes the gift to be caught by s102(1)(b). Even if the donor does derive a benefit from the property they have given away, the transaction will only fall foul of s102 if the benefit impairs the donee’s enjoyment of the gift.
In considering s102, the first question must always be: what is the property given away? Property is not the physical entity (such as a house) but the interest in the property, such as a lease. This is made clear by the decision of the House of Lords in Ingram v IRC [2000] 1 AC 293, which concerned a lease carve-out scheme.
Prior to 1999, a reversionary lease scheme was a popular arrangement, operating as follows. Take the example of a donor who owns a freehold house. The donor grants a lease that takes effect in, say, 20 years’ time. The lease is then given away. The donor retains the freehold. The donor is then able to continue to occupy the property (or receive rent from the property) by virtue of their retained freehold interest, the value of which reduces as the commencement date of the lease approaches. The gift is not caught by s102. The provisions of sections 102A–102C were designed to catch such schemes but HMRC appears to accept that such arrangements will still work for reservation of benefit purposes, provided that the retained interest has been owned for more than seven years: see s102A(5).
Buzzoni concerned a reversionary lease scheme. However, the donor did not own a freehold. She owned a leasehold flat. The reversionary sub-lease contained a number of tenant’s covenants, including positive covenants to repair and pay service charge. Those covenants simply reflected the covenants in the headlease and so operated, in effect, as an indemnity. The sub-tenant had already entered into a direct covenant with the landlord to comply with the various covenants in the headlease.
On the donor’s death, HMRC argued the covenants were a ‘benefit’ within the meaning of s102(1)(b). HMRC’s position was that the donor’s right to enforce the covenants against the sub-tenant was derived from the property she had given away and was a right that she had not enjoyed before, and therefore was a ‘benefit’ within s102.
Although HMRC succeeded before the First-tier Tribunal and the Upper Tribunal, the taxpayers were successful before the Court of Appeal. Despite Moses LJ deciding that the benefit of the covenants was referable to the property given away (Black and Gloster LJJ declined to express a view), the Court of Appeal decided that, in order for a ‘benefit’ to be caught by s102(1)(b), it had to impair the donee’s enjoyment of the gift. The donee’s enjoyment of the gift was not impaired by the direct positive covenants given by the donee to the donor, because the donee had already entered into a covenant with the head landlord to comply with the same covenants. The court held that the sub-tenant’s enjoyment of the lease was not impaired. There is some suggestion that an implied right of indemnity would also have been sufficient. This would be consistent with the fact that the earlier cases emphasised that the ‘form’ of the transaction is not important.
Where are we now?
Despite the enactment of provisions to prevent the use of reversionary lease schemes in 1999, the decision in Buzzoni remains of importance.
First, a number of taxpayers entered into reversionary lease schemes prior to March 1999. Those schemes are not caught by the provisions of ss102A–C. As those taxpayers begin to die, the issues relating to those schemes now fall to be considered.
Second, reservation of benefit questions arise in relation to property other than land. The question of what amounts to a ‘benefit’ for the purposes of s102 has continuing importance, not least because an arrangement will not be caught by POAT if it is caught by the reservation of benefit provisions.
Third, it is still possible to enter into a reversionary lease arrangement that is effective for IHT purposes, provided the property has been owned for seven years. If the property is leasehold, in order to be sure that the arrangement falls within the Buzzoni decision, the donee should first enter into a direct covenant with the landlord to comply with the covenants in the headlease. The downside to such arrangements is the POAT. This is a charge to income tax if the rental value of the property is more than GBP5,000 per annum and it is occupied by the donor. However, if the property is an investment property that is not occupied the donor, this problem does not arise.
Although not directly on the point, the decision in Buzzoni also further exposes the fallacy in HMRC’s position with regard to reservation of benefit and double trust home loan schemes. HMRC states in the Inheritance Tax Manual that, where a loan note is repayable only on death of the donor, the donor is to be treated as reserving a benefit because they have prevented the holder of the loan note from upsetting their enjoyment of the property. HMRC says that this benefit is ‘referable to’ the gift. This ignores the fact that the date of maturity was always an inherent restriction on the donated property, i.e. the loan note. The reasoning does not stand up to scrutiny. But, once it is realised that the donee’s enjoyment of the donated property must be impaired in order for there to be a relevant ‘benefit’ within s102(1)(b) at all, it is clear that a collateral benefit to the donor that derives from the very nature of the property given away (and a ‘defect’ to which that property was always subject) cannot possibly fall within s102(1)(b).
There remains the question of the General Anti-Abuse Rule (GAAR). Reversionary lease schemes are long-standing but that does not mean that such arrangements are immune from the GAAR’s tentacles. It is unlikely that such arrangements would be caught. First, although the arrangement would probably be a ‘tax arrangement’, it is not likely to fail the double reasonableness test. There may well be circumstances in which entering into a reversionary lease arrangement is a reasonable course of action, e.g. where the proposed donee is young so that it is not appropriate to make an outright gift, or even where the donor wishes to take advantage of s102A(5), which prevents an interest in property owned for more than seven years prior to the gift from being a ‘significant arrangement’ in relation to the land. Further, structuring a transaction in relation to leasehold property so that the donee enters into a direct covenant with the head landlord is unlikely to be regarded as unreasonable: in fact, the failure on the part of the landlord to require such a direct covenant would be regarded by many as unreasonable. Second, in deciding whether an arrangement is abusive under the GAAR, regard is to be had to the policy of the section. Given the decision in Ingram, which is based on the underlying policy of the section, as well as s102A(5), which provides a specific exemption for interests owned for more than seven years, it is difficult to see how such an arrangement could be regarded as abusive.
Buzzoni has not been appealed, probably because HMRC considers it of narrow application. However, the meaning of ‘benefit’ has implications beyond pre-Ingram schemes and, at the very least, leaves more room for argument for taxpayers when dealing with these provisions.
- 1Chick v Commissioner of Stamp Duties [1958] AC 444