Inheritance Tax: Gift with reservation and spouse exemption

Numerous professional bodies have been discussing with HMRC the availability of the UK inheritance tax (IHT) spouse exemption in relation to assets held in a trust that are treated as beneficially owned by the settlor as a result of the reservation of benefit rules.

HMRC has since indicated its agreement to the analysis set out below and on 1 March 2021 amended the IHT manual (IHTM14303) to reflect this.

A brief overview of the rules is summarised below.

• Property subject to a reservation at the donor’s death is treated by s102(3) Finance Act 1986 as “property to which he was beneficially entitled immediately before his death”.
  
  
• Section 4 IHTA 1984 requires tax on death to be charged as if the deceased had made a transfer of value and “the value transferred had been equal to the value of his estate immediately before his death”.
  
  
• Section 5(1) IHTA 1984 provides that a person’s estate is “the aggregate of all property to which he is beneficially entitled”.
  
  
• A chargeable tranfer is a transfer of value which is not an exempt transfer.
  
  
• Section 18(1) IHTA 1984 provides that a transfer of value is an exempt transfer “to the extent that the value transferred is attributable to property which becomes comprised in the estate of the transferor’s spouse”
  
  
• It follows that spousal relief applies to settled property subject to a reservation if on the death of the settlor the settlor’s spouse becomes beneficially entitled to the property under either:
  • the original terms of the settlement; or
  • a subsequent appointment made thereunder and prior to the settlor’s death.
     
• The same would apply where the spouse’s entitlement on the death of the settlor is to a qualifying interest in possession, i.e. to an interest in possession to which section 49 IHTA 1984 applies.
  
  
• It is not considered spousal relief applies where settled property ceases to be subject to a reservation inter vivos. This is because s102(4) Finance Act 1986 operates by deeming there to be a potentially exempt tranfer rather than by deeming the donor to be beneficially entitled to the gifted property.