Inheritance tax – Lifetime transfer – Reservation of benefit – Deceased granting reversionary sub-lease to sons out of head-lease interest by way of gift – Sub-lease providing same covenants as head lease – Following deceased’s death, respondent commissioners issuing notice of determination of liability to inheritance tax – First-tier Tribunal upholding determination – Upper Tribunal dismissing appellant executor’s appeal – Whether property disposed of by way of gift being subject to reservation – Appeal dismissed
The deceased was the head lessee of a property known as 67 and 67a Chelsea Square London SW3 granted in September 1979. The deceased was granted a licence to sub-let the property to her three sons for a term from March 2012 to December 2076. The sub-lease was subject to the same terms, covenants, provisos and conditions as the head lease. The deceased and her sons respectively covenanted to perform and observe those provisions.
Following the deceased’s death, the respondent commissioners issued a determination pursuant to section 102 of the Finance Act 1986 on the basis that the creation of the sub-lease was a disposal by way of gift by the deceased of property “subject to a reservation” within the meaning of section 102(2) which fell to be treated for the purposes of inheritance tax (IHT) as property to which she had been beneficially entitled immediately before her death. The respondents considered that the sub-lease was not property enjoyed to the entire, or virtually entire, exclusion of “any benefit” to the deceased as the donor, because she obtained a benefit, namely the sub-lessees’ covenants in the sub-lease to observe certain provisions of the head lease. Therefore, the case fell within the second limb of section 102(1)(b) and the sub-lease constituted property subject to a reservation.
The First-tier Tribunal dismissed the appellant executor’s appeal deciding that, as the sub-lessees were unable to enjoy their lease to the exclusion of the deceased, there was a gift with reservation by the donor and her house remained in her estate for IHT purposes: [2016] UKFTT 59 (TC). The Upper Tribunal dismissed an appeal against that decision: [2017] UKUT 276 (TCC); [2017] PLSCS 149.
The appellant appealed. The issue was whether the sons’ enjoyment of the sub-lease satisfied the second limb of section 102(1)(b) and was to the exclusion of “any benefit [to the donor] by contract or otherwise”.
Held: The appeal was dismissed.
(1) It was necessary to begin by identifying the true subject matter of the deceased’s gift to her sons. That was the “property” to which section 102 had to be applied. The “property” which the deceased gave to her sons could only be identified as the sub-lease of the property, which had to be regarded as a whole. No sensible distinction could be drawn, at this preliminary stage, between the legal estate in land which she created by the sub-demise, on the one hand, and the mutual covenants into which the parties entered in the sub-lease, on the other. Both the estate in land and the covenants formed part of a single transaction, and it would be artificial to distinguish between them because neither would have come into existence without the other. The gift made by the deceased was a gift of an interest in land subject to, and with the benefit of, the obligations which the parties agreed to undertake in the sub-lease. Any other analysis would involve a formalistic departure from reality, in a context where the form should not be allowed to prevail over substance.
(2) It was common ground that the sub-lease (albeit reversionary) was enjoyed by the sons “to the entire exclusion, or virtually to the entire exclusion” of the taxpayer, within the meaning of the first limb of the alternative condition in section 102(1)(b). The case therefore turned on the second limb of paragraph (b), which posed the question whether the sons’ enjoyment of the sub-lease was “to the exclusion, or virtually to the entire exclusion, … of any benefit [to the donor] by contract or otherwise”. If the gift of a leasehold interest was accompanied by positive covenants which conferred additional benefits on the donor, then there was a reservation of benefit within section 102(1)(b). To come within the scope of the second limb of the subsection the benefit had to consist of some advantage which the donor did not enjoy before he made the gift, where any such advantage clearly would have had an impact on the subject matter of the gift. While that was a necessary condition for the second limb of the subsection to apply, it was not a sufficient condition, because there might need to be a further enquiry whether the benefit had any impact upon the donee’s enjoyment.
The condition could not be satisfied when the deceased had the benefit of the positive covenants given by her sons, including the obligation to observe and perform the provisions of the head lease throughout the term of the sublease. That was a benefit to the deceased of real, and more than minimal, value and, crucially, had no prior existence before the grant of the sub-lease. The fact that that benefit was inseparable from the gift obviated the need for any separate enquiry as to whether the benefit was referable to, or trenched upon, the gift, because one could not exist without the other. The fact that the covenants given by the sons had no prior existence was of critical importance. It left little, if any, room for an argument that the benefit was something retained by the donor or otherwise separate from the gift which she made. Rather, the benefit was an inherent part of the gift itself: St Aubynv Attorney-General[1952] AC 15 and Ingramv Commissioners ofInland Revenue [2000] 1 AC 293 considered. Re Nichols (deceased)[1975] 1 WLR 534 and Buzzoniv Commissioners of HM Revenue and Customs[2014] 1 EGLR 181; [2014] EGILR 59followed.
Simon Taube QC (instructed by Penningtons Manches LLP) appeared for the appellant; Jonathan Davey QC (instructed by the General Counsel and Solicitor to HM Revenue and Customs) appeared for the respondents.
Eileen O’Grady, barrister
