Revenue closes Eversden inheritance tax spouse loophole

The Government has taken action to close what they regarded as an inheritance tax loophole.

It was this loophole that the Revenue tested in the recent Eversden Appeal Court Case, which the Revenue lost. Having lost the case the Revenue has decided to amend the legislation with effect from 20 June 2003 to stop the loophole being used in future.

The loophole relates to gifts of assets that are made in a donor's lifetime. These are what is called "potentially exempt transfers" (PETs): that is, they are exempt from IHT so long as the donor survives the gift by at least seven years.

A gift is not effective for IHT purposes where the donor reserves some benefit from the gifted assets. These 'gifts with reservation' (GWR) rules are intended to prevent the avoidance of the IHT charge on death through PETs, which reduce the value of the donor's death estate, while leaving the donor to continue enjoying the asset concerned much as they did before the gift.

However, there are exemptions where the gift is made to a spouse. For example, a trust can be set up by lifetime gifts of property, which the donor in fact intends (and needs) to use for the rest of their life. The trust initially gives an interest in possession to the donor's spouse, but on terms that this can be terminated, or will end automatically, after a brief period.

After that happens the property is then held on discretionary trusts for a class of beneficiaries including the donor. The trustees would typically allow the donor to use and benefit from the trust property so long as they are alive and need it. But under the law, as the Court of Appeal found in the Eversden case, the property would be entirely removed from the donor's taxable estate because the initial gift with reservation was to the donor’s spouse.

This has enabled those with large estates to pass significant assets on to their heirs by exploiting this route and without having to meet the seven year rule for lifetime gifts.

Section 102 of the Finance Act 1986 (c. 41) (gifts with reservation) is to be amended with effect for gifts made on or after 20 June 2003, to ensure that the gift with reservation rules also apply to situations where gifts by a married person are made through a trust which initially gives an interest in possession to their spouse.

The changes mean that the existing provisions in section 102 Finance Act 1986 are amended so that the normal "gift with reservation" charge will apply to gifts made on or after 20 June 2003 where:

- the gift is made into trust and the donor's spouse enjoys an interest in possession;

- the interest in possession comes to an end (whether on the donee's death or otherwise); and

- the subsequent use of the gift is such that it would count as a taxable "gift with reservation" if the gift had been made at the time the interest in possession comes to an end.

The Revenue has not said how much IHT was being avoided through the use of this loophole but it does say that the changes “are expected to protect a substantial part of the £2.4bn that is raised from IHT.”

If this is the case then this appears to be a far more cost effective tax measure than something like IR35, which probably raises less in tax while impacting far more taxpayers in a far more damaging way.