Usufructs are a common form of ownership in many countries. They allow a person to occupy a property and receive income, usually for their lifetime. Another person has a right to receive the property after the first interest ends. Names for these arrangements include usufruit, usufructo, usufrutto, and Nießbrauch.
Context
The tax treatment of usufructs in the UK is uncertain, with several competing schools of thought as to how they should be treated.
HMRC’s view is that a usufruct should be treated, at least for Inheritance Tax purposes, as a life interest trust. This view often leads to unexpected tax liabilities, usually for individuals who are originally from the UK. However, HMRC’s guidance mentions that their view is not universally accepted.
On 4 October 2024, Lincoln v HMRC [2024] UKFTT 886 (TC) became the first published case in the UK involving a usufruct and Inheritance Tax.
Background
This case involved the Inheritance Tax payable upon properties located in Malta belonging to the late Martin Falzon.
On 18 March 2006, Martin’s father died, leaving a usufruct in the properties to Martin’s mother and the remaining interest (known as the “bare ownership”) to Martin. Martin’s father was non-UK resident and not originally from the UK, so this transfer was outside the scope of UK Inheritance Tax.
On 31 December 2010, Martin’s mother died. Martin’s mother was outside the scope of UK Inheritance Tax.
On 25 April 2015, Martin died. He had been UK resident for sufficient time to become subject to Inheritance Tax on his worldwide assets. By the time of Martin’s death, the legal formalities regarding his mother’s inheritance had not yet been finalised.
Decision
The taxpayer argued that upon Martin’s death, the properties continued to be subject to his mother’s usufruct, meaning that Martin only owned a future interest in the property. Such future interests can, in some circumstances, be free from Inheritance Tax.
However, the Tribunal did not accept the argument, holding that the usufruct had terminated upon Martin’s mother’s death in 2010.
As an alternative, the taxpayer argued that Martin’s mother’s inheritance process had not been completed. The aim here was to conclude that Martin only had a future interest in the properties. This argument was not accepted, as UK Inheritance Tax legislation deems incomplete inheritances to have been completed, for tax purposes.
Implications
As the usufruct had already been terminated by the time Martin died, the Tribunal did not have to consider how it would be taxed. Therefore, this issue remains unresolved for other families going forwards.
The fact pattern in this case is far from unusual. It is common for inheritance laws outside the UK to control how a person must leave their assets. Many of these laws require a usufruct to be left to the surviving spouse, with the children inheriting the bare ownership.
To families from the UK, the concept of the law dictating how one’s inheritance should pass can seem surprising. To families from outside the UK, the possibility of usufructs being taxed as trusts can seem equally surprising.
All affected families can use this case as a reminder of how important it is to take tax advice in the UK. Even if they are familiar with the local tax treatment, it should not be assumed that the tax treatment in the UK will be the same. The UK tax treatment can differ significantly, depending on the location of the property (or other asset) and the background of the relevant family members.
What should I do?
Professional advice is key, given the continuing uncertainty of the tax treatment of usufructs.
If you would like to discuss the issues in this article, please email Andrew McIntyre.
This article should not be relied upon as a substitute for legal advice. Certain terms in this article have been simplified for the sake of brevity.