Excluded property and the IHT spouse exemption

The interaction of the spouse exemption and gift with reservation inheritance tax (IHT) rules has been a subject of debate, with some arguing that the spouse exemption is not available where the gift with reservation rules apply.

This has come into focus because of the excluded property changes in Finance Act (FA) 2020. The impact of the FA 2020 changes appears to be to remove the protection that excluded property treatment provided for gift with reservation purposes in certain cases where the trust was established prior to the FA 2020 changes.

This issue is being considered further by HMRC but is coloured by the possible availability of the spouse exemption. Further information about the excluded property provisions in FA 2020 is available to Tax Faculty members in an article in the October 2020 edition of TAXline.

ICAEW, together with other professional bodies provided an analysis of the rules, to which HMRC has now indicated its agreement and has amended the IHT manual (IHTM14303) to reflect it. The analysis states:

1. Property subject to a reservation at the donor’s death is treated by s102(3), FA 1986 as: “property to which he was beneficially entitled immediately before his death”.
2. Section 4, Inheritance Tax Act (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”.
3. Section 5(1), IHTA 1984 provides that a person’s estate is: “the aggregate of all property to which he is beneficially entitled”.
4. A chargeable transfer is a transfer of value which is not an exempt transfer.
5. 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”.
6. 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:
   (a) The original terms of the settlement; or
   (b) A subsequent appointment made thereunder and prior to the settlor’s death.
7. The same would apply where the spouse’s entitlement on the death of the settlor is to a qualifying interest in possession, (ie, to an interest in possession to which s49, IHTA 1984 applies).
8. It is not considered spousal relief applies where settled property ceases to be subject to a reservation inter vivos. This is because s102(4), FA 1986 operates by deeming there to be a potentially exempt transfer rather than by deeming the donor to be beneficially entitled to the gifted property.