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Pre-owned asset regulations - 'dismantling' relief from double charges

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28th Jul 2005
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Forthcoming regulations to provide relief from possible double inheritance tax (IHT) charges in situations caught by the pre-owned assets provisions under Schedule 15 of the Finance Act 2004 are the closest measure to-date of any form of 'dismantling relief' for individuals caught out by retrospective changes to tax legislation, writes Nichola Ross Martin

The pre-owned assets tax (POT) charge has caught the main marketed IHT avoidance schemes. This involves reversionary leases, lease carve-outs and loan trusts/double trusts relating to the taxpayers main residence or valuable assets. Whilst it is possible to dismantle some schemes, others cannot be untangled without recourse to the courts.

In view of the retrospective nature of the pre-owned asset rules, which can be triggered by transactions occuring as far back as 17th March 1986, many had hoped that the government would amend the legislation to allow:
* a form of dismantling relief for those wishing to reverse their earlier transactions, and
* to prevent a POT charge in entirely innocent cases.
The new measures do not go that far. Instead they provide a relief for gifts, which are potentially exempt transfers (PETS), that due to the dismantling of a scheme, are twice charged to IHT if the donor dies within seven years of the original gift.

With no form of 'dismantling relief', there are 'once-only' election procedures under FA 2004 Sch. 15 para. 21 which allows the taxpayer to opt out of the pre-owned assets charge on any particular property, and treat it as though it were subject to a gift with reservation (GWR). There is no requirement for there to have been a gift; an election simply invokes the GWR rules as though there had been a gift.

The opt-out election does not treat the taxpayer as though he were entitled to an interest in possession in the property for capital gains tax (CGT) purposes, and on his death it does not enable the estate to claim an uplift in base cost for capital gains tax. Further, it will not provide any guarantee that HMRC will accept that the property in question falls out of the taxpayer's estate for IHT on his death at some time in the future.

Opting out or not is a difficult question, as the POT income tax charge is then avoided, but the IHT charge on the original asset remains. For those able to dismantle schemes affected however there is a possibilty of a double charge to IHT by virtue of the rules for gifts which are potentially exempt transfers (PETS).

Loan trusts or double trusts involved an individual selling his home or asset to a trust, which then issued an IOU, which was in turn gifted into another trust. The gift is a PET, and if the loan trust was reversed or dismantled, the gift could still count in computing IHT liabilities, and the main asset would also be included, as having returned to the individual's estate. Such an individual would need to survive seven years from the date of the gift to prevent a double charge.

The new regulations will provide relief from a double charge to IHT in cases where:
* a deceased person has made a gift of a debt owned to them;
* the gift was chargeable to IHT or becomes so chargeable (by virtue of the donor's death);
* the donor dies within seven years of the gift and on or after 6 April 2005;
* the debt was entered into as consideration for the purchase of an asset owned by the donor, or to provide funds for such a purchase:
* the full value of that asset, or of property derived from it, is also chargeable to IHT as part of the donor's estate at death.

The new double charge relief clearly softens the financial blow for many involved in now defunct IHT avoidance schemes, the cost of dismantling such schemes often being greater than the set-up fees. The pre-owned asset tax charge applies for the first time in 2005/06.

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By Paul Soper
29th Jul 2005 13:13

Dismantling relief?
What nonsense - the taxpayer entered into an arrangement which was irrevocable and should have been warned that subsequent changes in legislation might make this course of action unattractive. Does the author really expect that the government will introduce a measure which will enable taxpayers who entered into (and I stress again) irrevocable transactions should be allowed to revoke them because it is no longer convenient?

Whilst I have no liking for the idea of the POAT its logic could be said to be immpecable and in line with the decision in the case of Cooper v Billingham - a person occupying property as a beneficiary of a settlement does derive a benefit from that occupation, in the same way that an employee occupying property provided by an employer derives a benefit. All the legislation does is provide a mechanism for taxing that benefit where the asset or the funds provided belonged previously to that beneficiary. In the days of the old Schedule A charge before 1963 there would have been an income tax liability on this occupation in any event.

The price to pay for irrevocable tax planning is that the law might change and reduce its attractiveness - I can see no justification for a proposition that under those circumstances the transaction could then be relieved by treating it as revocable.

The profession should be paying closer attention to those circumstances where such a liability might arise where it is not justified.

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By Taxi
30th Jul 2005 11:22

Paul, I agree entirely. I was rather surprised at the
announcement which appears on one hand to be aimed at those unfortunate individuals who accidently got caught up in the POA rules, through no attempts at tax avoidance, and on the other so blatantly helps people trying to wriggle out of a situation that is totally of their own making.

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