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In our May newsletter, we answered a few of the common questions that we are asked about co-occupation agreements. Recently several clients have asked to provide further detail around this topic and in particular the various pitfalls which can arise if such IHT planning is used.
What is it?
The most valuable asset in most estates is the family home. The problem with leaving your family home to your loved ones is that you live in it! That means that without planning, you can’t pass on this asset until you die; resulting in your loved ones paying IHT at 40% (after available NRB and RNRB).
Of course, one may pass legal ownership to those you want to inherit. However, if you do this and continue to live in the property (retaining beneficial ownership yourself), you have a gift with reservation of benefit (GWROB) and there will be a full charge to IHT on death.
However, the legislation contains specific exceptions to the GWROB rules, such as co-occupation.
Co-occupation is a statutory let-out of the GWROB rules. Broadly, the requirements are that the Donor and Donee occupy the property together and that the Donor does not benefit at the expense of the Donee.
This is a significant hurdle and a big risk area because ‘occupation’ is not defined in the legislation (or in case law, yet).
Co-occupation will be safest and surest when the Donor and Donee live together in the property as their only or main residence. The circumstances in which this is optimal for family circumstances may be rather limited. Some might say that living with one’s parents may be taxing, and so if the Donees ever decide to move out, this itself causes problems (see below).
‘Occupation’ is not the same as ‘residing’ and it seems reasonable to take the view that something less than residing at the property would be sufficient (it may be reasonable to think that Parliament would have used a different word, like ‘residence’, if residence had been the intended qualifying factor).
Here, it is difficult to give solid guidance; what is enough? You may as well ask us about the length of twine. To err on the side of caution, we would suggest that the Donee have at least a ‘substantial’ presence in the Property, staying there for a long period each year or regularly for shorter periods as well as keeping possessions there permanently.
If the Donor is not found to have done enough to have ‘occupied’ the property, then the PET which would have resulted from the let-out will fail and the entire property treated as being within the Donor’s estate on death.
Too Little and Not Enough
If the PET fails because of insufficient ‘occupation’, then the Donors will suffer double jeopardy. Not only will they pay full IHT on the property (after NRB etc.) but they will also have received a 50% (or other percentage) legal interest in the property at the time of the failed PET. Any increase in the value of the property will give rise to the higher rates of CGT (18% and 28%) if and when the property is sold. To make matters worse, PPR will not be available – if you weren’t occupying the property, you certainly weren’t living in it!
Had the planning not been done (and the property fallen to the Donee in its entirety on death), although full IHT would be payable, the Donee would at least have received it at probate value for CGT purposes.
The Scythe of Time
Another important consideration is that if a co-occupation is ever challenged by HMRC, it will be on the death of the Donor, when IHT is due. If you wish to claim that half of the property had already been gifted as a successful PET, HMRC will point to the recent residence of the deceased to say otherwise.
The burden of proof will be on you to show that you had also ‘occupied’ the property (continuously) since the gift.
Think now, on how you would do that? Perhaps twenty years have passed. What documentation will you have to show that occupation actually occurred? A written contract allowing for co-occupation is easily disregarded as not reflecting reality.
The End of Occupation
Times change; this is an immutable rule of our lives.
Marriage. Death. Divorce. Emigrating to Australia for a better life…..
Reducing one’s estate in lifetime is sound IHT planning but will it always be worth the cost? As Donees and future beneficiaries of the Donor’s estate, the burden of IHT will fall on you (as will the burden of an unexpected and unplanned for CGT liability if and when you sell the property).
In the event that you cease to occupy the property, then the PET will fail because the GWROB rules will reassert themselves. It is not enough that the co-occupation was valid immediately after the gift. The co-occupation must continue until the property passes in full to the Donees.
So, in the future, this forward-planning could present an unintended fetter to the plans of the Donee. Say the Donee wanted to relocate to Australia. Unless they returned to the UK to live in the property regularly enough (or for long enough) to ‘occupy’ it, the PET will fail and full IHT will arise on the death of the Donor.
An alternative is for the Donor to start paying full market rent for her residence in the property, but here, the non-resident landlord scheme would apply and the Donee, resident in Australia will become subject to UK tax on his or her income.
The focus of this article has been on the problems that may arise with co-occupation as a tool in planning. This should not discount it as an option in suitable cases; it remains a useful tool to have in the toolbox. It needs to be used with care and with a careful eye to the wider circumstances of your clients and their loved ones and avoid an unwelcome IHT liability on the value of an asset that was through to be outside the grasp of H M Revenue & Customs.
Please contact us for further information and specialist tax advice.
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