As we will all be aware, the concept of the gift with retention of benefit, or GROB, was introduced in 1986 to avoid individuals making gifts with strings attached. The legislation was designed to combat instances of donors seeking to transfer property outside of their estate, whilst continuing to derive benefit. As a result, most estate planning starts with a consideration of the GROB aspects and endeavours to construct a plan which avoids any situation where a GROB might occur. This has become particularly relevant in an agricultural context recently where partnership reorganisations tied to capital gifts need careful consideration.
Sometimes, however, it can be helpful to “embrace the GROB.” Consider the situation where an elderly client has a good pension and substantial cash resources, and a valuable main residence (£2m), but little else. The potential beneficiaries are in a similar position. With in-home care costs pending, there is a reluctance to deplete cash.
However, a GROB will not arise where a full market rent is paid on the gifted asset. IHTM14341 states:
“The donor’s possession, occupation or enjoyment of gifted land or chattels is not treated as a reservation if it is for full consideration in money or money’s worth.
Whether an arrangement is for full consideration will depend on the precise facts, but among the elements of an acceptable arrangement would be evidence of
- a bargain negotiated at arm’s length,
- by parties who were independently advised, and
- which followed the normal commercial criteria in force at the time it was negotiated.”
Normally there might be a reluctance to go down this route, since the donor would be paying rent out of taxed income, but the donee will pay income tax on the rent received. However, when one looks at the bigger picture:
- The gift of the house will not attract CGT and will give the donees an enhanced base cost
- For IHT purposes, the gift will be a PET but not a GROB, nor a “preowned asset.” If seven years elapse, it will become exempt, but, even after three years, it will attract taper relief, which, on a gift of this size, will be substantial
- The rent payments will reduce the cash balances, but not sufficiently to preclude funding care costs for several years
- In an agricultural context, this approach may work where the disposal of a farmhouse eligible for APR is in contemplation
- If the PET does crystallise, it is possible that the reduction in the estate, by virtue of the PET, will be sufficient to enable the residential nil rate to be claimed (the PET will not fall within the £2m taper figure since it is not an asset passing under the will)
- Depending on circumstances, the worst-case scenario is that the beneficiaries will pay 45% income tax on the rent, but every rent payment will reduce the estate so there will be a corresponding reduction of 40% in the eventual IHT liability. Where the donees comprise a mix of children and grandchildren, the income tax profile is likely to accrue at a much lower average rate so it may well be that the IHT liability reduces every month at a faster rate than the income tax liability accrues.
- Under the forthcoming Renters’ Rights Act, the donor will have significant occupation rights, which will give substantial security of tenure
The principle downside is that there might be a CGT liability when the property is eventually sold, but, given the uplift at the date of the gift and the current weakness in the market for high value properties, it is hard to see that the CGT disadvantages will outweigh the IHT saving, particularly if it is intended that the property will ultimately remain in the family.
Looking at it year by year:
- Years 1-3 will see an IHT reduction as the estate is depleted by the rent payments. The income tax charged on the rent will probably be less than the IHT saved. Any CGT on a sale will probably be minimal.
- Years 3-7 will see substantial taper relief to augment the advantages already in place. CGT liabilities may start to accrue if the property increases in value but the IHT saving will be greater because the PET will be lower than the enhanced market value.
- After 7 years the entire value of the property will fall outside IHT, with a saving of up to £800,000 plus 40% of the rent paid to date. Any CGT liability on increased value since the date of the gift will be exceeded by IHT savings, particularly since CGT is (currently) taxed at a lower rate than IHT.
Clearly this will only work well in particular circumstances. Life expectancy needs to be around 5-10 years, there needs to be sufficient cash and liquid investments to cover the cost of live in care and rent payments, and, most importantly, the family all need to be in agreement and on good terms. However, where most of these components are in place, it is certainly worth considering.
*the views expressed are the author's and not ICAEW's