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HMRC internal manual

Inheritance Tax Manual

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HM Revenue & Customs
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Pre-owned assets: specific avoidance schemes: land - reversionary leases

This scheme is an arrangement where a donor grants a long lease of their property for say 999 years to the proposed donee, and the lease does not take effect until some future date. The period for deferral is usually less than 21 years to avoid breaching the terms of s.149(3) Law of Property Act 1925.

Example

Victor, who has owned his house since 1990, grants a 999-year lease to his daughter Veronica in 1998 but it is not to take effect until 2018. Victor continues to occupy the property.

The effect of this transaction is that

  • Victor has made a PET (IHTM04057) of the lease. The loss to his estate (IHTM04054) will be the difference between the unencumbered freehold and the freehold subject to the lease,
  • Victor continues to occupy the property as the freeholder, and
  • the value of the freehold interest remaining in Victor’s estate will decline as the time for the lease to commence approaches.

Where a reversionary lease scheme is established before 9 March 1999 - the date legislation was introduced to counteract ‘Ingram’ schemes (IHTM44100) - the arrangement succeeds in avoiding the reservation of benefit provisions so long as the lease does not contain any terms that are currently beneficial to the donor, such as covenants by the lessee to, say, maintain the property. Consequently, the donor will be subject to the POA charge under FA04/Sch15/Para3(2) (IHTM44004).

Where the scheme is subject to the POA charge, the value subject to the charge will be calculated in accordance with FA04/Sch15/Para4(2) (IHTM44010). You will need to obtain three values to correctly assess the POA charge

  • the rental value (R), say, £25,000,
  • the value at the valuation date (IHTM44011) of the interest that was disposed of (DV); in this case, the value of the lease (that is to take effect in 20 years), say, £100,000, and
  • the value of the property at the valuation date (V), say, £800,000.

Following the formula at IHTM44010, the amount subject to the POA charge is

25,000 × 100,000 ÷ 800,000 = £3,125 - which would be covered by the de minimis rule (IHTM44056).

But note that as the date for the lease to start gets nearer, so the value of the interest that was disposed of (DV) will increase. The initial value will apply for the first five years of the POA charge, but on revaluation (IHTM44011) the portion of the rental value that is subject to the POA charge is likely to be higher.

Where a reversionary lease scheme is established on or after 9 March 1999 it was originally considered that FA86/S102A (IHTM14360) would apply because the donor’s occupation would be a ‘significant right in relation to the land’. If that were correct, the reservation of benefit rules would apply and there would be no POA charge.

However, where the freehold interest was acquired more than 7 years before the gift (this is the significance of giving the date of Victor’s purchase in the example above), the continued occupation by the donor is not a significant right in view of FA86/S102A(5), so the reservation of benefit rules cannot apply and a POA charge arises instead.

It follows that if the donor grants a reversionary lease within 7 years of acquiring the freehold interest, FA86/S102A may apply to the gift depending on how the remaining provisions of that section apply in relation to the circumstances of the case - for example, if the donor pays full consideration for the right to occupy or enjoy the land, that would not be a significant right in view of FA86/S102A(3), so the reservation of benefit rules cannot apply and a POA charge arises instead.

But, despite this, and irrespective of when the freehold interest was acquired, the reservation of benefit provisions may apply if the lease contains terms currently beneficial to the donor - see Buzzoni v HMRC [2011] UKFTT 267. But note that this decision is under appeal.