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What lessons can be learned from the first home loan scheme case?

Andrew Cockman explores the first reported home loan scheme case, which, while seemingly unhelpful, provides lessons to be learned about home loan schemes.

CoverThe First-tier Tribunal (FTT) decision in Shelford (Executors of J Herbert) v HMRC [2020] UKFTT 53 (TC) is the first reported case concerning a home loan scheme (HLS). These inheritance tax (IHT) saving arrangements were relatively common up until 2003 when the introduction of stamp duty land tax effectively brought them to an end.

At first sight, Shelford appears to be unhelpful as it does not resolve the longstanding challenges made by HMRC to the viability of the HLS arrangements. It does, however, raise points of concern for some HLS arrangements. Here the FTT found that the arrangement implemented was legally ineffective, which was possibly fortunate given that it could have resulted in double taxation from an IHT point of view had it been legally effective. 


Although HLS arrangements are now well known, it is worth setting out how they were set up. The owners of the home set up a life interest trust (the life trust). They were the life tenants with the right to income and to use the trust property. Their family members were also beneficiaries of the trust. The owners of the home usually set up a second life interest trust, typically for adult children, the family trust, under which the settlors were excluded from benefitting. The owners of the home sold the house to the life trust in return for debt. Sometimes this was a promissory note, payable following the death of the last surviving settlor. The intention was that the debt would offset the value of the property held within the life trust so that little or no IHT applied when a life tenant died. The debt was given to trustees of the family trust, although sometimes it was given to the adult beneficiaries to hold outright.

In practice there was never a single form of HLS, partially because different variants emerged to deal with the capital gains tax (CGT) issues on redemption of the indebtedness in different ways. These included tripartite sales of the property, whereby the family trust received the sale proceeds as original creditor, which precluded the operation of the secondhand debt CGT rules. Other variants used debt structured as a deeply discounted security in order to fall outside the CGT rules.

The basic HLS arrangements were initially accepted as being effective by HMRC, although subsequently they were challenged under several headings, including the gift with reservation of benefit rules because the settlor and his or her spouse continued to live in the property as their home. The introduction of the pre-owned assets tax (POAT) rules in Finance Act 2004 further discouraged the continuing use of HLS arrangements. This imposed a charge to income tax where a donor continued to benefit from certain types of property he had given away, including residential property.

Facts of the case

Mr Herbert, a widower with three children, owned and lived in the freehold house. The house was then worth £1.4m. The life trust was established with £10 on 21 March 2002. Mr Herbert held the life interest, which meant that at that time he was treated as owning the underlying capital value held by the trustees. His children could benefit under the trusts during his lifetime and, on his death, they were to benefit equally from the value held by the trustees. Mr Herbert and a solicitor, Mr Shelford, were the trustees. Mr Herbert as seller, and Mr Herbert and Mr Shelford as trustees entered into a sale agreement to acquire the house for £1.4m on 22 March 2002.

Mr Herbert (as lender) entered into a loan agreement with himself and Mr Shelford as borrowers in their capacity as trustees of the life trust, which was also dated 22 March 2002. It was at this stage that the transaction began to unravel.

Subsequently Mr Herbert assigned the indebtedness to his three children equally. Mr Herbert continued to reside in the house until he died and was the person recorded as being the owner at HM Land Registry. With effect from 2005/06 Mr Herbert paid POAT until he died in 2013. At that time the property was worth £2.85m and was later sold in 2016 for £3.9m by the trustees.

The decision

The effect of the agreements

The trustees argued that Mr Herbert had agreed to sell the house to them for £1.4m. Shortly afterwards he had agreed to pay the trustees £1.4m under the terms of the loan agreement. They argued that that the two liabilities were set off against each other, meaning that Mr Herbert was entitled to receive £1.4m after his death, which he assigned by way of gift equally to his children.

Unfortunately, the paperwork did not bear this out. The contract for sale recorded that a 100% deposit would be paid. However, it incorporated other contractual provisions set out in the standard conditions of sale in force at the time. These were expressed to be enforceable but only to the extent that they did not contradict the conditions in the sale agreement. Although the standard conditions of sale stipulated a smaller level of deposit (which was ignored), it did provide that the deposit should be paid to the seller’s solicitors as stakeholder (effectively on behalf of both parties to the sale).

This refinement was incorporated into the overall agreement. While the movement of funds hadn’t taken place, there was case law that effectively permitted set-off of liabilities (ie, the payment of the loan and the payment of the sum due under the contract). But this set-off would only work when there were two parties involved, and not three, recognising that the solicitors were acting as stakeholder.

The judge did not think that the set-off rules could apply in this situation. All that had happened was that the obligation to pay the deposit had become wrapped up in the extended debt due under the terms of the proposed loan. He thought it was going too far to suggest that the liability to pay the deposit had been satisfied because there were other aspects of the transaction that weren’t compatible with the terms of the sale agreement. These included the requirement that the property had to be sold with vacant possession, and there were provisions that would apply where this was not the case, and title had to be deduced prior to signing the agreement. There was no evidence that this had taken place.

This led the judge to find that the true effect of the sale agreement and the loan agreement (when read together) was that Mr Herbert agreed to sell the house to the trustees, with completion to occur (and the consideration to be paid) on notice following his death. Unfortunately, this meant that the sale agreement fell short of the requirements of s2, Law of Property (Miscellaneous Provisions) Act (LPMPA) 1989:

”(1) A contract for the sale or other disposition of an interest in land can only be made in writing and only by incorporating all the terms which the parties have expressly agreed in one document, or where contracts are exchanged, in each.

(2) The terms may be incorporated in a document either by being set out in it or by reference to some other document.”

This meant that the judge found that the agreements for the sale of the house to the trustees, and the purported loan by Mr Herbert to the trustees, were void.

Accordingly, when Mr Herbert attempted to give the debt to his children, nothing happened because there were no sale proceeds or loan benefit that could be assigned. As a result, the deed of assignment was also void.

When Mr Herbert died, the house, then worth £2.85m, was included in his death estate. The net effect was that the scheme had failed because it was legally ineffective.

Double IHT charge

The judge also gave his analysis of the position if the legal documentation had not been defective, as he recognised that there might be an appeal in relation to his decision. The effect of the agreement would have been that Mr Herbert retained beneficial ownership of the house and continued to live in it, irrespective of the agreement to sell the property to the trustees.

This would have meant that at the date of Mr Herbert’s death, the value of the settled estate was the £10 originally settled by Mr Herbert (together with any accumulated interest on that amount), plus £1.45m (being the value of the house at death (£2.85m) less £1.4m being the purchase price due under the contract and now payable to Mr Herbert’s children). This meant that £1.45m would have been included in the IHT computation.

The position as regards the value left in Mr Herbert’s estate was more complex. Section 163, IHTA 1984 is concerned with limiting the effect of restrictions on the freedom to dispose of an asset. HMRC stated that Mr Herbert had agreed to sell the house to the trustees with completion (and payment of the consideration) to be deferred until after death. This right to acquire the house amounted to a restriction of the ability of Mr Herbert to dispose of the house to any other party.

The effect of this could only be taken into account on death to the extent that consideration in money or money’s worth was given for it. In this context, it was accepted by the parties that the value of the debt under the terms of the loan was worth only £532,500 at a time that the property was worth £1.4m. The judge also found that the deferred purchase price of £1.4m was payable for the house, not for the right to acquire the house, and in any case the price had not been paid at the time of Mr Herbert’s death. As a result, the judge found that the full value of the house (being £2.85m without regard to the terms of the sale to the trustees) had to be included in Mr Herbert’s personal estate.

He acknowledged that such an interpretation would result in an element of double taxation, since this value would be taxable in addition to the net value of the trust of £1.45m. This led the judge to comment: “this serves as a warning that the implementation of tax avoidance schemes can sometimes have the consequence of the participants paying more tax than if they had done nothing: if you play with fire, do not be surprised if your fingers are burnt.”

Miscellaneous points

There was a discussion about whether the documents fell foul of the legal sham rules because of the divergence between the way that the transaction was set out in the legal agreement and the way that the court held that it took effect. The point wasn’t decided because the judge held that it was not open to the court to make a such a finding in this case.

The POAT that Mr Herbert paid during his lifetime should not have been paid. No CGT would have been due on the sale of the house by the trustees. The judge left it to the parties to resolve these matters but left the door open to return for his determination should this not prove to be the case.

True import of the case

The case may not provide any insight into the value of the various technical arguments raised by HMRC into the effectiveness of HLS arrangements. However, if there is a lesson to be learned from the case it might be that it is important to have regard to the way that tax planning arrangements are implemented in practice. It is also reasonable to assume that HMRC will want to scrutinise the way that other HLS cases were implemented because it is possible that they followed a similar template to that used in this case. It is not known whether the taxpayer will appeal the decision of the FTT.

About the author

Andrew Cockman, Director, Grant Thornton UK LLP and member of the Tax Faculty’s Private Client Committee