Interest in possession trust was ineffective in avoiding inheritance tax charge

In James Charles Pride (as trustee of the estate of the late Geraldine Jill Pride) v HMRC [2023] UKFTT 00316 (TC), the First-tier Tribunal (FTT) determined that the assets of a property trust were beneficially held by the principal beneficiary and formed part of her estate for inheritance tax purposes.

Background

At the time of her death in 2016, Mrs Pride was the principal beneficiary of a family property trust (the Property Trust). Mrs Pride was entitled to the income from the Property Trust, and the trustees could use the trust fund for Mrs Pride's benefit. The Property Trust held a flat and investment bonds, which had been acquired through complex sets of arrangements (the Arrangements): the flat by way of transfer from Mrs Pride, and the bonds by way of funds provided by Mrs Pride from the sale of her house. 

The Property Trust was also the provider of an indemnity to a nominee in respect of loan notes that had been transferred by Mrs Pride to another family trust of which her two children were the principal beneficiaries (the Children's Trust). The income and capital of the Children's Trust were to be held for the benefit of the principal beneficiaries in equal shares. The loan notes had an issue price of £1,335,000 and a 2025 redemption price of £5,099,366. By way of a deed of release in 2017, the trustees of the Children's Trust released the nominee from its liability in respect of the loan notes. 

In October 2018, HMRC issued a notice of determination under section 221, Inheritance Tax Act 1984 (ITA), confirming HMRC's view that inheritance tax of some £1.7m was payable in respect of Mrs Pride's estate (the Estate). The basis of HMRC's determination was that: 

1.  the liability sought to be deducted from the Estate in relation to the debt allegedly owed to Mrs Pride in respect of the loan notes should be abated to nil, in accordance with section 103, Finance Act 1986 (FA), because it consisted of an incumbrance, the entire consideration for which was property derived from Mrs Pride; 

2.  having regard to the purpose and effect of the totality of the Arrangements, the assignment by Mrs Pride of her interest in the flat and the house to the trustees of the Property Trust was a 'gift' for the purposes of section 102, FA, with the consequence that the flat and the bonds held by the Property Trust were subject to a reservation of benefit and part of the Estate; and 

3.  the Arrangements were a composite transaction effected by associated operations such that the debt was property subject to a reservation at the death of Mrs Pride, and therefore property to which she was beneficially entitled immediately before her death. HMRC subsequently asserted that section 175A, ITA, applied in the event that section 103, FA, did not. 

Mrs Pride's son, as executor and trustee of the Estate, appealed to the FTT. 

The key issues before the FTT were whether the value of the loan notes (as a liability of the Property Trust) was to be left out of account in determining the value of the Estate under either section 103, FA, or section 175A, ITA, and whether the loan notes (as an asset held by the Children's Trust) or the flat and bonds (as assets held by the Property Trust), formed part of the Estate in accordance with section 102, FA.

FTT decision

The appeal was dismissed. 

Section 103 FA

In the view of the FTT, in determining the value of the Estate, account should be taken of any liability consisting of a debt incurred by Mrs Pride or an incumbrance created by a disposition made by Mrs Pride. Viewed realistically, the loan notes were a debt incurred by the Property Trust: the nominee was a mere nominee in relation to the obligations of the issuer of the loan notes, and it was the Property Trust that assumed the liabilities through its indemnification of the nominee. Further, by operation of the deeming provision in section 49(1), ITA, the loan notes were to be treated as a debt incurred by Mrs Pride. That was because the purpose of the statutory fiction of section 49(1) was that trust property, subject to trust liabilities, was beneficially held by the trust beneficiary, and the inevitable consequence of Mrs Pride's deemed 'holding' of the liability was that she 'incurred' the debt represented by the loan notes for the purposes of section 103, FA. In determining the value of the Estate, and in accordance with section 103(1), the loan note liability fell to be abated in its entirety as the whole of the consideration given for the loan note debt consisted of property derived from Mrs Pride.

Section 175A ITA

In the alternative, the FTT determined that section 175A, ITA, would apply with the same substantive result as section 103, FA, i.e. that the loan note liability could not be taken into account in determining the value of the Estate. That was because, by virtue of section 49, ITA, the liability fell within the ambit of section 175A(1). The FTT dismissed the appellant's argument that the delivery of the account under section 216, ITA, was the 'latest time' for applying section 175A(1)(a), as there was no basis for such an approach in the statute.

The FTT found that, in accordance with section 175A(1)(a), the loan note liability was not discharged on or after Mrs Pride’s death, out of the estate or otherwise. Rather, the liability was released by the holders of the loan notes by the deed of release in 2017. It therefore followed that section 175A(2) must be applied, and read together with section 175A(3), there was no real commercial reason for the loan note liability not being discharged. In the view of the FTT, section 175A(2)(b) was not satisfied, as it was a main purpose of the release of the loan notes to secure a tax advantage. Accordingly, the loan notes could not be taken into account in determining the value of the Estate. 

Section 102 FA

The FTT concluded that the transfer of the loan notes to the Children’s Trust was a 'disposal by way of gift' by Mrs Pride such that section 102(1), FA, was potentially engaged if the loan notes were 'property subject to a reservation'. However, the FTT rejected HMRC's argument that the loan notes were subject to a reservation. That was because possession and enjoyment of the loan notes was assumed by the Children’s Trust, who enjoyed the loan notes to the entire exclusion of Mrs Pride, in the last seven years of her life.

As to the flat and bonds, the FTT determined that section 102 did not apply because section 49, ITA, already treated them as property to which Mrs Pride was beneficially entitled.

Comment

This decision emphasises the importance of careful estate planning, particularly where complex trust arrangements are involved, and highlights the significant tax liabilities that can arise where that planning is ineffective. Subject to any appeal to the Upper Tribunal, the FTT's decision would appear to render so-called 'double trust' arrangements ineffective when seeking to avoid a charge to inheritance tax.

The decision can be viewed here.