Tax Planning and the Family Home

Ingram v IRC

Tax planning involving the family home, when the family home is the main asset, is a tricky business. If the plan is to transfer the value in the property whilst continuing to live there, the tax planner has the choice of entering into complex ownership structures, which run the risk of being disregarded by the Inland Revenue as artificial, or paying a full rent to his or her children which is not a satisfactory solution for many people.

The difficulty with tax planning using the family home arises from the fact that where property has been given away by the would-be tax planner but he or she reserves a benefit in it, typically by continuing to live in the property, the Inland Revenue will charge inheritance tax on his or her death as if the property had never been given away. Section 102(1) of the Finance Act 1986 provides that property is subject to a reservation if:

a) "possession and enjoyment of the property is not bona fide 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".

"Relevant period" for these purposes means the period of seven years prior to the donor's death or the period is shorter than seven years.

The gift with reservation of benefit ("GROB") rules are a throw back to estate duty days. Most of the tax planning schemes designed to avoid the GROB rules were developed (and challenged) under the estate duty regime and the case law predates the introduction of gifts with reservation of benefit into the inheritance tax regime. The High Court decision of Mr Justice Ferris in the case of Ingram v IRC changed all this in May this year.

The facts of the case were these. In March, 1987 Lady Ingram transferred the freehold of her property to her solicitor as a nominee. The following day the solicitor granted a lease for twenty years to Lady Ingram thus creating two separate interests; a leasehold interest and freehold reversion. The solicitor, conveyed the freehold reversion to the trustees of a family trust. Lady Ingram continued to live in the property rent free under the terms of her tenancy.

Ferris J considered three main points:-

1. Was the lease a nullity?

2. Did Lady Ingram reserve a benefit?

3. Did Ramsay v Commissioners of Inland Revenue ¹ apply?

Taking each point in turn:-

1. The Revenue argued, successfully, that the lease was invalid. It was held to be well established by the House of Lords in Rye v Rye ²: that a person may not grant a lease to himself and the Scottish Court of Session Kildrummy (Jersey) Limited v CIR ³ that under Scots law a person may not grant a lease to his nominee. Ferris J held Kildrummy to be good law in England based on the reasoning that a lease is a contract, a person cannot contract with himself, therefore a nominee cannot grant a lease to his principle. The lease to Lady Ingram was found to be nullity in law.

Despite reaching this conclusion, Ferris J found that Lady Ingram had an equitable interest in the property which arose when the declaration of trust by the nominee in favour of the family beneficiaries took effect. The trustees and the family beneficiaries took their respective interests subject to Lady Ingram's prior equitable request.

2. Ferris J held that Lady Ingram did not reserve a benefit. What she had done was to transfer to the trust the freehold reversion of the property subject to her equitable interest. She did not purport to transfer her equitable interest. The problem here is that Lady Ingram's equitable interest arose on the creation of the trust simultaneously with the transfer of the freehold reversion to the trust. In the earlier estate duty case of Re Nichols, deceased 4 the Court of Appeal had held that for the grant of the lease to be a "prior and independent transaction". Ferris J decided that the view of the Court of Appeal in Re Nichols was obiter and so he was not required to follow it. It seems likely that the Court of Appeal in its turn will have a chance to comment of Ferris J's view of the same point, assuming that the Revenue takes the Ingram case to appeal.

3. Having decided that there was no prior and independent transaction, there was no artificial step in the arrangement and therefore the Ramsay case did not need to be considered.

The stage appears to be set for taxplanners to take advantage of Ferris J's judgement but needles to say they should proceed with caution. It seems highly unlikely that the Revenue will let this one go without further challenge and it is difficult to summarise how the Court of Appeal will react to the judgement.

Before taxplanners are tempted to follow the Ingram route of the leasehold carve-out scheme, the capital gains tax implications need to be considered. At the date of the transfer of the freehold reversion the donee will acquire the property at a low base value, the principal value being in the leasehold interest at that time. As the freehold increases with the reduction in the term of the lease the donee's potential capital gains tax liability on a future sale may increase substantially.

It is vital to ensure that the lease is for a sufficiently long period of time to cover the lifetime of the taxpayer, but it is essential to avoid leases for life for fear of the application of Section 43(3) of the Inheritance Tax Act 1984 which treats the property subject to a lease for life, as settled property and will draw the entire value of the property back into the tax payer's estate.

Ferris J's bold judgement in the Ingram case was a welcome ruling for the taxpayer and practitioners generally. Despite its vulnerability to an adverse decision by the Court of Appeal, the judgement has at least, and at last, brought some of the old estate duty considerations into the inheritance tax arena and it may well be the forerunner of more definitive guidelines on gift with reservation of benefit problems generally. ECA

Ceris Gardner
Partner
Allen & Overy

(1) [1981] STC 74

(2) [1962] AC 496

(3) [1990] STC 657

(4) [1975] STC 278