Potential income tax trap when caring for an elderly parent!
In some cultures, caring for an elderly relative is expected and the norm. Although not quite so common in the UK, most people want to avoid going into a care home and would rather live with family if they are no longer able to manage at home alone. But how many elderly people in this situation realise it could trigger an income tax charge?
Most people have heard of Inheritance Tax (“IHT”) but asking about Pre-Owned Asset Tax (“POAT”) usually draws a blank expression, even from some accountants and legal advisers!
Obviously, taxes fund the infrastructure of our society, and some taxes and allowances are arguably designed to encourage or discourage certain action. And this is certainly the case when you look at the interaction of IHT and Pre-Owned Asset Tax.
We have, for a long time, been free to give away assets during our lifetime and, if lucky enough to survive seven years, the gift will be ignored when working out if our estate must pay IHT. However, what if you make a gift but benefit from it in some way? For instance, you have a holiday home, you don’t stay in it much anymore and decide to give it to your children. Ignoring capital gains tax, you may have to pay on the deemed disposal of the property, and surviving seven years to save IHT, the value would still be taken into account when you die when working out the size of your estate for IHT purposes if your children allow you to carrying on using it without you paying them a full market rent. This is due to IHT anti-avoidance rules which would treat this as a ‘gift with reservation of benefit’. From an IHT planning point of view, a failed exercise!
But what if you make a gift, don’t reserve any benefit from it, and find yourself indirectly benefitting in the future? This is the trap some elderly people find themselves in – usually without even realising. A typical scenario would be the helpful bank of Mum and Dad giving cash to their child to part fund a property purchase. Many years pass, happily more than seven and you think you have successfully reduced the value of your estate for IHT purposes and helped your offspring get on the housing ladder. One day you are too old or poorly to live alone and you do not want to go into a care home. Your grateful loving child invites you to live with them. After selling your property you might even help them with some more cash, possibly for a Granny Annex. You have gifted cash, from which you cannot reserve a benefit for IHT purposes and seven years has elapsed. So far so good, but you are now benefitting from a pre-owned asset. You used to own the cash, you gave it away, you are now living in a property part funded by the cash, and Pre-Owned Asset Tax bites. A tax introduced to find a way of taxing those who have managed to circumvent the IHT gift with reservation of benefit rules. If they can’t tax you in one way, HMRC will find another! That’s how taxes work, if there appears to be a legitimate reason to tax something, HMRC will – particularly with the public finance black hole we keep hearing about. But how do you collect a tax that is hideously more intricate and complicated than this simple example when nobody seems to know about it?
POAT operates to treat occupation of the property as a benefit which, subject to a de minimis disregarded benefit any rental value seemingly higher than the threshold triggers an income tax charge on the elderly occupier at their marginal rate. And how do you know what the benefit is? Inevitably, only after the additional expense of a chartered surveyors report to assess the rental value on an open market basis with a periodic review.
Ask several people about the fairness of different forms of taxation and you will get several different opinions, very often influenced by their financial security and political views. However, how fair is a tax (not just POAT) that only traps those with a love of tax books, the Financial Times or have the benefit of professional advice. This is very much the case with POAT, you must spot the circumstances that trigger it, and this tax (let alone many other forms of taxation) are so complicated, how can you report to HMRC in self-assessment to pay tax on something you didn’t even realise exists, let alone understand. If you don’t spot it during your lifetime, last chance saloon for HMRC to recover the tax is from your executors when they complete an IHT Account. There is a whole section on it in the Lifetime Gifts Schedule. Most executors would not know or enquire about the history of funding for a property, and with the rise of online DIY probate applications, most lay executors wouldn’t think POAT applies, let alone make extensive enough enquiries to realise it may be an issue. If the government introduce such taxes, there must surely be a better way to monitor and collect taxes.
At present, unfairness is created as those who seek professional advice may become aware of and declare the position, whereas those who have no knowledge of the area and manage their own affairs without professional input likely get away with it. Not necessarily deliberately but simply because they do not know about the tax, let alone understand it. All taxes need simplification if the government is to achieve its aim of collecting all taxes due; you can’t report what you do not know about!
And what if you unfortunately find yourself with a Pre-Owned Asset Tax issue and can’t afford or don’t want to pay the tax? HMRC have a solution: you can elect to be caught by the IHT gift with reservation of benefit rules instead, so they can potentially collect IHT on your death. One way or the other, tax can bite, and which regime is more favourable will depend on a number of factors for which specialist advice is essential. For further advice on planning your inheritance effectively or if you need further tax advice, please get in touch with one of our estate planning solicitors.
