Thursday, 15th May 2025

Gifts with reservation, the Inheritance Tax trap that still springs (and gets worse)

Inheritance Tax (“IHT”) is often referred to as the UK’s most hated tax.  The tax rate of 40% is very unpalatable for those that it hits. So, it is no surprise that those families who may have to pay IHT seek ways around it. It is also no surprise, given how much wealth is tied up in property in the UK, that the ‘family home’ is often the asset that people want to protect.

Any professional who encounters IHT knows that trying to remove the family home from your taxable estate is fraught with risk. The recently reported case of Chugtai v The Commissioners for His Majesty’s Revenue & Customs [2025] UKFTT 00458 (TC) provides a helpful reminder.

What was the case about?

Mr Mohammed Chugtai (the ‘Deceased’) died on 26 February 2017, leaving an estate valued at £401,711. On 16 February 2000 he executed two deeds creating discretionary trusts. One trust had an account with Abbey National, later Santander Bank (the ‘Santander Trust’). The other trust (the ‘Property Trust’) held the Deceased’s property in Caversham, Berkshire (the ‘Property’). The Property was mixed-use, containing the Deceased’s home and a retail unit that the Deceased ran at the time. The Deceased was excluded from benefitting from both trusts.

HMRC determined that the transfers to both Trusts were gifts with reservations of benefit (‘GROBs’) and so were included in the Deceased’s taxable estate for IHT purposes. The family appealed against this determination.

 

 Gifts with Reservation of Benefit

Where an individual makes a gift of an asset and either:

o             Bona fide possession and enjoyment of the asset is not assumed by the recipient at or before the date of the gift; or

o             At any point in the 7 years prior to death (or between the date of the gift and the date of death, if shorter) enjoyment of the asset is not at the exclusion (or virtually to the exclusion) of the donor

For as long as that remains the case, there is a reservation of benefit and the donor is to be treated as beneficially entitled to the asset at the date of his death.

 

At the date of death, the Santander Trust held £62,239, and the Property was valued at £380,000 (though this value was contested).

After creating the Trusts, the Deceased briefly moved out of the Property, but returned at the request of his daughter, who resided in the Property, to provide care for her. He did not pay rent. The Deceased continued use the retail unit (rent-free) until it was leased to another business, which paid rent into the Santander Trust. The Deceased continued to use the account in the Santander Trust.

What did the Tribunal find?

The First-Tier Tribunal agreed with HMRC that: (i) the use of the bank account constituted a benefit to the Deceased, such that the value of the Santander Trust was included in the Deceased’s estate; and (ii)the Property Trust, too, was included in the Deceased’s estate because:

1. The Deceased did not pay rent for his use of either the residential property or business unit.
2. His reason for returning to the property did not meet the exemption given in paragraph 6 of the schedule 20 to the Finance Act 1986.
3. The Deceased received (via the Santander Trust) the rent from the retail unit.
4. The trust documents may have stated that the Deceased was excluding from benefitting, but he did, in fact, benefit.

As a result, the appeal was dismissed.

What does this mean for the family?

This case illustrates the dangers of an imperfect gift.

1. The Santander Trust and Property Trust will form part of the Deceased’s estate for IHT purposes. This brings the total estate to £843,950, exceeding the maximum tax-free Nil-Rate Band (‘NRB’) of £650,000.
2. The Residence Nil-Rate Band (‘RNRB’) was not available. Although the value of the Property was added back into the Deceased’s estate, his children did not receive a beneficial interest in the Property because of his death; the gift into the trust is not undone, it is just imperfect for IHT purposes.
3. Furthermore, when the Property is sold, the trustees of the Property Trust will face a charge to Capital Gains Tax (‘CGT’). Given rising house prices in the southeast of England at a rate of 24% the CGT due is likely to be substantial; trustees only have a tax-free CGT allowance of £1,500.

If the trusts had never been created, the Deceased’s estate would be valued at £843,950. However, it would have had a greater tax-free allowance, up to £1m (assuming a full NRB, transferred NRB, RNRB and transferred NRB). Furthermore, the value of the Property would be re-based at the date of death. On sale, CGT would only be charged on the gain from the date of death.

What are the lessons?

Lesson 1: Be aware of the risk of imperfect gifts, particularly of family homes.  Ensure you obtain professional advice.  In some circumstances, depending upon timing, it may be possible to undo or perfect a GROB.  If neither of those options are available, the family need to be prepared for the tax that will be payable.

Lesson 2: Trusts are often created to save tax, but the failure to achieve a tax goal does not undo such trusts. The consequence of such failure can often be that, when all taxes are taken into consideration, a family pays more tax than they would have in the first place. As asset values increase and tax allowances shrink, these traps bite harder and deeper. Families and their advisors should always take full advice from a certified tax advisor before making such arrangements.

 

If you would like any help or advice on a gift with a reservation of benefit, or any issues relating to inheritance tax or probate do get in touch with Alex Shah or Henry Braithwaite in our specialist Private Client team or your usual contact at the firm on +44 (0)20 7526 6000.

 

This article is for general purpose and guidance only and does not constitute legal advice.  It should not replace legal advice tailored to your specific circumstances.