HMRC told to Buzzoni off in inheritance tax case

15 / 01 / 2014

There was an important victory reported recently for the tax-payer in a long-running inheritance tax (“IHT”) case: Buzzoni and others v HMRC [2013] EWCA Civ 1684. The outcome is good news for those who seek to mitigate IHT on their estate by making gifts during their lifetimes.

If you own an asset at death, it is subject to IHT unless any reliefs or exemptions apply. This leads many people with sizeable estates, especially later in life, to start giving away assets to the next generation in order to avoid the IHT charge at death. Does this work? Yes, lifetime giving can be a very effective and successful way of reducing IHT, meaning a greater proportion of your estate passes to your loved ones and not to H M Revenue & Customs (“HMRC”). However, as with most tax planning, there are traps for the unwary.

It is not quite so simple as giving your favourite valuable painting to your son, and – bingo – IHT saved. First, you must survive seven years from the date of the gift before the gift fully falls outside of your estate for IHT purposes. Secondly, you must not retain any benefit in the asset given away.

Prior to 17 March 1986, it was entirely possible to give an asset away and claim that the asset was not “yours” even if you still continued to use it in some way. However, the government brought in the “gift with reservation” rules in Finance Act 1986 to change all of that and it is not now possible to make an effective gift for IHT purposes if you do not properly part with possession of it.

The “gift with reservation” rules were at issue in the Buzzoni case. The donor owned a lease of a flat in Knightsbridge and sought to reduce the value of this by giving away an under-lease of it to a trust. The under-lease contained covenants by the trustees that mirrored those for which the donor was responsible under the head-lease, meaning that the trustees assumed the burden of those covenants to the benefit of the donor. HMRC argued that the benefit that the donor was deriving as a result made the under-lease a “gift with reservation” for IHT purposes, and accordingly, the original value of the donor’s lease would effectively still be included in her estate for IHT purposes. The donor’s executor brought court action against HMRC’s decision, but was initially unsuccessful.

Following a recent appeal however, the Court of Appeal has ruled that HMRC was wrong and the under-lease is not subject to the “gift with reservation”. The rationale being that, for the “gift with reservation” rules to bite, the benefit to the donor must have an impact on the donee’s enjoyment of the gifted property. If the donee suffers no detriment, the gift can stand and the IHT planning is effective. This was so in this case as the covenants that the trustees assumed merely mirrored and did not add to the obligations that the under-lease already bore: the trustees’ enjoyment of the under-lease was not in any way impaired.

The Court has therefore made an important development in the law in this area by including as part of the “gift with reservation” tests, the requirement that detriment to the donee must be proved. This should make it more difficult for HMRC in future to “claw-back” lifetime gifts as not fully effective for IHT purposes, and should provide greater opportunities for inheritance tax planning in this area.

Making lifetime gifts remains a good way to reduce your estate and save IHT. For further information on how to do so or to discuss your tax planning generally, please contact Wedlake Bell partner Eleanor Metcalf or your usual Wedlake Bell adviser.