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REV BN 40: Tax Treatment Of Pre-Owned Assets

 
 

Who is likely to be affected?

1. People who have entered into contrived arrangements to dispose of valuable assets, while retaining the ability to use them. The main purpose of arrangements subject to the charge is to avoid inheritance tax. There are specific exceptions to the charge which are explained below.

General description of the measure

2. Pre-Budget Report announced that a free-standing income tax charge will apply from the 6 April 2005 to the benefit people get by having free or low-cost enjoyment of assets they formerly owned (or provided the funds to purchase). The charge will apply in appropriate circumstances both to tangible assets (with separate provision for land, including living accommodation, and for chattels) and to intangible assets. Broadly following the model of the benefit-in-kind charge on employees, the rules will quantify an annual cash value for the benefits enjoyed by a taxpayer: this will be treated as an addition to their taxable income, subject to a de minimis threshold, and a set-off for any amounts made good by them for the benefit.

Operative date

3. The charge will apply when a benefit is received in chargeable circumstances in or after the income tax year 2005-06.

Current law and proposed revisions

4. The Government is aware that various schemes designed to avoid inheritance tax have been marketed in recent years. These use artificial structures to avoid the existing rules about gifts made with reservation. As a result, people have been removing assets from their taxable estate but continuing to enjoy all the benefits of ownership. The Government is determined to block this sort of avoidance and announced in the Pre-Budget Report that people who benefit from these sorts of schemes would be subject to an income tax charge from April 2005, to reflect their additional taxable capacity from receiving these benefits at low or no cost.

5. Following consultation, the Government has confirmed, and proposes to extend, the exclusions outlined in the consultation document published following the Pre-Budget Report. So the proposed charge will not apply to the extent that:

  • the property in question ceased to be owned before 18 March 1986;
  • property formerly owned by a taxpayer is currently owned by their spouse;
  • the asset in question still counts as part of the taxpayer’s estate for inheritance tax (IHT) purposes under the existing “gift with reservation” (GWR) rules;
  • the property was sold by the taxpayer at an arm’s length price, paid in cash: going further than the consultation document, this will not be restricted to sales between unconnected parties;
  • the taxpayer was formerly the owner of an asset only by virtue of a will or intestacy which has subsequently been varied by agreement between the beneficiaries; or
  • any enjoyment of the property is no more than incidental, including cases where an out-and-out gift to a family member comes to benefit the donor following a change in their circumstances.

6. More generally, the rules for tangible assets will mean that former owners will not be regarded as enjoying a taxable benefit if they retain an interest which is consistent with their ongoing enjoyment of the property. For example, the proposed charge will not arise where an elderly parent formerly owning the whole of their home passes a 50 per cent interest to a child who lives with them.

7. Intangible assets formerly owned by the taxpayer (or derived from other property formerly owned by them) will be treated as giving rise to a taxable benefit, only to the extent that the taxpayer may derive benefits from them, and those benefits would diminish the benefits potentially available to others. So for example, no charge would apply if the taxpayer has funded life insurance policies held on trust and the taxpayer’s continuing claims are limited to particular retained benefits, such as the return of the life assurance premium, and the balance of the policy value is held on trust solely for others. But a charge would be due if, say, the whole value of such a life policy was held on discretionary trusts for a class of beneficiaries including the settlor (and the circumstances were such that the trust property was not covered by the existing “gift with reservation” rules).

Territorial scope

8. The charge will apply to residents of the UK. For taxpayers who are domiciled in the UK (or deemed to be), the charge will apply to their assets anywhere in the world. For taxpayers who are not domiciled in the UK (or not deemed to be), the charge will apply only to their UK assets. For taxpayers who have become domiciled in the UK (or deemed to be), the charge will not apply to any non-UK assets which they ceased to own before they acquired that domicile.

De minimis

9. The consultation document said that there would be a substantial de minimis threshold below which the cash value of benefits in a given year would be disregarded. The Government has decided to set this threshold at £2,500 per year.

An election for transitional relief

10. A number of responses in consultation made the point that existing users of tax-driven schemes may find it difficult or impossible to dismantle the resulting structure – so eliminating any income tax charge and re-instating the potential IHT charge they originally sought to avoid – although that is, with hindsight, the outcome that many of them would prefer. In response to that, the Government proposes, additionally, that taxpayers involved in existing schemes may choose a special transitional treatment if they elect for this by 31 January 2007. If they elect, they will not be subject to the new income tax charge in relation to property covered by the election, but the property in question will be treated as part of their taxable estate for IHT purposes, while they continue to enjoy it, in essentially the same way as under the existing “gift with reservation” rules. As under those rules, property subject to such an election would be potentially eligible, in due course, for the normal IHT reliefs and exemptions available, for example, to business and agricultural property, and to heritage assets.

Valuation and further consultation

11. The Government has confirmed the approach outlined in the consultation document and proposes that the cash value of benefits should be determined by reference to market rentals in the case of land, and by reference to imputed percentages of capital value in the case of chattels and intangible assets. They would welcome further representations, in the light of the decisions now announced, on the detailed arrangements that should apply to valuation and on the rates of return for chattels and intangibles, so they reflect available market evidence while minimising avoidable compliance costs. They therefore propose to settle these matters in secondary legislation following a further round of consultation which the Inland Revenue will undertake later this year.

Further advice

12. If you have any questions about this change, please contact the Probate/IHT Helpline on 0845 3020 900.

www.inlandrevenue.gov.uk

 

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