The grant of sub-lease containing maintenance obligations undermined IHT planning. Andy Keates explains why the gift with reservation (GWR) rules applied in the case of Lady Hood.
The executors of the estate of Lady Diana Hood v HMRC (2017, UKUT 0276) is an important Upper Tribunal (UT) case which examined in detail the IHT gifts with reservation (GWR) provisions in FA 1986 s102.
Can’t give away but continue to use
The GWR rule for inheritance tax was put there to prevent people from “having their cake and eating it” by making a gift of an asset (so it was no longer in their taxable estate at death) but retaining some use of the asset while alive.
The law in FA 1986 s102(1) sets out that a GWR is made if either:
(a) “possession and enjoyment of the property is not bona fide assumed by the donee… ; or
(b) … the property is not enjoyed to the entire exclusion, or virtually to the entire exclusion, of the donor and of any benefit to him by contract or otherwise”.
In most cases, this is relatively straightforward, as the facts will show whether there is a reservation of benefit or not. In the present case, as in so many of the more complex IHT cases, the difficulty does not lie in the IHT legislation itself but correctly identifying what precisely is the asset being gifted.
In 1979, Lady Hood was granted a head-lease over premises in London by Viscount Chelsea, and in 1997 she granted a sub-lease to her sons. The sub-lease included conditions which obliged the sons to paint the property inside and out at specified intervals and to keep it in good repair. If these maintenance conditions were not met the lease could be forfeited. These conditions written into the sub-lease matched maintenance conditions which Lady Hood had herself entered into towards Viscount Chelsea when obtaining the original head-lease.
Since Lady Hood died in 2008, more than seven years after the grant of the sub-lease, the value of that gift of the sub-lease should have fallen out of her taxable estate for IHT purposes. This would save a considerable amount of IHT, unless HMRC could show that she had in some way reserved a benefit in the property.
Enjoyment of the property
It was accepted by all parties that the sons had in fact assumed full enjoyment of the property, so the first part of the GWR rule: FA 1986 s102(1)(a) was not triggered. HMRC also accepted that the sons enjoyed the property to the entire exclusion of Lady Hood, which might lead one to think that the second part of the GWR rule: FA 1986, s 102 (1)(b) was similarly not triggered.
However, FA 1986 s102(1)(b) also contains some niggling additional words, which HMRC believed tainted the gift by making it a GWR: “and of any benefit to him by contract or otherwise”. HMRC argued that the sons’ requirement to paint and repair the property, by effectively relieving Lady Hood of her own obligations under the head-lease, represented such a benefit.
Lady Hood’s executors, however, took the view that HMRC (and indeed the FTT when it originally found in HMRC’s favour) were looking at the wrong asset. She had not made a gift of a full and unfettered sub-lease and then taken back a benefit to herself; instead, she had gifted to her sons a lease which was already “imprinted” with the obligations to keep up the maintenance of the property.
This line of reasoning works on the basis that, while the law does not allow a donor to have their cake and eat it, there is nothing to stop them from carefully dividing up the cake, eating part and having the rest. If the benefits which the donor continues to enjoy are by virtue of something she never gave away, she has no GWR in the property which she did give away.
So the issue was whether the benefit to Lady Hood of the maintenance obligations related to the sub-lease she had granted, or to the reversionary interest in the head-lease she had retained.
A further legal wrinkle was whether she enjoyed the benefit at the expense, or to the detriment, of her children. If it makes no difference to their enjoyment of the property, then it does not “trench upon” the exclusivity of their enjoyment and does not constitute a reservation of benefit.
A win for HMRC: the asset gifted to her sons by Lady Hood was the whole sub-lease, and the benefit of them complying with their obligations to maintain the property was something she received back. The gift had been of a single proprietary interest, and all its associated benefits and burdens went with it. There was no scope for reassigning those benefits and burdens to the reversionary interest in the head-lease which was not gifted.
So far as the “trenching” issue is concerned, the maintenance obligations the sons committed to were “for the protection and better enjoyment by her of her retained interest in the head-lease”. They were more than negligibly onerous to the sons, and as Lord Hoffmann said in Ingram v IRC (1 AC 293); “as long as covenants given by the donee are more than a few de minimis crumbs of what has been given the donor is treated as having retained the whole cake”.
Few things are more complex than land law, as so many subtly different interests can be held over the same land at the same time. This can make what would normally be quite straightforward IHT planning into a minefield. Getting around the GWR provisions requires tax planners “to define precisely the interests which they are giving away and interests, if any, which they are retaining” - not always the easiest of tasks!
This was potentially an important case (the two UT judges were the Presidents of the two Tribunals, so the big guns were brought out); by underlining that donors have to separate themselves entirely from their gifts, it may serve to deter some other attempts at IHT planning using sub-leases.