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Beware the risks of making a gift but retaining a benefit from it

Making a gift to children or other relatives is a common tactic used to save inheritance tax (IHT). However, in some circumstances, this fails to have the desired effect and can lead to inheritance tax still being due or indeed a yearly income tax charge being payable by the person making the gift.

In order for a gift to be effective for IHT purposes, you must not retain a benefit from that gift.

Imagine the following situation:

  • Parent A gifts Child A their property known as Property X.
  • Parent A continues to live in Property X and does not pay Child A market rent.

This gift was made in order to mitigate inheritance tax. In these circumstances however, Parent A has reserved a benefit, i.e. they continue to live in and enjoy their property rent free.

This is known as a Gift with a Reservation of Benefit (GROB) and the impact of this is that, for inheritance tax purposes, the gift is not effective. If Parent A dies whilst still living in Property X, the gift will form part of Parent A’s estate at the time of death. The value at the time of death (if higher than at the date of the GROB) will be included within the tax calculations.

For Capital Gains tax (CGT) purposes, Property X belongs to Child A from the date of the gift so, when they come to sell it, they will also pay CGT on the increase in value from the date of the gift to the date of sale at a rate of as high as 28%.

To get around the GROB rules, people often pay a full market rent to their children as the new owners of the home. This in itself isn’t often sufficient, as proper tenancy agreements should be in place with regular rent reviews and increases. Further, the children will pay income tax on the rent paid to them.

Another alternative would be for Parent A to sell Property X and gift Child A cash, which they then use to buy a new property for Parent A to live in rent free. As they have never owned the new house, this is not a GROB but instead a charge to income tax can arise.

POAT

Pre-Owned Asset Tax (POAT) is a tax that many individuals may not be familiar with.

POAT is an additional charge to income tax which looks to tax the yearly benefit an individual is deemed to receive from the continued use of a gift.  This additional income tax charge must be declared yearly to HMRC on an individual’s tax return.  It is the responsibility of the person making the gift to ensure they have declared this correctly to HMRC.

A gift can fall within the POAT scope, whether it is a gift of cash, land or chattels.

The purpose of POAT is to catch those transfers which have managed to escape the GROB rules and are otherwise exempt from IHT.

Stuck between the IHT rock and the POAT hard place?

The POAT rules were introduced to prevent IHT avoidance.  To understand POAT, it is important to distinguish in which circumstances it applies and when the GROB rules apply instead.

Retaining a Benefit

The rules surrounding POAT are very broad.  HMRC interprets an individual’s continued use of a gift very widely.

As in our example above, it is clear that Parent A is retaining a benefit by living in Property X, which their funds helped to purchase.  However, you may be surprised to know that POAT would still be payable if Parent A didn’t live in property X but, for example, simply used the property for storage!  Simply using a spare bedroom in Property X to store furniture would be deemed as retaining a benefit under the rules with the result that a POAT charge is due.

The details to be included on your tax return and total amount payable to HMRC would depend on the type of gift you are retaining a benefit from. For personal effects, such as an antique piano, the benefit would be classed as a percentage of the market value. With land and property, HMRC deems the benefit to be the open market rent.  The open market rent is fixed for 5 years and then reviewed.

Where POAT doesn’t apply

Circumstances where POAT would not be chargeable include if a gift is caught by the GROB rules, or an individual elects to keep an item in their estate for IHT purposes.

In our example, if Parent A would have paid open market rent for living in Property X, POAT would not be chargeable.  As Parent A would no longer be retaining a benefit from Property X, they would not fall within the scope of the rules.

If the total value of the items potentially subjected to POAT is £5,000 or less, then POAT would not be payable.  Similarly, if the gift is covered by the yearly exemption of £3,000, there would be no POAT charge.

Making gifts should not be entered into lightly. In addition to the tax implications outlined in this article, it can cause implications for later life care and care funding is an important consideration when making gifts.  It is strongly advisable to obtain a professional opinion before making a substantial gift as you may cause other problems and get more than you bargained for.

For further information, please contact one of our Wealth and Estate Planning specialists.

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