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HMRC internal manual

Inheritance Tax Manual

Employee benefit trusts: Inheritance Tax operation: disregard of small interest in possession

Under IHTA84/S86(4)(b) an interest in possession in any part of the settled property is to be disregarded for the purposes of the IHTA84 (except IHTA84/S55) if that part is less than 5 per cent of the whole. A typical example would be a small annuity to a particular employee. Since the terms of IHTA84/S86 do not exclude an interest in possession if it satisfies the conditions of IHTA84/S86(1) and (3), the part in which the interest in possession subsists may itself be subject to IHTA84/S86, and the interest, and its coming to an end, would not give rise to charges that would otherwise apply on property leaving an employee benefit trust.

The wording of IHTA84/S86(4)(a) is such that:

  • all the settled property at any particular time within IHTA84/S86 should be regarded as comprised in one settlement distinct from any other property (nominally under the same settlement) which is outside IHTA84/S86, and
  • that five per cent of the whole is taken to be five per cent of all of the property falling within IHTA84/S86.

The interest must not equal or exceed five per cent. If it does there is no relief to that extent. The words ‘an interest in possession in any part of the settled property’ suggests that more than one interest of less (individually) than five per cent may qualify. The interest of each person has to be considered separately.

As a small interest in possession is disregarded for the purposes of the Act there will be no charge to tax on it under IHTA84/S72(2)(a) (IHTM42981).

As the interest must be disregarded for the purposes of the Act, no tax can become payable in respect of the slice of the settled property in which it subsists. Also, the property is not part of the life tenant’s estate under IHTA84/S5(1) so it will not incur a charge under IHTA84/S4(1) on their death. There may be a charge under IHTA84/S55 if the life tenant buys a reversionary interest in the trust fund; but this is an unlikely transaction except for tax avoidance purposes.