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HMRC internal manual

Inheritance Tax Manual

From
HM Revenue & Customs
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Foreign property: valuation of assets: usufruct

Usufruct is a civil law term referring to right of one individual to use and enjoy the property that is vested in another, provided the property concerned is neither impaired nor altered.  The right of ownership gives the owner the ability to

  • use the property, or live in it,
  • receive the income from it, for example in the form of rent, and
  • sell or otherwise dispose of the property.

 

The owner can split his ownership in two so that there is

  • the usufruct; which is right to use the property and receive the income from it, and
  • the bare ownership of the property, which includes the right to dispose of it.

 

The person who holds the right to use and enjoy the property is known as the usufructuary and the person who holds the right to dispose of the property is known as the bare owner – in French, the ‘usufruitier’ and the ‘nu-propriétaire’

You may come across a usufruct where an estate includes land and buildings in EU or other foreign countries.  It may be referred to as a usufruct or ‘usufruit’ in French, or given another name such as a ‘Niessbrauch’ in German.  But no matter how it is labelled, it is important to identify the underlying rights of the arrangements and understand the circumstances that apply to the usufruct in each case.  For example, another means of providing an income for life in Germany is a ‘Leibrente’ – which may be closer to an annuity than the rights under a usufruct.

In HMRC’s view, a usufruct should be treated as a settlement for IHT purposes given the closing words of IHTA84/S43(2), ‘….or would be so held charged or burdened if the disposition were regulated by the law of any part of the UK….’.  This creates a fiction solely for the purposes of charging IHT and requires us to look at the outcome of the disposition and then consider how that outcome could be achieved under the law of any part of the UK.  Bearing in mind the nature of the split in ownership that a usufruct achieves, the closest equivalent under UK law is a life interest settlement, with the bare owners holding the property for the benefit of the usufructuary (life tenant) with remainders to themselves.

On the footing that a usufruct should be treated as interest in possession settlement, the following consequences will flow.

  • Where the usufruct was created prior to 22 March 2006, it should be treated as an interest in possession created prior to that date.  Consequently, if the donor gave a property to their children, retaining the usufruct, there will be no loss to their estate at that time; but the property, at the open market value, will remain part of their estate on death.  If a husband gave his wife a usufruct over his property, the transfer will benefit from spouse or civil partner exemption and the property, at the open market value, will form part of the spouse’s estate on her death.  If a father gave a usufruct over his property to his children, the transfer will be a PET.  In all cases, the bare ownership of the property should be treated as a reversionary interest and will normally be excluded property under IHTA84/S48(1).

 

  • Where the usufruct is created on or after 22 March 2006, the settlement will be a relevant property settlement.  On creation of a usufruct, the donor will be making an immediately chargeable transfer of the full value of the property which will then be subject to relevant property charges.  No spouse or civil partner exemption will be due.  If the donor has retained a usufruct over the property, they may well have reserved a benefit in the property; but otherwise, no part of the property will form part of any person’s estate.

 

The property over which the usufruct exists should be valued on the open market basis, without regard to the values that may be ascribed to the different rights by the relevant foreign law.  The property is treated for IHT purposes as regulated by UK law – which does not recognise any other statutory regime for valuation – leaving us with the usual valuation approach under IHTA84/S160.  But it is important to establish the detail of the circumstances surrounding the property because if the property is mortgaged, the mortgage is an incumbrance against the property which is very likely to be a valid deduction against the property under IHTA84/S162(4).  If the property is subject to a lease, that too will reduce the value of the property depending on the terms of the lease.  The terms of some overseas leases, particularly around renewal, may be quite onerous and have a significant impact on the value of the property.  If the property is farmland in the European Economic Area, it may also qualify for agricultural relief in view of IHTA84/S115(5)(b).

SAV are responsible for valuing overseas property and they should provide the open market value with vacant possession of the property.  The question of any reduction in value to reflect the impact of a lease should be referred to Technical, once the open market value has been agreed, as should any case where the taxpayer does not accept the position outlined above.

The correct treatment of a usufruct for IHT purposes is not universally accepted.  One leading commentator refers to it as a ‘toss of a coin matter’; some accept HMRC’s view, whilst others are strongly opposed to it.  It is for this reason that any case where the taxpayer is not prepared to proceed along the lines above should, once the detailed facts have been ascertained, be referred to Technical to consider how to take the case forward.  It is possible that the value for tax that emerges from applying HMRC’s approach may not be (so) very different from the value offered by the taxpayer, particularly where there are encumbrances against the property; but each case will need to be considered on its own merits.