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Failure of excluded property scheme for inheritance tax could have capital gains tax consequences

Failure of excluded property scheme for inheritance tax could have capital gains tax consequences

The taxpayers have recently lost a First Tier Tribunal case relating to an inheritance tax liability, Nader, Dickins, Gill & others v HMRC [2018] UKFTT 294. The circumstances are described as a “death-bed avoidance scheme”, but there are likely to be many other taxpayers who are affected. The interpretation of the exemption for a disposition which was not intended to confer a gratuitous benefit taken in the case is a restrictive one. The reasoning in the case also appears to have consequences for capital gains tax.

In 2010, an individual paid £1,075,000 for an “income interest” in a discretionary trust which had been settled by a non-UK domiciled individual and was thus expected to be an excluded property trust, so the trust interest would be outside the scope of UK inheritance tax. (This was before the amendment to the legislation with effect from 20th June 2012 which prevented an acquired interest from being excluded property). The income interest was not an interest in possession, but a right to call annually for the trust income. The trustees also agreed to amend the class of discretionary beneficiaries to comprise the purchaser’s family rather than the settlor’s family, although this was not actually done until after the purchaser’s death.

The tribunal found against the individual’s executors on a number of grounds, some of which have wide application.
• They held that the purchase of the trust interest was a transfer of value, despite the fact that it was purchased from an unconnected person, because the trust interest was not worth the sum paid for it.
• They held that the exemption for transactions (including associated operations) not intended to confer gratuitous benefit was not available, because although the purchase of the trust interest was between unconnected persons, in these circumstances, it was not on arm’s length terms. Again, the fact that the income interest was not worth the sum paid was relevant. The wider implication here is that where a transaction is undertaken to obtain a tax benefit, but the transaction does not make commercial sense otherwise and the taxpayer loses value, then this can be a chargeable transfer.
• They held that the individual was a settlor of the trust. The particular circumstances here were that although the trust existed at the time when she agreed to purchase the income interest, the vast majority of the funds were settled after she agreed to purchase the interest. Thus, although she did not fund the settlement, she was regarded as the settlor when the situation was “viewed realistically”. They held that for inheritance tax there was no requirement for an element of bounty. The wider implication of this is that since she was UK domiciled, almost none of the trust assets were excluded property.
It seems to us that this “realistic” approach to who is the settlor could result in a purchaser of a trust interest being treated as a settlor for the purposes of section 86 TCGA 1992, and the settlor being assessable on trust gains as they arise. This would extend to gains in close companies whose shares are held in the trust, subject to any claim to the section 13(5)(cb) motive defence.

In our view, the following groups of UK domiciled people should review their tax position as a result of this case:
• Anyone who has acquired an interest in an excluded property trust before June 2012.
• Anyone who has undertaken an inheritance tax planning scheme where reliance was placed on a payment to a third party not being a transfer of value or being an exempt transfer of value
• Anyone who has acquired an interest in an excluded property trust, where they have not then reported taxable gains in the trust or an underlying company.
Someone in this position could have historic tax liabilities, including an inheritance tax charge on the transfer of value when the trust interest was purchased and subsequent capital gains tax liabilities.

Many taxpayers in this position will not have been able to obtain advice on this issue before the requirement to correct deadline on 30th September 2018. We recommend that specialist advice is taken as soon as possible to consider the best approach to rectifying their position.