The Court of Appeal (CoA) has ruled on a case involving a tax planning exercise that was performed before the gifts with reservations rules were tightened by Parliament in 1999.  Where a person gifts property to someone and that gift has reservations, such the donor being able to occupy property at a rent less than market value, then the value of the whole property is taken into account when determining inheritance tax payable.

In this case the donor had granted her sons a sub-lease in a valuable leasehold property she held in Chelsea.  The sub-lease required that the sons enter into positive convents requiring them to pay the ground rent and respect the covenants that the donor had entered into when acquiring the head-lease, such as maintain the property and keep it insured.  The taxpayers, the sons, had argued that the gift of the sub-lease was the only gift and that the covenants were of little merit considering the value of the leasehold.

The CoA disagreed and agreed with the lower tribunals that the sub-lease was a gift with reservations, and therefore the whole value of the property would be relevant for inheritance tax purposes.  The CoA held that the covenants created a benefit that didn’t exist before the gift of the sub-lease.  The requirement to pay the ground rent, insurance and maintenance of the property had always been an obligation of the donor and would remain so while she held the head lease.  The sub-lease removed her from her obligations to the freeholder of the property that otherwise she would have to cover.

It was noted by the CoA that this tax planning exercise has been entered into in haste as the donor’s advisers were expecting imminent changes in the gift with reservation rules, that didn’t take effect until a year or so after the gift of the sub-lease.

The decision can be found at: Hood v HM Revenue and Customs – Find case law (nationalarchives.gov.uk)

This is a sad outcome for those involved but it highlights that other methods of gifting can be more effective than others.  In this case, if the head lease had been assigned to the sons as a gift as opposed to the granting of a sub-lease then the requirements to pay ground rent, insurance and maintenance would have also passed to the sons while remaining effective for inheritance tax purposes.

Please do contact us if you have any questions with inheritance tax planning.