In recent years, the Inland Revenue has become increasingly frustrated by the widespread use of ‘artificial’ schemes to save inheritance tax (IHT), in particular on the family home. There have been Ingram schemes, Eversden schemes, home loan schemes, reversionary lease schemes, chattel leaseback schemes… The list goes on. It is estimated that as many as 30,000 Eversden schemes alone may have been implemented. In an attempt to confront what it sees as unacceptable avoidance and to send out a warning for the future, the Revenue has turned to income tax to cover up the cracks in the IHT rules.
On 6 April 2005, the new income tax charge known as the pre-owned assets (POA) charge comes into effect. The Paymaster General has stated that the charge will send “a clear message that artificial avoidance is not acceptable”. Unfortunately, the new legislation, contained in Schedule 15 to the Finance Act 2004, is far from clear and affects innocent transactions as well as artificial ones. Furthermore, it is retroactive, and can tax the results of transactions which in some cases were carried out more than 17 years ago – this could cause compliance headaches where relevant information is no longer held.
The POA charge is payable by individuals in respect of the benefits they enjoy (or in certain circumstances are capable of enjoying) from assets that they have owned, but have since disposed of (in whole or part) since 17 March 1986. Direct or indirect contributions by taxpayers to the acquisition of the asset that they are enjoying can also be caught by the charge. There are separate provisions in relation to three different kinds of property: land occupied by the taxpayer; chattels in the possession of, or used by, the taxpayer; and property that the taxpayer settled or added to a trust that the taxpayer can benefit from. In the case of land, the chargeable amount is set by reference to the rental value of the land. In the case of chattels and settlor-interested trust property, the charge is set by reference to a prescribed rate of interest set by the Revenue (likely to be around 5 per cent initially).
There are a number of important exclusions and exemptions from the charge. Generally, an outright transfer of property to a spouse will be excluded. A disposal of the taxpayer’s whole interest in the property by an arm’s-length transaction is excluded. In addition, property will usually be exempted from charge to the extent that its value is in the taxpayer’s estate for IHT purposes, or where the taxpayer has reserved a benefit in the property so that it is caught by the IHT rules. Certain posthumous arrangements such as deeds of variation and disclaimers are also exempted from charge. The payment of full market consideration for the benefit enjoyed will generally exempt the taxpayer from charge. Also, where a taxpayer’s combined chargeable amount under the charge is less than £5,000 in any tax year, then it is ignored.
The peculiar thing about the POA charge is that it does not appear to necessarily catch its intended targets. Certainly, it catches Ingram and Eversden schemes, but to some extent these had been caught by previous IHT legislation. It is not clear that it applies to leaseback chattel arrangements, which appeared to be a main target of the charge. It is also not clear that home loan schemes are caught, although no doubt the Revenue will argue strongly that they are.
Most worryingly, though, it appears to catch some innocent transactions. It is easiest to show this by an example. Suppose that Mary lives with her father Bob, who owns the home they live in, which is worth £500,000. Bob decides that he wants to sell half of the home in order to raise some funds for his retirement. He sells to Mary, who pays £250,000, and both continue to live in the property. Despite the fact that Bob’s actions had nothing to do with tax avoidance, he is prima facie caught by the charge on the rental value of the half share now owned by Mary. If he had sold his whole interest in the property then he would have been protected by an exemption, but there is no exemption for sale of part of a person’s interest.
People who have entered equity-release schemes that work in a similar way to this example may also find themselves caught by the charge. It is very hard to see why, if a person is simply trying to raise funds out of the equity of their home, they should have to pay income tax not only on the funds raised (if these produce interest) but also on their ‘enjoyment’ of the share of their home which has been sold. It is very much hoped that the Government will amend the legislation prior to 6 April this year to deal with this unsatisfactory situation.
If people find they are affected by the POA charge, they have a choice to either pay it or, within the appropriate time periods, to elect to have the previously owned asset treated as part of their estate for IHT purposes. Depending on the age and health of the taxpayer, it may be cheaper for the family to pay the income tax charge rather than run up a large IHT bill on the person’s death. Alternatively, it may be possible to arrange the taxpayer’s affairs so that they no longer enjoy the pre-owned property and so escape the charge.
Self-assessing the charge could be fraught with difficulties. If, for instance, John gave Jackie £200,000 in 1988, which she then mixed with her bank account from which in 1990 she bought a house for £300,000, how much of the £300,000 relates to John’s original gift and how much to all the other capital and income that will have passed through Jackie’s account between 1988 and 1990? Given the complexities, lawyers should encourage taxpayers to seek advice, they should exchange their understandings of the working of the POA charge wherever possible and, most importantly, they should call upon the Revenue to provide further clarity, if necessary by way of revision to Schedule 15.
