To gift or not to gift?

Under the current tax regime, gifts of assets do not necessarily get reported until a death occurs. How do you know that effective gifts for inheritance tax (IHT) purposes have been made that will stand up to HMRC scrutiny?

It may seem simple when considering transferring chattels and personal property (property) to offer and accept them as a gift. However, without careful planning, the donor could inadvertently retain a benefit of the property gifted. This would result in it being included in the donor's estate for IHT purposes, possibly what the donor was trying to avoid in the first place. It is important to identify the property as a legal gift.

The gift with reservation of benefit (GWR) legislation applies if the donee does not genuinely take possession and enjoyment of gifted property within the last seven years of the donor's life (or if the period is shorter, the period from gift to the date of death), or the donee does not enjoy the property in that time to the "entire exclusion" or "virtually the entire exclusion" of the donor.

The GWR has two effects. If the donor dies with the reservation still in place, the property is included in their estate for IHT purposes and the gift will have failed. In addition, if the reservation ends within seven years before death, there is a potentially exempt transfer at the time the reservation ends based on the property's value at that time. Therefore if the donor dies within seven years of making the original gift, there are two potential charges to IHT: one on the original gift and one when the reservation ended. HMRC will, however, choose to tax the one which yields the highest tax.

Damage limitation

One way to limit the impact of GWR is to charge a rental for the use for the property. However, such arrangements can come under further anti-avoidance legislation called the pre-owned asset tax (POAT), which applies when a disposal is made and the donor subsequently benefits from that property, but the GWR rules do not apply.

The tax works as an income tax charge on the benefit of the use of the property at market rates. For example, if it is a house, the charge will be on the value of the market rate rent for a property. If payment is made for the use of the property, this reduces the value on which the tax is paid and if it is a market rate payment, the charge is reduced to £nil.

An individual who has made a gift subject to the POAT can elect for the property to be treated as a GWR and, therefore, falling within the donor's estate. But the election must be made by 31 January immediately following the tax year of the gift. So when making a gift, attention must be paid to the transfer of both the possession and enjoyment of the property to ensure it is seen as a bona fide gift.

Another complication can be if the property is not in the direct possession of the donor at the time of gift, for example an item held in storage, if the donee is not present or if the gift is made to trustees.

To demonstrate the transfer, a deed of gift or at least a supporting letter is advisable in all situations, rather than a verbal offer alone. If the property is held by a third party, notification should be made of the ownership change. And it would be wise for the new owners to inspect the property and ideally attend the formal handover. New storage and sometimes loan agreements should also be put in place.

If property is to be leased back to the donor, usually there is no formal delivery, so it is important to document the transfer of responsibility for the property to the new owner to make the gift effective. In many instances, it is usual for a formal receipt to be signed by the donee, their new insurable interest notified to the insurance company and the terms of any lease arrangement for insuring. Dealing with maintenance and preservation, and the payment of rent for the property, must be strictly adhered to.

Good news

Also worth noting are some updates on IHT provisions, proposed in the recent Budget, which limit the deduction for liabilities in calculating the tax. When the provisions were first drawn up, they would have impacted on planning already in place as well as that going forward. Amendments have now been made to the original proposals and they will only impact debts incurred from 6 April 2013.

It is some good and welcome news, although there continues to be a need to plan for IHT in the future when debts are incurred, particularly if the assets involved are likely to attract relief from this tax.

Lucy Brennan is a partner at Saffery Champness 

She writes a regular blog on tax and estate planning for Private Client Adviser

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