Annuities: calculations where an annuity is secured on land
IHTM16213 shows how the capital value of the fund required to generate an annuity could be manipulated to obtain a favourable tax outcome and how IHTA84/S50(3) seeks to address that possibility. There are also circumstances where the rules in IHTA84/S50 could give rise to an unfair outcome, so in the very limited circumstances set out below how we apply IHTA84/S50 is amended.
The circumstances where the rules in IHTA84/S50 are amended are
- an inheritance tax charge arises where an annuitant under a settlement either dies or disposes of his interest, and
- the annuity is charged, either wholly or partly, on real or leasehold property, and
- the capital valuation of the property, at the date the charge arises, is restricted to the property’s current use and the valuation reflects an anticipated increase in rents that can be obtained from that same use after the date of charge.
Where all of these circumstances are met, which will only ever be in a very limited number of cases, the calculation of the proportion of the property on which tax is charged is adjusted as set out below.
The rules in IHTA84/S50(2) mean that where a person is entitled to an annuity (IHTM16211) from settled property, they are treated as being beneficially entitled to the same proportion of the whole property as their share of the income bears to the whole income generated by the property. So if a property worth £250,000 generates £12,500 income per year and Sandra is entitled to receive an annuity of £2,000 per year, Sandra is treated as being beneficially entitled to property worth
£2,000 ¸ £12,500 x £250,000 = £40,000.
This value is subject to the higher and lower rates specified in accordance with IHTA84/S50(3) (IHTM16213).
If the property valued at £250,000 was let land, that value might only reflect the current use of the land and the current £12,500 per year rent. If, however a rent rise is due, which will increase the rent to say £15,000 per year for the same use, the value of that land might be increased to £300,000.
The formula in IHTA84/S50(2) would then give a value for Sandra’s beneficial interest in the property as
£2,000 ¸ £12,500 x £300,000 = £48,000.
This is because it is the actual level of income (£12,500 per year) that has to be used in the calculations but the expected higher level of rent has increased the value of the land. This can lead to inconsistent results between cases depending on whether the rent increase is imminent (when the capital value might be higher; but the increase in income is not taken into account) or someway off (when the capital value will reflect the actual level of rent).
Where this imbalance occurs, the value of Sandra’s beneficial interest in the property should be adjusted by taking account of the increased level of rent that had been used to arrive at the valuation of the land.
In the circumstances set out above, the income proportion would be calculated using the increased rent figure of £15,000 per year. Sandra’s beneficial interest in the property would be calculated as £40,000
(£2,000 ¸ £15,000 x £300,000) = £40,000 (instead of £48,000 as above).
This adjustment to the valuation under IHTA84/S50(2) is still subject to the rules in IHTA84/S50(3) (see IHTM16212). In the example above the capital value of £40,000 to produce income of £2,000 per year implies a yield of 5%. If this yield is outside of the higher and lower rates for the relevant date the capital value would need to be adjusted.
For example, on 15 August 2014 the higher rate was 3.81% and the lower rate was 3.30%. The capital value to generate income of £2,000 per year could not be less that £2,000 ¸ 3.81% = £52,493, or greater than £2,000 ÷ 3.30% = £60,606.
Where the adjusted value falls outside of the range of values the lower and higher rates would provide you must explain the position fully to the trustees and seek an acceptable value that reflects a yield between the lower and higher rates.
Any case where it is suggested that this relief applies should be referred to Technical to confirm that the precise conditions are met and to note.