IHT gifts of leaseholds and reservations of benefit – Buzzoni v HMRC

The most effective way of saving IHT is to make an outright gift of property, as a potentially exempt transfer (PET) and survive the making of the gift by seven years so that the PET becomes a completely exempt transfer. However, to be effective in saving IHT, the gift must be made without reservation of benefit. Section 102 Finance Act 1986 requires that possession and enjoyment of the gifted property must have been bona fide assumed by the donee at or before the beginning of the seven year survival period. Additionally s. 102 (1) (b) Finance Act 1986 states the property must be enjoyed throughout the seven year period to the entire exclusion or virtually to the entire exclusion of the donor and of any benefit to him by contract or otherwise. The requirement to make a gift free of any reservation of benefit has traditionally made it very difficult to make an effective PET of the house in which the donor lives, and in which he intends to go on living after the gift. The continued occupation by the donor, after the gift has been made, will clearly be a “benefit by contract or otherwise”. One solution is, of course, for the donor to pay a rent amounting to a “full consideration in money” or money’s worth for the continued occupation (see paragraph 6 Schedule 20 Finance Act 1986) . Up until March 1999 it was possible for the house owner to carve out a leasehold interest under which he could continue to occupy the property. This took advantage of the principle explained by Lord Hoffmann in Ingram v CIR (1999) STC 37. This confirmed that the leasehold interest enabling the donor to continue to occupy the property, and the freehold reversion which he gifted, were separate items of property and that occupation by virtue of the leasehold was not a reservation of benefit out of the freehold. Anti-avoidance legislation, in section 102A to 102C IHT Act 1984 has rendered the lease carve out arrangements ineffective. However, even before the anti-avoidance measures, it was possible for a leasehold carve-out arrangement to go wrong. This is because a lease normally contained covenants, by both freeholder and lessee, and the terms of a covenant by the donee may be regarded as providing the donor with a benefit. This is what happened in Re Nichols (1975 1WLR 534),where the donor gifted the freehold to his son subject to a lease under which the father continued to occupy the house. The lease contained a covenant by the freeholder, to repair the house and this was held to be a reservation of benefit which rendered the gift ineffective to save Estate Duty.