How to gift your cake and keep it

Taxes are never popular, but inheritance tax is surely one of the most disliked. Not only is it quite a heavy tax compared to others but, rightly or wrongly, it's also often seen as unfair. Having paid tax at all stages of building up their wealth, most people feel they should be able to pass it on to the next generation unhindered.

An obvious solution is to pass on wealth in advance. Unfortunately the law says gifts normally have to be made at least seven years before death to escape inheritance tax. The dilemma here is that unexpected longevity or unforeseen costs can mean that a person finds out (often too late) that they have gifted away
too much and left themselves short.

A similar dilemma can arise about gifting something with more than just a monetary value such as a treasured artwork, or even the much-loved family home. A common response is to gift the item now but hold back on delivery until death. For example,
to gift a painting but keep it hanging above one's own fireplace, or to gift a property but to carry on living there. However in order to escape the tax, a gift must be irrevocable and complete. In the examples above, the clients have 'reserved a benefit' to themselves and so the plan falls flat; inheritance tax is still payable.

However a possible solution is a chattel lease scheme, which I first saw used for a client with a world-class and very beautiful collection of valuable porcelain. Moving it would have left a gaping
hole in the client's home - but being worth more than a million pounds, the potential tax bill was
a pressing concern.

The scheme involves owners making an absolute and irrevocable gift, either to an individual or to a trust. Then, the donors arrange to lease the item back again, for a set (renewable) term, from the new owner.
It is vital that the valuation of the item and also the setting of the rental amount are both done on
open-market terms on a commercial basis.

Of course for properties, there are lots of well qualified people to assess a fair lease. It's more difficult to put a value on the right to enjoy a piece of art, drive a vintage car or wear a piece of jewellery, but such experts certainly do exist. In cases like this however, it's wise to get more than one opinion, and take pains to ensure scrupulous impartiality of all parties. In drafting the lease and deed of gift, it's also wise to use a legal adviser who is familiar with potential complications.

There are also caveats to consider; a key one being that the donors must now pay rent to the new owners. Assuming affordability is no problem, this might actually be a slight advantage in the sense that a stream of rental payments is just another way of gradually reducing the taxable estate. On the other hand, the rent is taxable in the hands of the new owner, so there's only actually a saving if their income tax rate is less than the inheritance tax rate (i.e. they're a basic rate taxpayer).

If the asset has an accrued gain, gifting during life means that capital gains tax is payable immediately, or at best is deferred until later sale if the 'hold over' option into a trust is used. This contrasts with the pre-gift position where capital gains tax is wiped out for free on death. This tax bill might be considered a small price to pay for the hoped-for inheritance tax savings. Remember though, that if inheritance tax becomes payable after all (i.e. if the donor doesn't live past the seven year period) then the asset will have borne both taxes - a double whammy.

With these potential tax complications, it's important to examine all of the angles early on - and of course with legal costs and valuer's costs, it's probably only worthwhile for extremely valuable assets. However where a client's head is telling them to act now,
but their heart just can't bear to part with something, it's good to know there's a way to satisfy both.

Scott Gallacher is a director at Rowley Turton

He writes the regular IFA comment in Private Client Adviser