Writing for Taxation magazine, BKL tax adviser Terry Jordan responds to a query on the tax consequences of the grant of a lease extension if paid by the beneficiary of a trust.
Our clients are an interest in possession trust that was created before 1950 and the beneficiary of that trust. The trust’s sole asset is a leasehold residential property which is let. Trust income comprises the annual rent, and the net income from the property is paid to the beneficiary and shown on form R185. The beneficiary is a life tenant of the trust and on her death the asset will vest to her children absolutely.
The trustees are negotiating a lease extension at an estimated cost of £50,000 which the trust does not have. It has been proposed, therefore, that the beneficiary will pay this.
We would appreciate readers’ advice on how to best conduct this transaction. We wish to avoid unfortunate tax consequences now or in the future for the present beneficiary, who is quite elderly, and for the children who will ultimately receive the asset.
We look forward to replies.
Query 18,998 – Spock.
Reply by Terry ‘Lacuna’ Jordan, BKL
It is implicit in Spock’s query that the now elderly life tenant’s interest arose before 22 March 2006 and accordingly is an ‘estate’ interest in possession with the value of the underlying capital forming part of the beneficiary’s inheritance tax estate.
Because the trust was created before 1950, during the estate duty era, it is possible that the exemption now in IHTA 1984, Sch 6 para 2 will be in point on the death of the life tenant.
It is proposed that the cost of the lease extension estimated at £50,000 should be paid by the life tenant. The addition by the life tenant of that amount will, for inheritance tax purposes, be an immediately chargeable transfer (of about £44,000 if two annual exemptions are available) and no inheritance tax will be payable on the premise that the life tenant has not made previously chargeable transfers.
Going forward, the value referable to the addition will be relevant property, in theory subject to ten-year and proportionate or ‘exit’ charges (although on the face of it the rate would be nil) and will form part of the life tenant’s inheritance tax estate under the gifts with reservation of benefit provisions.
From the tax point of view a neater solution would be for the trustees to borrow from a commercial lender to fund the lease extension.