HMRC has recently won an important inheritance tax case, in which a home-loan or double-trust, tax planning scheme failed.
The case is James Charles Pride as trustee of the estate of the late Geraldine Jill Pride and HMRC’, was heard at a tax tribunal in December 2022 – Have a look at the fill judgement:
Regular readers of my blog posts my remember my review of the Shelford case in my post of 15 January 2021. While I do not propose reiterating my views regarding this type of arrangement they remain and will remain pertinent, and the current case offers a fine example of where things can lead. Also bear in mind that the family has been unable to finalise the estate for over six years!
What is the Nature of the Scheme?
The purpose of the home loan or double trust scheme was to remove the value of a house from an individual’s estate for inheritance tax purposes whilst allowing that individual to remain living rent-free in the house for the rest of their life. The supposed plan is that the individual sells the house to an interest in possession trust of which the individual is the settlor and principal beneficiary. The purchase price is left outstanding as a loan (the home loan) owed by the trustees to the settlor. The settlor then gives the benefit of the loan to a second trust (the double trust) for his or her children The settlor cannot benefit from the second trust and the gift of the loan is a potentially exempt transfer or PET. Assuming the settlor survives seven years from the gift it will not be taken into account in determining the inheritance tax liability on the settlor’s death.
The scheme designers claimed that the outstanding loan could be deducted from the value of the house which would always remain in the settlor’s estate. A cunning plan? There were many variations on this basic plan. Various factors including the introduction of stamp duty land tax, the introduction of pre-owned asset tax and the 2006 changes to the inheritance tax treatment of trusts brought an end to this type of planning. It is thought that around 30,000 such arrangements were set up.
HMRC remains of the view that the schemes do not work as intended and have been challenging schemes following the death of the settlor.
So, What Happened in Practice?
Mrs Pride was the principal beneficiary of an interest in possession trust established in 2002. She was entitled to the income arising on the trust fund and additionally the trustees had the power to advance capital for her use and benefit. Because this was a life interest trust, the trust fund was deemed to be in Mrs Pride’s estate for inheritance tax purposes. This trust was known as the property trust. Mrs Pride also established a trust, the children’s trust, for the benefit of her children. Mrs Pride was not a beneficiary of this trust. In 2002, she wished to downsize. She arranged the sale of her house to the property trustees for £800,000. They immediately sold it to an unconnected party. The trustees thereafter had cash of £800,000 but owed Mrs Pride the same amount. This cash was invested in an investment bond. Mrs Pride negotiated the purchase of a flat for £535,000 funded by her but owned by the property trustees. Under the terms of the trust, she was entitled to live in the flat.
As a consequence of these transactions the trustees had assets of £1,335,000 but owed Mrs Pride an identical amount. The property trustees had a loan note created, and given to Mrs Pride, which provided that the note could be redeemed for £5,099,366 − 23 years after issue. £5,099,336 is £1,335,000 compounded at 6% for 23 years, by the way. The value of the loan note was capped at the value of the trust fund. Mrs Pride immediately transferred the loan note to the children’s trustees.
Mrs Pride moved into sheltered accommodation in 2005 and later moved to a nursing home. She died in October 2016. At that time, the property trust fund was valued at £3,013,942 (the flat was valued at £650,000, and the bond at £2,363,942.) This amount fell to be taken into account for the inheritance tax calculation on Mrs Pride’s death.
The Result on Death?
Mrs Pride’s executor claimed to deduct the value of the loan note, capped at the value of the trust fund. This meant that no inheritance tax was due in respect of the property trust.
There is anti-avoidance legislation which prevents the deduction of certain liabilities created by the deceased. The question was whether the trustees’ debts were created by Mrs Pride?
The executor argued that the liability was a liability of the trustees only and so fell outside of the anti-avoidance legislation.
The Tribunal’s Ruling?
The tribunal held that as a matter of law, the property trust assets, subject to any liabilities, are beneficially held by the trust beneficiary, Mrs Pride. The legislation, properly interpreted, brought the property trust assets and liabilities into Mrs Pride’s estate for inheritance tax purposes. The loan note was derived from her actions. The tribunal pointed out that had Mrs Pride not transferred the loan note to the children’s trust, her estate would have had equal and offsetting assets and liabilities. End of story!
The value of the loan note could not be deducted in arriving at Mrs Pride’s inheritance tax liability. HMRC’s view (as expressed in its inheritance tax manual) is that the anti-avoidance legislation “is intended to prevent the avoidance of tax through the ‘artificial creation’ of liabilities which would normally be allowable as deductions. Broadly, the rules apply when the deceased has both borrowed money from someone and made a gift to that same person.