Can a client with three private residences sell two of them to a trust he had previously settled with a view to mitigating his exposure to IHT and CGT? Terry Jordan answers a query for Taxation magazine.
Is there a tax-free benefit in transferring main residences to an existing trust?
Our client created a discretionary settlement tax-free with valuable shares that qualified for business property relief. The trustees are an ex-wife and a friend. The potential beneficiaries are his three children, two of whom are adults.
He is thinking of selling two of his three private residences to the trust at full market value with the consideration left outstanding on loan. Apart from stamp duty land tax no tax liabilities arise on the sale.
The client wants to continue to occupy the residences rent-free – which feels “wrong”. The question is what the future tax consequences of this proposal might be. The issues appear to be as follows.
First, there can be no issue with the gift with reservation of benefit legislation because there is no element of gift.
Second, the pre-owned assets tax regime does not apply because the transaction does not contravene the distribution or contribution conditions – the HMRC manual confirms that the contribution condition does not apply.
Third, as long as any future loan repayments are not made from undistributed income there is no issue with the capital payments legislation at ITTOIA 2005, s 633 to s 643.
Fourth, any increase in value will be subject to the 10-year inheritance tax charging regime at 6%.
Finally, main residence relief on the properties will be lost to the extent that it might otherwise have been available.
The client accepts the 10-year charge and possible loss of main residence relief. He also accepts that the idea would merely be a “value freezing” exercise because it simply stops his estate growing. He accepts that his tenure in the properties would be at the whim of the trustees.
Are we missing any tax consequences? If not, we do appreciate that the trustees would need to take legal advice as regards their duties before they permitted the client to occupy rent-free.
Query 18,436 – MBK
Reply from Terry “Lacuna” Jordan, BKL
There are some odd features of this case. We are told that the client transferred to the trust valuable shares that benefited from inheritance tax business property relief, but one of the beneficiaries is apparently a minor child of the settlor.
Consequently, unless he or she is married or has a civil partner, capital gains tax holdover relief would not have been available on the client’s disposal of shares by virtue of TCGA 1992, s 169B.
We are also told that the client has three private residences and that, on the sale of two of them to the trust, the only tax issue will be stamp duty land tax. On the face of it only one of the three residences would benefit from only or main residence relief.
It is accepted that a sale for full consideration is not a gift and accordingly the inheritance gifts with reservation of benefit provisions are not in point.
However, for the income tax charge on pre-owned assets (POAT) to be avoided, the disposal needs to satisfy the conditions of FA 2004, Sch 15 para 10(1)(a).
It has been suggested that the terms of the loan should be the same as those offered by a bank or building society with interest being paid, not rolled up, secured and the usual deposit paid because it needs to be “…a transaction such as might be expected to be made at arm’s length between persons not connected with each other.” Subject to those queries and caveats, the planning appears sound.