A taxing dilemma

Pre-owned asset tax (POAT) places a heavy burden on the individual. The legislation is ambiguous and unclear, often making it hard for individuals to establish the basis of their personal position.

A bolt-on approach

Introduced by The Finance Act 2004 (FA 2004) s.84 and sched.15, POAT levies an annual income tax charge on any person making a gift (the donor) of an asset at any time since 17 March 1986, where the donor continues to use it, in situations where the transaction is not treated as a 'gift with reservation'.

The regime is the result of an 'add-on' to the reservation of benefit rules, which in themselves had been attached on to the basic IHT legislation. It is largely this bolt-on approach that has created problems and why Revenue practice has not always been crystal clear on the subject.

However, according to the Revenue the intention of the new regime was to restore the IHT position of gifts of interests in land to what the reservation of benefit rules were originally intended to achieve.

The broad structure of the regime in sched.15 is to establish a separate charging system for each of the three different kinds of property, namely land, chattels and intangible property.

The POAT charge applies where:

• the chargeable person occupies any land (including property) or uses or possesses any chattels, either alone or with other persons; and
• either the 'disposal condition' or 'contribution condition', defined in paras.3 and 6 of sched.15, is met.

The 'disposal condition' (paragraphs 3(2)(a) and (b)) applies if an individual:

• owned an interest in land, chattels or other property where the proceeds from any disposal after 17 March 1986 were directly or indirectly applied by another person towards the acquisition of land; and
• has disposed of all or part of their interest.

This covers a simple example where X previously owned and disposed of the land he now occupies, and also cases where the land was acquired by someone other than X using proceeds from the disposal of property previously owned by X.

The rather long-winded 'contribution condition' (para.3(3)) provides that at any time after 17 March 1986, the chargeable person has directly or indirectly provided the consideration given by another person for the purchase of land or an interest in any other property, the proceeds of the disposal of which were directly or indirectly applied by another person towards the acquisition of an interest in the land.

Paragraph 2 of sched.20 FA 1986 had already provided for reservation of benefit to apply to substitute on replacement property, as well as the originally gifted property. However, there was an exception (under para.2(2)(b)) where the gift was for money. This allowed for examples such as where an outright gift of cash has been made by father to son, and the son then purchased a property for the father to live in. It is for this circumstance that para.3(3) of sched.15 FA 2004 applied the POAT charge, on the grounds that the taxpayer provided the consideration for the purchase of the property by another party.

In calculating the income tax charge to be paid by the taxpayer, land is calculated on the basis of the open market rental value, and chattels on the notional interest on the value of the assets (currently 6.25 per cent). If the chargeable person did not own the whole of a property or chattel then the charge is determined to a large extent by the proportion in which the value of the taxpayer's original interest in, or contribution towards the purchase, bears to the current value of the property or chattel.

Intangible property

There is only one condition to be met for the charge on intangible property to apply, defined in para.8 of sched.15. The charge extends to intangibles that are held within a settlement and 'intangibles' is defined to include cash, equities, and insurance products.

Paragraph 8 brings into account any income arising from a settlement that would be treated under s.624 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005) as income of the chargeable person as settlor. This would mean that a charge under para.8 would not be triggered where s.624 ITTOIA 2005 applies only because the settlor's spouse rather than the settlor has retained an interest. To use a simple example, if A set up a trust for his wife on marriage and he himself is excluded from all benefits then there is no possibility of an income tax charge under para.8. However, if he sets up a trust where his wife receives the income, but he can benefit if she dies, then para.8 may apply.

Exclusion and exemption from the pre-owned asset tax regime

There are a number of circumstances and situations where a charge to income tax under sched.15 will not apply; the Revenue views certain transactions as excluded whereas others are exempt if certain conditions are met.

Excluded transactions

There are no excluded transactions in relation to intangible property, but only land and chattels.

If the disposal condition has otherwise been satisfied then it will be deemed to be an excluded transaction if the chargeable person disposed of their whole interest in the property in a transaction made at arm's length with a person not connected with them or at least the transaction could be argued to be such a disposal, even if they are connected. Initial concerns for partial sales to mortgage lenders as equity release schemes were recognised and excluded in the regulations, and were also extended to other disposals of a part share in property to include:

• the transfer of property to their spouse or former spouse in divorce proceedings by an order of the court;
• a gift conferring an interest in possession (IIP) to a spouse or former spouse so long as the IIP does not come to an end by means other than their death;
• a disposal falling under s.11 of the Inheritance Tax Act 1985 (IHTA) allowing disposals for maintenance of family; and
• outright gifts that are transfers under s.19 (annual exemption) or s.20 (small gifts) of the IHTA.

For the purposes of the contribution condition, an exclusion will apply to the chargeable person if the provision by that person of consideration for another's acquisition of any property is for the same reasons as those outlined for the disposal exclusion above with an additional exemption also applying. This additional exclusion applies if the consideration constituted an outright gift of cash by the chargeable person, and was made at least seven years before the earliest date on which the chargeable person occupied the land or had use of the chattel.

Exemption transactions

There are a number or exemptions that may be applied, one of which is if the relevant property instead falls within the GROB provision set out in FA 1986 for IHT purposes.

Paragraphs 21 and 22 give the chargeable person the option of electing that any relevant property that would otherwise be subject to the income tax charge to instead be treated as subject to a reservation under FA 1986. This would simply mean that the taxpayer would have a choice to either pay an annual income tax charge or a charge to IHT on death unless the occupation or use of the relevant property ceased permanently and for seven years before the date of death, or the taxpayer pays a full consideration or market rent for the use of the property.

If the taxpayer decided that on balance they would prefer to make an election back into the GROB rules rather than the POAT then an election needed to be made to the Revenue in a prescribed form: IHT500 (see SI 2007/3000 The Income Tax (Benefits Received by Former Owner of Property) (Election for Inheritance Tax Treatment) Regulations 2007). The deadline for this election was 31 January 2007 for any person who would have been subject to the new charge from the initial year (2005/6), and if they become subject in a later year then 31 January the year following the rise to the charge. If an election was not made, or it was after the prescribed date, then they would become subject to income tax on the relevant property from the initial year, or from the year that the property became subject to the charge, unless the Revenue accepted a late election.

The provisions of sched.15 would also not apply in other instances where a reservation of benefit would otherwise be applied; s.102(5)(d) '“ (i) FA 1986 allows for disposal by way of gift to charities or political parties for example; s.102C (3) and para.6 of sched.20 provides for the donor's occupation of the land where, due to some unforeseen downturn in a donor's circumstances after a gift of land made to a relative, the donee provides for the donor's care and maintenance by allowing them to return and occupy the land; and s.102B provides for rules relating to gifts of undivided shares of interests in land, ss.4 preventing the gifted share from being property subject to a reservation if the donor occupies the land jointly with the donee and they receive either no benefit, or only a negligible benefit, at the donee's expense. This allows for a situation where perhaps 50 per cent is transferred and they both occupy and pay their share of household expenses.

Declare pre-owned asset tax

Individuals must obtain further advice on the basis of their personal position and must declare if they are subject to pre-owned asset tax in their tax return. This may not be easy given the ambiguity and lack of clarity of legislation.

The taxpayer must decide which is the most attractive proposition: to return themselves to their previous position, with a potential charge to IHT on death; or be subject to an annual income tax charge taking into account factors such as their personal financial position during their lifetime, their age, and the likely charge to IHT of the relevant property on death.

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