HM Revenue & Customs (HMRC) has won an inheritance tax (IHT) case, in which a home-loan, double-trust, IHT planning scheme failed.
The case (James Charles Pride as trustee of the estate of the late Geraldine Jill Pride and HMRC), was heard at a tribunal in December, with the decision published at the end of March.
Gerry Brown, trust and estate planning expert at QB Partners, warned: “Advisers with clients using this type of scheme should take specialist tax advice in the light of the HMRC ‘campaign’ against this type of planning.
“The purpose of the home loan or double trust IHT scheme was to remove the value of a house from an individual’s IHT estate whilst allowing that individual to remain living rent-free in the house for the rest of their life.
“The basic idea is that the individual sells the house to an interest in possession trust of which the individual is the settlor and principal beneficiary. The purchase price is left outstanding as a loan owed by the trustees to the settlor (the home loan). The settlor then gives the benefit of the loan to a second trust for his/her children (the double trust). The settlor cannot benefit from the second trust and the gift of the loan is a potentially exempt transfer (PET). Assuming the settlor survives seven years from the gift it will not be taken into account in determining the IHT liability on the settlor’s death.
“The scheme designers claimed that the outstanding loan could be deducted from the value of the house (which would always remain in the settlor’s estate).
“There were many variations on this basic plan. Various factors including the introduction of stamp duty land tax (SDLT), the introduction of pre-owned asset tax (POAT) and the 2006 changes to the IHT treatment of trusts brought an end to this type of planning. It has been suggested that some 30,000 such arrangements were set up.
“HMRC remains of the view that the schemes do not work as intended and have been challenging schemes on the death of the settlor.”
Decision on the case
Commenting on the case, Brown explained: “Mrs Pride (Mrs P) was the principal beneficiary of an interest in possession (IIP) trust established in 2002. She was entitled to the income arising on the trust fund and additionally the trustees had the power to advance capital for her use and benefit. Because this was an IIP trust, the trust fund was deemed to be in P’s estate for IHT purposes. This trust was known as the property trust.
“Mrs P also established a trust, the children’s trust’, for the benefit of her children. Mrs P was not a beneficiary of this trust. In 2002, she wanted to downsize. She arranged the sale of her house to the property trustees for £800,000 ($1m, €907,000). They immediately sold it to an unconnected party. The trustees thereafter had cash of £800,000 but owed Mrs P the same amount. This cash was invested in an investment bond. Mrs P negotiated the purchase of a flat for £535,000 funded by her but owned by the property trustees. Under the terms of the trust, she was entitled to live in the flat.
“As a consequence of these transactions the trustees had assets of £1,335,000 but owed Mrs P an identical amount. The property trustees had a loan note created, and given to Mrs P, which provided that the note could be redeemed for £5,099,366 − 23 years after issue. (£5,099,336 is £1,335,000 compounded at 6% for 23 years.) The value of the loan note was capped at the value of the trust fund. Mrs P immediately transferred the loan note to the children’s trustees.
“Mrs P moved into sheltered accommodation in 2005 and later moved to a nursing home. She died in October 2016. At that time, the property trust fund was valued at £3,013,942 (the flat was valued at £650,000, the bond at £2,363,942.) This amount fell to be taken into account for the IHT calculation on Mrs P’s death.
“Her executor claimed to deduct the value of the loan note, capped at the value of the trust fund. This meant that no IHT was due in respect of the property trust. There is anti-avoidance legislation which prevents the deduction of liabilities created by the deceased. Were the trustees’ debts created by Mrs P? The executor argued that the liability was a liability of the trustees only.
“The tribunal held that as a matter of law, the property trust assets, subject to any liabilities, are beneficially held by the trust beneficiary, Mrs P. The legislation, properly interpreted, brought the property trust assets and liabilities into Mrs P’s IHT estate. The loan note was derived from her actions. The tribunal pointed out that had Mrs P not transferred the loan note to the children’s trust, her estate would have had equal and offsetting assets and liabilities.
“The value of the loan note could not be deducted in arriving at Mrs P’s IHT liability. The HMRC view (as expressed in its inheritance tax manual) is that the anti-avoidance legislation “is intended to prevent the avoidance of tax through the ‘artificial creation’ of liabilities which would normally be allowable as deductions. Broadly, the rules apply when the deceased has both borrowed money from someone and made a gift to that same person.”
Brown added: “HMRC provides the following example of the type of arrangement the legislation is designed to prevent:
- A gives land valued at £100,000 to B;
- B raises £100,000 by way of mortgage and loans this to A;
- A dies eight years later with the whole £100,000 outstanding; and
- The gift by A escapes tax as a PET made more than seven years before death while the £100,000 debt is claimed as a deduction from A’s estate.
An HMRC spokesperson told International Adviser: “We welcome the tribunal’s confirmation of our longstanding position that properties in these circumstances remain an asset of an estate on death and are subject to inheritance tax.”
