Section 15: related property
The Valuation Office Agency's (VOA) technical manual relating to Inheritance Tax.
There are special rules for valuing property that is included in an estate if there is other property that is ‘related’ to it, s.161 IHTA 1984. The rules apply in situations where valuing the property together with the related property produces a higher value than by valuing the property on its own.
Broadly speaking, related property is property that
- in the estate of a spouse/civil partner, or
- comprises, or has comprised within the preceding five years, property donated by either spouse or civil partner to a charity, charitable trust or to one of the political, national or public bodies to which exempt transfers may be made
The rules apply to both lifetime transfers and transfers on death.
HMRC will decide what property is to be regarded as related property.
Related property provisions apply for IHT purposes only. There are no similar provisions in CGT legislation.
The rule is intended to prevent the reduction in value, for IHT purposes, of property by fragmentation of ownership, aimed at passing the family estate within the family at minimum charge to IHT. The fact that transfers between spouses or civil partners are exempt from IHT would enable the prior fragmentation of the estate between spouses or civil partners to take place at no cost in IHT. Controlling shareholdings could be split into minority holdings, farms into isolated fields, buildings or building plots severed from essential access etc. The application of the rule has the effect of recombining the spouses’ or civil partners’ ownerships for valuation purposes.
The rule does not apply if the value arrived at by s.161 IHTA 1984 apportionment is equal to or less than the value of the transferor’s property on its own. In other words, the rule does not apply if the transferor’s property would not realise a better price by being sold with the related property.
The value to be included in the deceased/transferor’s estate is the ‘appropriate portion’ of the value of the aggregate of the transferors and related property.
This is a two-step process:
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Establishing the enhanced value of the aggregate of the transferor’s property and the related property (see para 15.5).
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Calculation of the appropriate proportion (see para 15.6).
The first step is to value the property in the transferor’s estate together with the related property (the aggregate referred to in s.161(1) IHTA 1984). For this purpose the VOA should value both interests together, as if already merged, and make no reduction in the aggregate value because the related property is owned by the spouse or civil partner and not by the transferor. If vacant possession would become available on the merging of the interests the property should be valued with vacant possession. In all cases the aggregate value should reflect the full enhancement attributable to the merging of the transferor’s property with the related property and no deduction should be made because more than one ownership is involved.
The next step is to arrive at the “appropriate portion” of the enhanced aggregate value referred to in para 15.5 above, which is to be attributed to the transferor’s property.
There are two methods of calculating the appropriate portion:
- the ‘general rule’, s.161 (3) IHTA 1984 (see para 15.7)
- the ‘special rule’, s.161 (4) IHTA 1984 (see para 15.10)
The general rule is used where the items of property being aggregated for valuation purposes are different, such as freehold and leasehold interests in the same piece of land, or for example if the related property comprises adjacent parcels of land owned and the relationship between the two parcels of land – one has no access without the other – they together make a more valuable natural unit.
The special rule is mainly used for calculating the value of shareholdings, but also applies to undivided shares in property.
For disparate or unequal items of property the “appropriate portion” is determined in accordance with s.161(3) IHTA 1984 by applying the Formula 1:
Where;
A = the enhanced value of the aggregate of the transferor’s property and the related property, the aggregate being valued in accordance with para. 15.5,
T = the value of the transferor’s property, and
R = the value of the related property
Both T and R are valued separately as if each property did not form part of the aggregate (see para.15.8).
HMRC will calculate the appropriate portion based on the VOA’s valuations for T, R and A.
Where related property consists of a separate estate or interest in the transferor’s property (eg a freehold reversion, a leasehold or a tenancy) the principles set out in para 15.5 apply. For example, if a transferor had leased freehold premises to a spouse or civil partner the lease would be regarded as having merged with the ownership of the freehold and the s.161(1) IHTA 1984 aggregate value would be the freehold vacant possession value of the premises.
However in order to arrive at the appropriate portion under s.161(3) IHTA 1984 the value of the aggregate, the transferor’s freehold should be valued subject to the lease. Similarly, the spouse’s or civil partner’s leasehold interest would be valued separately. In valuing both the freehold reversion and the lease as if it did not form part of the aggregate under s.161(3) IHTA 1984 consideration should be given to the possibility that either the freeholder or leaseholder would be in the market as a special purchaser of the other interest in order to merge the interests and thus obtain vacant possession.
A house stands in 10 acres of parkland, which together are valued at £1,500,000. The transferor owns the house, whilst her spouse owns the surrounding parkland (the related property).
Calculation of value of wife’s interest in the house on death (or the occasion of a chargeable lifetime transfer)
A Aggregate value of the entirety with vacant possession is £1,500,000.
T Value of transferor’s interest in the house if not part of the aggregate:
say £1,200,000 (i.e. what the market might pay and not the arithmetical proportion)
R Value of husband’s related interest in the parkland as if not part of the aggregate:
say £50,000
Appropriate portion of the value of the aggregate attributable to the transferor’s interest in the house:
The issue of whether s.161(4) IHTA 1984 applies to shares of land was considered by the Special Commissioners in Arkwright and another v Inland Revenue Commissioners [2003] UKSPC00392, [2004] STC (SCD) 89. There it was held that whilst s.161(4) IHTA 1984 could apply to property which had a distinct individual existence as a unit, such as unit trusts or a set of furniture (for example twelve dining chairs), it did not apply to fractions of units.
This issue was not considered further when the Revenue’s appeal against the decision was heard by the High Court. HMRC subsequently received legal advice that s.161(4) IHTA 1984 may, in fact, apply to fractional shares of units and on 27 November 2007 issued Revenue and Customs Brief 71/07. This brief stated that for all IHT cases where the account is received after the publication date, HMRC would consider applying s.161(4) IHTA 1984, where undivided shares in land are involved.
On this basis the aggregate value of the merged shares needs to be ascertained and then apportioned proportionately on an arithmetic basis. HMRC will calculate the appropriate portion based on the VOA’s valuation.
A transferor owns a 95% share in a house and his wife owns the other 5% share. The entirety is valued at £500,000. The relative values would be apportioned as follows:
Husband’s share £500,000 x 95% = £475,000
Wife’s share £500,000 x 5% = £ 25,000
£500,000
S.176 provides relief in cases where property, which has been valued on a death with related property, is sold within three years after the death as a separate interest, and the price realised is less than that determined for IHT purposes. (See Section 12).
Reference of cases to the VOA
15.13 HMRC to indicate Related Property when known to them
When HMRC are aware that related property is involved (normally those cases in which the transferor’s spouse or civil partner owns an undivided share or a separate estate or interest in property comprised in the transferor’s estate) they will advise the provision applies and give full details of the related property concerned.
If the VOA is aware that the transferor’s spouse or civil partner owns property (not referred by HMRC as “related property”) and the transferor’s estate would realise a better price if sold together with the spouse’s or civil partner’s details of the “related property” should be provided to HMRC and their instructions awaited. No enquiries should be made of the parties concerning the apparent existence of such related property unless authorised by HMRC; nor should any special search of office records be instituted for this purpose without a specific request from HMRC.
Valuations required by HMRC
In every related property case the VOA will first have to decide whether a better overall price would be realised if the transferor’s property and the related property were sold together. If not, the transferor’s property should be valued without applying the related property valuation rule of s.161 IHTA84. The report to HMRC should provide an explanation.
If the transferor’s spouse or civil partner holds a separate interest in the transferor’s property or owns other property HMRC will require:
- an aggregate valuation of the transferor’s property and the related property together
- separate valuations of the transferor’s property and the related property as if not part of the entirety or aggregate
HMRC will calculate the appropriate portion attributable to the transferor’s property in accordance with s.161(3) IHTA84. See para 15.7.
Where the transferor and spouse or civil partner own property jointly as undivided shares HMRC will require:
- an aggregate valuation of the transferor’s property and the related property together.
HMRC will calculate the appropriate portion attributable in accordance with s.161(4) IHTA84. See para 15.10.