ON APPEAL FROM CHANCERY DIVISION
MR JUSTICE LIGHTMAN
Royal Courts of Justice
Strand,
London, WC2A 2LL
Before :
LORD JUSTICE BROOKE
LORD JUSTICE CARNWATH
and
MR JUSTICE NELSON
Between :
THE COMMISSIONERS OF INLAND REVENUE | Appellant |
- and - | |
(1) ELIZABETH VALERIE EVERSDEN (2) IAN DAVID EVERSDEN (as Executors of the will of Margaret Hunter Greenstock deceased). | Respondents |
(Transcript of the Handed Down Judgment of
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Mr David Ewart (instructed by Solicitor of Inland Revenue) for the Appellant
Mr Andrew Thornhill QC and Mr Jeremy Woolf (instructed by Triggs Wilkinson Mann) for the Respondents
Judgment
As Approved by the Court
Crown Copyright ©
Lord Justice Carnwath :
This appeal raises a short point on the “reservation of benefit” provisions of the inheritance tax legislation. It was decided against the Revenue by both the Special Commissioner (Dr N Brice) and Lightman J. Permission for an appeal to this Court was granted by Aldous LJ because of the general importance of the point involved. The Revenue is concerned that if the judgments below are upheld the efficacy of the reservation of benefit provisions would be seriously undermined.
The law
The relevant law is contained in the Inheritance Tax Act 1984 and the Finance Act 1986. The former started life as the Capital Transfer Tax Act 1984; but by Section 100 of the 1986 Act, the name of the tax was changed to “inheritance tax”, and it was provided that references in previous legislation to capital transfer tax should have effect as references to inheritance tax.
The tax is charged on “a chargeable transfer”, which is “a transfer of value” made by an individual other than “an exempt transfer”. A transfer of value is defined as -
“a disposition made by a person (the transferor) as a result of which the value of his estate immediately after the disposition is less than it would be but for the disposition; and the amount by which it is less is the value transferred by the transfer.” (1984 Act, s3(1)).
On the death of any person, tax is charged as if, immediately before his death, he had made a transfer of value equal to the value of his estate at that time (s 4(1)).
A person’s estate is “the aggregate of all the property to which he is beneficially entitled…” (other than “excluded property”) (s 5 (1)). Part III contains special provisions dealing with settled property. Section 49 (1) is particularly important in the present context. It provides -
“49. Treatment of interest in possession.
(1). A person beneficially entitled to an interest in possession in settled property shall be treated for the purposes of this Act as beneficially entitled to the property in which the interest subsists.”
Reference should also be made to 1986 Act Schedule 20 paragraph 5, which deals with changes in the property subject to a settlement. It provides:
“5(1) Where there is a disposal by way of gift and the property comprised in the gift becomes settled property by virtue of the gift…the principal section…shall apply as if the property comprised in the gift consisted of the property comprised in the settlement on the material date, insofar as that property neither is, nor represents, nor is derived from, property originally comprised in the gift.”
The “material date” is the date of the donor’s death (Schedule 20 para (1) (1)).
Certain categories of “Exempt transfers” are defined by Part II of the Act. For present purposes the most important is:
“18. Transfers between spouses.
(1) A transfer of value is an exempt transfer to the extent that the value transferred is attributable to property which becomes comprised in the estate of the transferor’s spouse or, so far as the value transferred is not so attributable, to the extent that that estate is increased.”
The other exempt transfers can be summarised more briefly: s 19 (Annual exemption for transfers in one year up to £3,000); s 20 (Small Gifts – that is, transfers in one year by “outright gifts to any one person…if the values transferred…do not exceed £250”); s 21 (Normal expenditure out of income); s 22 (Gifts in consideration of marriage); s 23 (Gifts to charities); s 24 (Gifts to political parties); s 25 (Gifts for national purposes etc); s 26 (Gifts for public benefit); s 27 (Maintenance funds for historical buildings); s 28 (Employee Trusts).
By Section 3A (inserted by the 1986 Act) provision is made for “potentially exempt transfers”. In summary, this enables the tax to be avoided on gifts made more than seven years before the death of the transferor, subject to certain conditions; they are potentially exempt until the seven years have elapsed. Although it is unnecessary to refer to the detail of this provision, I shall refer later to the definition of “a gift” in this context.
The section at the heart of the present appeal is Section 102 of the 1986 Act which reads as follows:
“102. Gifts with reservation
(1) Subject to subsections (5) and (6) below, this section applies where, on or after 18th March 1986, an individual disposes of any property by way of gift and either -
(a) possession and enjoyment of the property is not bona fide assumed by the donee at or before the beginning of the relevant period; or
(b) at any time in the relevant period the property is not enjoyed to the entire exclusion, or virtually to the entire exclusion, of the donor and of any benefit to him by contract or otherwise;
and in this section ‘the relevant period’ means a period ending on the date of the donor’s death and beginning seven years before that date or, if it is later, on the date of the gift.
(2) If and so long as—
(a) possession and enjoyment of any property is not bona fide assumed as mentioned in subsection (1)(a) above, or
(b) any property is not enjoyed as mentioned in subsection (1)(b) above,
the property is referred to (in relation to the gift and the donor) as property subject to a reservation.
(3) If, immediately before the death of the donor, there is any property which, in relation to him, is property subject to a reservation then, to the extent that the property would not, apart from this section, form part of the donor’s estate immediately before his death, that property shall be treated for the purposes of the 1984 Act as property to which he was beneficially entitled immediately before his death.
(4) If, at a time before the end of the relevant period, any property ceases to be property subject to a reservation, the donor shall be treated for the purposes of the 1984 Act as having at that time made a disposition of the property by a disposition which is a potentially exempt transfer.
(5) This section does not apply if or, as the case may be, to the extent that the disposal of property by way of gift is an exempt transfer by virtue of any of the following provisions of Part II of the 1984 Act,—
(a) section 18 (transfers between spouses);
(b) section 20 (small gifts);
(c) section 22 (gifts in consideration of marriage);
(d) section 23 (gifts to charities);
(e) section 24 (gifts to political parties);
(f) section 25 (gifts for national purposes, etc.);
(g) section 26 (gifts for public benefit);
(h) section 27 (maintenance funds for historic buildings); and
(i) section 28 (employee trusts).”
The background and purpose of this section were discussed by the House of Lords in Ingram v IRC [2001] AC 293. Two particular passages in the leading speech of Lord Hoffmann set the scene for the arguments in this appeal:
“Section 102 has a long history. Provisions in similar terms existed in connection with estate duty (section 2(1)(c) of the Finance Act 1894 (57 & 58 Vict. c. 30)) and before that account duty (section 11(1) of the Customs and Inland Revenue Act 1889 (52 & 53 Vict. c. 7)). There have been similar provisions in Australia. It has been interpreted on a number of occasions by the House of Lords and Privy Council. The theme which runs through all the cases is that although the section does not allow a donor to have his cake and eat it, there is nothing to stop him from carefully dividing up the cake, eating part and having the rest. If the benefits which the donor continues to enjoy are by virtue of property which was never comprised in the gift, he has not reserved any benefit out of the property of which he disposed: see Lord Simonds in St. Aubyn v. Attorney-General [1952] A.C. 15, 22-23.
If one applies this proposition to the highly sophisticated English land law, by which various interests, each regarded as separate items of property, can subsist simultaneously in respect of the same land, it is clear that the scope for discrimination in limiting the terms of the gift to exclude interests which the donor wishes to retain is very wide. In particular, the beneficial ownership of land may be divided in terms of time as well as space, so that the right to enjoyment of the land for a limited period, such as for life or a term of years, and the right to enjoy the land after the expiry of that period, can exist simultaneously as property interests in possession and in remainder or reversion….” (pp 299-300)
Before parting with this aspect of the case, I should say something about the more general considerations involved in the application of section 102. Its policy has puzzled people for a long time. For one thing, it is in one sense a penal section. Not only may you not have your cake and eat it, but if you eat more than a few de minimis crumbs of what was given, you are deemed for tax purposes to have eaten the lot. Secondly, a superficial reading of phrases like "beneficial enjoyment of the property" and enjoyment of property "to the entire exclusion ... of the donor" has led to numerous occasions in the past century in which the revenue has put forward the proposition that, as a matter of practical common sense, it simply must be contrary to the policy of the statute for a donor to be able to give away property such as a house and go on enjoying the benefit of the property by continuing to live there. This is the premise upon which the revenue claim the high ground of substance and reality. Mr. Nugee said that for Lady Ingram to have made a potentially exempt transfer and retained the right to stay in the house was simply too good to be true and in the Court of Appeal, Evans L.J. accepted this proposition. But this approach ignores the fact that "property" in section 102 is not something which has physical existence like a house but a specific interest in that property, a legal construct, which can coexist with other interests in the same physical object. Section 102 does not therefore prevent people from deriving benefit from the object in which they have given away an interest. It applies only when they derive the benefit from that interest…. What, then, is the policy of section 102? It requires people to define precisely the interests which they are giving away and the interests, if any, which they are retaining. Once they have given away an interest they may not receive back any benefits from that interest. In Lang v. Webb, 13 C.L.R. 503, 513 Isaacs J. suggested that the policy was to avoid the "delay, expense and uncertainty" of requiring the revenue to investigate whether a gift was genuine or pretended. It laid down a rule that if the donor continued to derive any benefit from the property in which an interest had been given, it would be treated as a pretended gift unless the benefit could be shown to be referable to a specific proprietary interest which he had retained. This is probably the most plausible explanation…” (pp 304-5)
The facts
The relevant facts in the present case were summarised by Lightman J as follows:
“By the Settlement, the Settlor appointed herself and two others to be the trustees of the Settlement (“the Trustees”). The Settlement provided that the income of the trust fund thereby constituted (“the Trust Fund”) should be paid to the Settlor’s husband (“the Husband”) during his life, and after his death, (subject to a special power of appointment to a class of beneficiaries including the Settlor) for a specified period of eighty years on discretionary trusts for a class of beneficiaries including the Settlor, and at the end of the specified period on trust for the Settlor’s daughter Mrs Eversden and the remoter issue of the Settlor as should then be living absolutely. The Settlement conferred on the Trustees the additional powers set out in the Schedule to the Settlement (“the Additional Powers”). These included (in paragraph 3(b)) power to acquire immovable property for residence, occupation or use and enjoyment in specie by any person interested in possession in the income of the moneys used on such acquisition (including a person to whom such income may be paid in exercise of the Trustees’ discretion); and in paragraph 3(c) to acquire any reversionary interest in property or other investments not producing income or in respect of which no rent is payable.
By a conveyance dated the 20th December 1988 (“the 1988 Conveyance”) the Settlor conveyed a property known as Beechwood Cottage (“Beechwood”) to the Trustees to hold on trust as to 5% for the Settlor absolutely and as to 95% on the trusts of the Settlement. The Husband thereafter as life tenant occupied Beechwood (together with the Settlor) until his death.
The Husband died on the 6th February 1992. The Trust Fund then comprised the 95% share of Beechwood, with a value of £147,251.
In or about 1993 the Trustees both sold Beechwood and out of the proceeds (including the 5% to which the Settlor was entitled) purchased 6 Barn Meadows (“Meadows”) and an investment bond (“the Bond”). Thereafter the Settlor had a 5% interest in Meadows and the Bond. From the date of its purchase until her death on the 27th October 1998 the Settlor was in sole occupation of Meadows and paid all the expenses relating to it. She received no benefit from the Bond.
On the death of the Settlor the Trust Fund comprised the 95% interest in Meadows (valued at £171,000) and the 95% interest in the Bond (valued at £149,213,43).”
The issue in the appeal
The issues between the parties have narrowed significantly as the case has proceeded. Before the Special Commissioner and the Judge there was a dispute whether the conditions in s 102 (1) were satisfied on the facts of the case. These issues were decided in favour of the Revenue, and have not been re-opened on the appeal.
Accordingly, in applying the statutory provisions to the above facts, there is much common ground. When the settlor transferred Beechwood to the trustees the value of her estate was diminished and there was accordingly a “transfer of value” (IHTA s 3 (1)). Her husband had an interest in possession in the trust fund, and so he was deemed to be beneficially entitled to Beechwood immediately it became part of the trust fund (IHTA s 49 (1)). It therefore became comprised in his estate (s 5 (1)). Accordingly the transfer of value was an exempt transfer, because it was attributable to property which became comprised in the estate of the settlor of the transferor’s spouse (IHTA s 18 (1)). For the same reason, on his death the property in the trust fund was part of his estate and as such subject to inheritance tax (IHTA s 4 (1))
Turning to the reservation of benefit provisions, it is now common ground that, as decided by Lightman J, the reservation of benefit provisions apply in principle for two separate reasons:
in relation to the Meadows alone, because the settlor actually enjoyed a benefit by virtue of her rent-free sole occupation; and
in relation to both the Meadows and the Bond, because the settlor was a discretionary object in relation to the entire trust fund.
Thus, on the death of the settlor, apart from s 102 (5), the property which had been the subject matter of the gift, being “subject to a reservation” as defined, would be treated as part of her estate immediately before her death (s 102 (3)), and accordingly subject to tax by virtue of the deemed transfer of value under s 4. The property actually in the trust at that date, having been derived from the original property, is treated as the subject matter of the gift (1986 Act Sch 20, para (5)).
The only issue before us is whether the provisions are displaced by virtue of s 102 (5) (a), taken with IHTA s 18.
Discussion
Against this background it is necessary to look in more detail at the effect of s 102 (5). At first sight, it appears reasonably straightforward. The section is displaced “if or, as the case may be, to the extent that” the disposal is an exempt transfer by virtue of various provisions of Part II of the 1984 Act. They are the exemption provisions which I have already outlined, with the exception of ss 19 (annual exemption) and 21 (normal expenditure out of income). The words “if or…to the extent that” appear to correspond to the same words as used in the exemption provisions. For example, s 18 provides that a transfer of value is exempt “to the extent that” the value satisfies the provisions of the section. Conversely, s 20 (small gifts) provides that transfers of value are exempt “if” the values do not exceed the stated amount. On a natural reading, therefore, the draftsman has simply imported into section 102(5) the 1984 Act exemptions, subject to the same conditions.
In the present case the “disposal of the property by way of gift” was the transfer of the property in 1988. As is common ground that was an exempt transfer, by virtue of s 18. Accordingly, it is outside section 102, and the settlor’s estate is not subject to tax in relation to the subject-matter of the gift. On the other hand, although the interest of the husband was limited to his life, he was treated by virtue of s 49 as beneficially entitled to the whole property, and his estate was charged to tax on that basis.
This seems the natural reading of the section as applied to this case. However, Mr Ewart for the Revenue has argued that it is an over-simplification, and is inconsistent with Lord Hoffmann’s authoritative exposition of the section in Ingram, set out above. Mr Ewart submits that, properly understood in the light of Ingram, the concept of the disposal of property by way of gift in s 102 cannot be directly equated with that of transfer of value in s 18. There is as he says a “mis-match” between the two which requires some modification to be made to the language of s 18 in order to give effect to Parliament’s intention. Following Lord Hoffmann, he submits that the term “property” in section 102, in relation to a house, is not referring to the house as a physical object, but to “a specific interest in that property, a legal construct, which can co-exist with other interests in the same physical object”.
Thus, he says, the gift of Beechwood in 1988 cannot properly be treated as the transfer of a single property or of the value of that property, but must be analysed as a gift of a number of distinct interests in the property as defined by the settlement. In summary, he divides the transaction into four separate elements:
the husband’s life interest;
the interest of the potential beneficiaries, as a class, under the discretionary trust during the specified period of eighty years;
the interests of the settlor’s daughter and other beneficiaries at the end of the specified period; and
in default of any such beneficiaries, the resulting trust in favour of the settlor or her estate.
The “gift” for the purposes of s 102 comprises the first three elements, which are thus potentially within s 102; the fourth, which was an interest retained by the settlor, is outside the scope of s 102 altogether.
Following this analysis, he says that s 18, which refers in terms to the different concept of “transfer of value”, needs to be adjusted in order to apply it to a gift of property in the sense used by s 102. He proposes the following wording (the words in square brackets indicating the changes from the original):-
“[A gift] is an exempt transfer to the extent that [the property which is the subject matter of the gift] becomes comprised in the estate of the transferor’s spouse…”
On his analysis, the only part of the 1988 gift which became part of the spouse’s estate was the interest defined by his life, and accordingly it is only “to that extent” that the gift is to be treated as an exempt transfer. Since that interest had ceased to exist by the material date (that is, the death of the settlor), there is no relevant exemption, and nothing to prevent the full application of s 102 to the interests then remaining.
In spite of the ingenuity of the argument and its attractive presentation, I find it unconvincing. It involves an unwarranted extension of the reasoning of the House of Lords in Ingram, and an unwarranted distortion of the statutory language. It is important to keep in mind the factual background of Ingram. In that case the settlor had procured the conveyance of her house and surrounding land to trustees for her children and grandchildren, but before doing so had procured the grant to herself of two leases of different parts of the property for 20 years rent-free. The conveyance to the trustees was subject to those leases. The House of Lords held that the reservation of benefit provision had no application because her enjoyment of the land was derived from her leasehold interest which was not subject of the gift. It was in that context that it was relevant to distinguish between the property as a physical object and the interests in it. Section 102 did not prevent the donor deriving benefit from the physical property, provided that benefit was not derived from the interest which she had given away. That case, in my view, throws no light on the present. Lord Hoffmann was solely concerned to identify the nature of the interest retained by the settlor. He was not considering section 102(5), or the interaction of section 102 with the exemption provisions of the 1984 Act. Nor was it necessary for him to consider the position of successive interests forming part of a gift under a settlement.
Mr Ewart also relied on the decision of the Privy Council in Commissioner for Stamp Duties of New South Wales v Perpetual Trust Company Ltd [1943] AC 425. This concerned similar reservation of benefit provisions in the New South Wales Stamp Duties Act 1920. Under the settlement in that case the trustees were required to hold certain company shares, to apply the income for the maintenance of the settlor’s son during his minority, and to transfer the shares to him absolutely on his attaining the age of 21. It was held that, although the son’s interest was contingent upon his attaining 21, the property comprised in the gift was his equitable interest in the shares; that was assumed by him immediately upon the gift and retained thereafter to the entire exclusion of the settlor; accordingly the shares were not part of the settlor’s dutiable estate. In the opinion of their Lordships (see pp 439 – 440, per Lord Russell of Killowen) –
“The property comprised in the gift was the equitable interest in the 850 shares which was given by the settlor by his son…The son was (through the medium of the trustees) immediately put in such bona fide beneficial possession and enjoyment of the property comprised in the gift as the nature of the gift and the circumstances permitted…”
Again, in my view, this case does no more than show that in applying the section, one needs to have regard to the nature of the particular gift. It throws no light on the application of s 102(5) of the 1986 Act, nor on the treatment of successive interests under a settlement.
In any event, it is impossible to introduce such conceptual subtleties into s 102(5) without distorting the language. Rightly or wrongly (from the purist’s point of view), the draftsmen clearly did find it possible to equate a disposal by way of gift with a transfer of value. That is the effect of posing, in the sub-section, the question whether the disposal by way of gift “is an exempt transfer”, with specific reference to the provisions of Part II of the 1984 Act all of which are references to “transfers of value”. The alleged “mis-match” to which Mr Ewart refers would apply equally to all the provisions listed in s 102(5). No doubt corresponding amendments would be needed to those other provisions, in line with that suggested by Mr Ewart for s 18. In my view such an approach is neither necessary nor within the scope of the Court’s powers of interpretation.
If further support were needed for this view that the draftsmen of the 1986 Act did not share Mr Ewart’s conceptual problems, it may be perhaps be found in IHTA s 3A (see above), as inserted by the 1986 Act, dealing with “potentially exempt transfers”. Such a transfer is defined as “a transfer of value,” subject to certain conditions, “to the extent that it constitutes…a gift to another individual…” By sub-section (2), a transfer of value is regarded as a gift for these purposes to the extent that either (a) “the value transferred is attributable to property which…becomes comprised in the estate of that other individual”, or (b) “to the extent that, by virtue of the transfer, the estate of that other individual is increased.” Although (b) may be seen as an extension of the normal meaning of “gift”, (a) is wholly consistent with the interpretation which I would regard as the natural reading of s 102(5), and shows no difficulty in marrying the two concepts. Although the relationship is not spelt out in s 102(5) in the same detail, it would be surprising if the draftsman was intending to use the term “gift” in a radically different sense in two places in the same Act.
I have already referred to the Revenue’s concern that this interpretation will undermine the effectiveness of the provisions. Mr Ewart illustrates the problem by the following example:
“A husband owns property. He settles that property on trusts which give his wife an initial interest in possession for her life or 3 months whichever is the shorter. Thereafter, there are discretionary trusts in favour of a class of beneficiaries which include the husband and wife. If the construction favoured by the Respondents and Lightman J is correct, the husband can continue to enjoy substantial benefits from the property (in the present case Mrs Greenstock had sole occupation of the dwelling-house) without it being part of his estate on death. Schemes such as this are currently being promoted.”
Mr Thornhill for the Respondents does not dispute that this is a possible effect of his submissions. However he counters it by putting forward potential anomalies which would result from the Revenue’s interpretation, in this and other provisions. I do not find it necessary to examine these suggested anomalies in detail. Experience shows that the Court’s task of applying a particular statutory provision to a particular set of facts is rarely assisted by considering the hypothetical application of other provisions to other hypothetical sets of facts. I am ready to accept that this particular battle of anomalies comes out in favour of the Revenue. However the problem if it exists derives from s 49, which treats the acquisition of an interest in possession as equivalent to the acquisition of the property itself. That has the result that, in the present case, the estate of the settlor’s husband is taxed on the property, but that of the settlor is not. There is nothing in section 102 to modify that aspect of the scheme of the 1984 Act. If that is of concern to the Revenue, they must look for correction to Parliament, not to the Courts.
Accordingly I would dismiss this appeal.
Nelson J
I agree
Brooke LJ
I also agree.
ORDER: Appeal dismissed. The appellants to pay the respondents' cost of the appeal subject to detail assessment if not agreed. Permission to appeal to the House of Lords refused.
(Order not part of approved judgment)