The Dowager Duchess grand plan - Elderly Client Adviser

Feature

posted 1 Mar 1999 in Volume 4 Issue 3

The Dowager Duchess' grand plan

In an article originally written before the Budget, Christopher Sokol, barrister, considers the potential planning possibilities following the Ingram decision.

Readers should be aware, however, that it is the Chancellor's stated intention to reverse the Ingram decision in relation to the tax treatment of certain gifts. At this stage it is unclear as to how wide ranging the proposed changes will be.

These changes may also concentrate on pure Ingram techniques allowing potential scope for slightly different planning. Readers are invited to review the planning possibilities but be aware that changes in the law, active from budget day, will be made. Please also refer to Ingram Loophole Closed? (Page 26)

It is an axiom of tax litigation that the further up the courts one goes, the less the chances are of them getting it right. A victory in the House of Lords, therefore, is the stuff of which ballads are, or at least, ought to be made, particularly where it is also a victory for common sense.

Before going further, however, an honourable mention should be made of Lord Justice Millett in the Court of Appeal who, in his dissenting judgement, set out with exemplary judicial clarity and learning what lesser mortals had been saying in their muddled way in opinions for years. Although the arrangement set out in Ingram v Commissioners of Inland Revenue [1999] STC 37 can hardly be described as a tax avoidance scheme, really comprising no more mischief than a man giving away one part of his savings and retaining the other, it is felt that sooner or later the Revenue will convince the Government that the safety of the realm will be imperilled if this 'loophole' is not stopped up. My (free!) advice therefore to anyone of the age of 60 plus, owning property of substantial value with reasonable outside assets, is to follow the example of the late, but wise Lady Ingram as soon as possible.

Not a catch all

There are circumstances, however, where the Ingram scheme may not be the best option, and its degree of attraction does depend on the circumstances of each case. Where the putative donor's real property includes assets of value other than the principal house, then it may be simpler and more effective to give away these rather than the freehold reversion expectant on the determination of a lease of the whole property. This severance may be advantageous for example where the donor has a country house and broad acres, or a bungalow with building plots in its garden.

Equally, it is not necessary to follow the Ingram route where the donee intends to occupy the property jointly with the donor in undivided shares (see Hansard dated 10 June 1986, column 425, and the published Inland Revenue letter of 18 May 1987). In a case where there is a substantial mortgage liability on the property concerned, the scheme is likely to be impractical as the mortgagee would most probably require its repayment. An attempt to effect this scheme without the consent of the mortgagee is likely to be ineffective and fail. In the case of the intended donor with insignificant outside assets, then putting out of his or her reach a substantial part of his property may be simply unwise.

In other cases, however, it is the best means of reducing an inheritance tax liability on what normally will be unrelieved domestic property, while at the same time continuing to enjoy that property as a home. As Lord Hoffman put it in Ingram at page 41 of the judgement:

'although the section does not allow a donor to have his cake and eat it, there is nothing to stop him from carefully dividing up the cake, eating part and having the rest.'

Ingram type arrangements can be used in respect of other sorts of property but it is in transmitting the family home that they really come into their own.

Simplicity itself

The bones of the scheme are simple and well known. The Dowager Duchess of Omnium transfers Castle Omnium to her trusted legal adviser Gargoyle to hold as nominee for her. Gargoyle, more or less at once (the next day in Ingram), grants the duchess a lease of Omnium Castle on terms which will have been agreed prior to the transfer. Subsequently, and this can be a somewhat variable date, Gargoyle disposes of the freehold reversion in accordance with her grace's instructions. Had his grace been extant and still personally seized of the property, he could have transferred it to his wife and himself jointly qua nominees, which probably would give the scheme a greater air of verisimilitude than the introduction of old Gargoyle.

That, at its simplest, is all that has to happen. What are the tax consequences? The dowager duchess' transfer to a nominee gives rise to no charge to tax, inheritance tax, capital gains tax or stamp duty. Neither does Gargoyle's grant of the lease back. The transfer of the freehold reversion expectant on the determination of the lease constitutes a part disposal of the underlying property by the duchess for capital gains tax purposes. Castle Omnium has always been her principal residence, so relief under section 222, Taxation of Chargeable Gains Act 1992 will be available.

Subject to one vital point, to be dealt with later, providing the donee of the reversion is an individual, the trustees of a trust in which an interest in possession then subsists, or those of an accumulation and maintenance settlement, the transfer of the freehold reversion will constitute a potentially exempt transfer for the purposes of inheritance tax. Consequently that tax will only be charged on the transfer of value in the event of the death of the Duchess within seven years from the date of the gift and at a reducing, tapering, rate if she survives more than three years.

Advantageous transfer value

There is another hidden advantage. In the event of the Duchess's death during the seven year period and the transfer becoming chargeable, the value transferred will be taken to be the value as at the date of the transfer, not the value as at the date of death. Lady Ingram did not survive seven years after making her gift, in fact she did not even survive three, but the rise in property prices over that period, at least in respect of a large mansion and 60 odd acres in Berkshire was such, that it was still worth taking the case all the way to the House of Lords.

But what if &

Let us suppose that the Duchess of Omnium lives to a great old age comfortably surviving the seven year period. At her death, her estate will comprise so far as Omnium Castle is concerned, the unexpired lease, which may not be of very great value depending on its residual duration and terms. The greater part of the value of the property will have passed free of inheritance tax. There is, however, a hidden disadvantage. The young duke actually much prefers his villa in the south of France to the fairly hideous Castle Omnium and proposes to sell the latter at once. The gain attributable to the unexpired lease is likely to be effectively capital gains tax free, but prima facie a significant capital gains tax liability will arise on any gain in respect of the freehold reversion since the date of the gift.

All this is very simple, but only because it deals with the matter in principle and not in practice. As so often in tax matters, the devil is in the detail and in particular in this case, the detail of the lease.

Obsolete alternative

What the duchess really wanted was a lease for life and not for a term of years at all. Inconveniently, section 43(3), Inheritance Tax Act 1984 provides that:

'A lease of property which is for life or lives, or for a period ascertainable only by reference to a death, or which is terminable on or at a date ascertainable only by reference to a death, shall be treated as a settlement and the property as settled property, unless the lease was granted for full consideration in money or money's worth.'

This would seem to defeat entirely the object of the exercise.

Funnily enough there used to be an alternative to the Ingram type arrangement which very much involved a lease for life. It relied on a statement of practice which survived until 1996 when it was declared 'obsolete', a wonderfully Orwellian use of language if ever there was. If and when their lordships good work is undermined by Parliament, I expect this alternative will have to be revisited.

Linguistic argument?

But this is to digress. Does not the duchess give more than full value for her leaseback? Why should her position be worse than if she had received a price? On a fair reading of subsection (3), I think the answers are that she does and it should not, but it would be a courageous decision, as Sir Humphrey would put it, to test that now before a court.

At this point, however, Gargoyle has a bright idea. How about a lease for a term of years, but terminable by the freeholder within a certain period of the duchess' death? While this is somewhat more hopeful it really does depend on how one interprets one's 'onlys'. Can one distinguish a lease which is terminable at a date ascertainable only by reference to a death? Does the former carry with it the latter's clear exclusivity? This is just the sort of point with which to impress old Gargoyle in conference, but which could make judicial eyebrows disappear into their wigs before a broad brush, purposive approach, Court of Appeal. Linguistically I suspect correct, it is an argument better avoided.

Caution required

One is left therefore with a term of years which carries with it its own problems. Too long and too much value may be left in the Duchess' estate and the quantum of the potentially exempt transfer too small; too short and there will be the general embarrassment of her surviving the expiration of the leasehold term. The basic rule of thumb is to look at the potential donor's actuarial life expectancy and, given no special health considerations, then to add a couple of years or so. But the term must be determined with caution and with a proper knowledge of the relevant property law.

My exposure to the statutes concerning landlord and tenant, land registration, and leasehold enfranchisement was mercifully brief and a long time ago, but my recollection is that minutely different leasehold terms can carry very different legal incidents. In Lady Ingram's case, 20 years was the term and there were no lurking horrors. Anyone minded to grant a lease for more than a maximum of 21 years should take appropriate specialist advice.

Break clause?

The dowager duchess is worried. The cost of upkeep of Castle Omnium is huge even in a good year, but she knows that a few acres of roof will also have to be replaced soon and the curious aroma in the cellar indicates that the drains may have to be re-dug. She is less than keen to expend her personal resources on either, but understands that a leaseback of the castle would have to be on tenant's full repairing terms. Gargoyle is inspired. 'A break clause your grace', he says, 'so that at any time you can give notice of surrender'.

Well, it seems a good idea at first, but I wonder. It is essential for the scheme to work that any reservation of benefit is avoided. A term in the lease itself can constitute a benefit; see Nichols v Commissioners of Inland Revenue [1975] STC 278. A benefit may be equally the provision of a plus or the avoidance of a minus. If the terms of the lease of Castle Omnium are that the tenant cannot turn it to account in any way, but on the contrary she is about to be obliged to expend a great deal of money on it, could the Revenue not argue with some prospect of success, that her facility to remove this imminent burden constitutes a benefit?

Even if the answer is no, the duchess' heir will not thank one for taking him to the House of Lords to find out. A fixed term of not more than 21 years without breaks, with all financial obligations in respect of the property exclusively placed on the tenant, with the landlord giving only a covenant for quiet enjoyment, and the tenant being entitled neither to sublet nor assign (at least for value), is the safest and most sensible course by which the intention of the donor may be satisfied and the reservation of benefit problem avoided. Incidentally, apart from the terms of the lease a little thought has to be given to the completion of the Land Registry transfer form, in particular boxes 11 and 12.

Selling up complications

While it is not very likely that the duchess will wish to sell up and leave during the currency of the lease, she is concerned at the prospect of being quite unable to do so. What is the position? All that she can dispose of is the unexpired leasehold term and even that will not be assignable for value, at least without agreeing terms with the landlord to that effect. On the other hand, the reversioner could sell the reversion at any time without obtaining the consent of anyone, although he could not put the duchess out of possession during the currency of the lease.

A further complication arises, however, if the Duchess wants to use all or part of the sale proceeds of the reversion in Omnium Castle in the purchase or part purchase of a replacement property. Prima facie this would constitute a reservation of benefit. This unhappy consequence might be avoided, however, if the reversioner and lessee purchased the replacement property as tenants in common, and either the duchess pays the reversioner the compensation mentioned in the Trusts of Land and Appointment of Trustees Act 1996, or gives other equivalent consideration; alternatively occupation of the replacement property could non-exclusive to the duchess, but liable to be shared with the reversioner.

Unfortunately the dowager duchess and her daughter-in-law have never really got on; the idea of 'that girl' ensconced as châtelaine of Omnium if anything happened to the young duke, his mother found extremely provoking. Could not matters be arranged so that if he died during her lifetime the property reverted to her? The answer is yes. The Revenue accepts, in my view rightly, that where a gift is made into trust the retention by the donor of a reversionary interest under the trust will not constitute a reservation, whether the retained interest comes under the express terms of the trust or by operation of the general law.

If any criticism is to be made of their lordships' speeches in Ingram, it is that statements like: 'The scope of the Ramsay principle does not arise and I therefore prefer to say nothing about it', while impressively concise and unquestionably correct, do not help a great deal in understanding this increasingly unpredictable area of tax law. What is important to remember however is that the Ramsay principle applies or not according to the facts and that no great changes in those can have a remarkable overall effect. For example, if as part of the same transaction old Gargoyle were to amend the duchess' will, so that there was a specific demise of the unexpired lease to the young duke, could the Revenue not categorise the whole as a circular or self-cancelling transaction of the type to which Lord Wilberforce referred in the Ramsay case?

Perhaps surprising

In one way the Ingram case was a slightly surprising one. In its published letter of 18 May 1987 the Revenue declared:

'You raise the possibility that a donor might give his house subject to a prior lease created in his own favour. Consistent with the principles established in the case of Munro v The Commissioners of Stamp Duties (New South Wales) 1934 AC 61 we would not normally expect the donor's retention of a lease to constitute a reservation, assuming that the creation of the lease and the subsequent gift of the property subject to that lease are independent transactions. The application or otherwise of the decision in Re Nichols [1975] 1 WLR 534 concerning a (donee) landlord's covenant would be a matter for determination in the light of all the facts at the time of the donor's death.'

One can only suppose that on the facts of Ingram, the Revenue did not think that the two transactions were independent enough, but this is a problem which does not have to arise. For example, in these days of leasehold enfranchisement either by agreement or under statute, the opportunity for inheritance tax planning which this presents should not be overlooked. If the freehold is acquired by a nominee for the fortunate lessee and then disposed of according to his instructions, the complications which arose to Lady Ingram's executors should be avoided. Whether or not Parliament sees fit to overturn the taxpayers' admirable and justified success in Ingram, the possibility of the existence of concurrent interests in the same property, which is of the very nature of English land law, will still give rise to opportunities for intelligent estate planning. Black sheep apart, Castle Omnium could stay in the family for a while yet.

Christopher Sokol. The author is a member of tax chambers at 24 Old Buildings, Lincoln's Inn, London WC2A 3UJ.

This article was originally published in Taxation Magazine, 25 February 1999.