Finance Act 1986, Section 102: Reservations of Benefit and Inheritance Tax

Section 102 of the Finance Act 1986 introduced significant changes to the taxation of gifts with reservation of benefit for inheritance tax (IHT) purposes. Prior to this legislation, it was relatively common for individuals to make gifts of assets but continue to enjoy some benefit from them, often mitigating potential inheritance tax liabilities. Section 102 aimed to close this loophole and ensure that such arrangements were treated more effectively for IHT.

The core principle established by Section 102 is that if a donor (the person making the gift) disposes of an asset but retains some benefit from it, the asset is treated as still forming part of their estate for IHT purposes upon their death. This means that the full value of the gifted asset, at the date of death, will be subject to IHT, regardless of whether the gift was made more than seven years before death – the usual period for potentially exempt transfers (PETs) to fall outside the IHT net.

The concept of "reservation of benefit" is crucial. This means that the donor continues to enjoy some form of advantage or right related to the gifted asset. Common examples include:

• Occupation of Land: Gifting a property to children but continuing to live in it rent-free or at a significantly reduced rent.
• Income from Assets: Gifting shares but continuing to receive the dividends.
• Control of Assets: Gifting assets to a trust but retaining significant control over the trustees or the investment decisions.

The legislation also addresses situations where the reservation of benefit ceases before the donor's death. If the donor ceases to enjoy the benefit at least seven years before their death, and the asset was a potentially exempt transfer, then it falls outside the IHT net as a normal PET. However, if the cessation occurs within seven years of death, the original gift is treated as a gift with reservation, and the value of the asset at the date of death is included in the donor's estate.

There are exceptions to the general rule under Section 102. A notable exception applies where the donor pays full market value for the benefit they receive. For example, if a parent gifts a property to their child but pays a full, commercially realistic rent, the gifted property would likely not be considered a gift with reservation of benefit. Another exception may apply if the benefit enjoyed is of a trivial nature. Professional advice should always be sought to determine whether an exception applies.

Furthermore, Section 102 impacts gifts into trusts. If a settlor (the person creating the trust) makes a gift into a trust but retains some benefit from the trust property, the gift is treated as a gift with reservation of benefit. This can have significant implications for the ongoing tax treatment of the trust and the inheritance tax position of the settlor.

In summary, Section 102 of the Finance Act 1986 is a cornerstone of IHT legislation, designed to prevent avoidance through gifts where the donor retains enjoyment of the asset. It's essential to understand the implications of this section when considering gifting strategies, particularly where the donor intends to continue benefiting from the gifted assets. Careful planning and professional advice are crucial to ensure compliance and avoid unintended IHT consequences.