I am going to assume that F has not only “declared” the income as his own to HMRC but has actually received the income and presumably paid the tax out of it.
F has made a gift of cash to S. The deal with the rent seems at least arguably referable to that gift. That will often not be so. The money transferred simply disappears into the donee’s estate by being banked. The statutory tracing rules in Sch 20 do not apply and it is usually hard to see how a donor of money can continue to benefit from it unless there is some clear legal or factual link. Such as its being plainly applied to purchase an asset to then becused by the donor, as donor and donee intended all along. That is why the rent deal is potentially vulnerable, regardless of the precise mechanics to achieve it (which are not stated).
The test for a GROB in s.102 (1) FA 1986 is twofold.
1 The test in (1)(a) is both legal and factual. It is legal in catching a gift with the reservation of some legal right out of the gifted property; here if the cash gift by F was made on the specific basis that F would retain/obtain the rental income or its cash equivalent. This need not be contractually binding: equity would constrain S from grabbing back the rent as it would be unconscionable. It is also factual: a key component of the enjoyment of the gifted asset is arguably not bona fide assumed by the donee if S had agreed to cede the rent.
2 The test in (1)(b) is purely factual. Is a the gifted property de facto enjoyed exclusively and without benefit to the donor, noting that this need not flow from a contract. It would seem catch a mere understanding (“or otherwise”) about the rent if that was a contemporaneous mutual expectation.
3 Under both 1 and 2 the “relevant period” must be borne in mind. A situation that was not present at the time of a gift which emerged later at any time before F’s death would engage the GROB. This becomes more difficult for HMRC to demonstrate, absent a provable plan, if reverse transfers commence much later on.
4 Note that the implementation of the rent arrangement however informal and totally gratuitous could be a GROB by associated operations: para 6(1)(c) Sch 20 FA1986, s.268 IHTA. If S gave F a sum equivalent to the net of tax, or even gross, amount of the rent from (for maximum assurance) a source of funds not directly traceable to his receipt of the rent that might not be caught. But it is likely to be if the rent is paid direct to F by the tenant (definitely) or by S immediately after collecting it (highly probable) coupled with F declaring it to HMRC (strongly evidential).
5 A termination of a GROB, whether arising initially or later would set a rolling 7 survival period running because of the deemed PET in s.102(4). Just because the cash gift entailed a GROB does not negate its also being a PET. So if the deal operates for a short period only e.g. F could have 2 PETs cumulating at once, instead of one plus a GROB.
The classic planning device is shearing. S could grant F a lease for a period which is a fixed term, the maximum of which would be F’s estimated life expectancy (but not for his life to avoid a settlement). The problem with this is that S will have to use up a large part of his base cost for CGT on the market value part disposal to F, with a corresponding small part attributable to the reversion which will grow in value if only due to the expiration of the lease.
If the idea is to make good the money given the lease could be for a relatively short period, reducing the CGT impact.
For IHT the gift of a lease (an interest in land) would not be caught by s102A because S’s reversion would not be a “significant right or interest”.
A TOV for IHT cannot be retrospective for tax purposes but it can be so between the parties. F and S can enter into a lease now and entitle F to past rent as well (if he clearly was not or that was ambiguous). By deed of course as gratuitous. Past gifts by S to F of rent would remain TOVs made when actually made. The deed would have to take account of the precise mechanics of the rent deal.
6 The more strongly the argument is made that F’s cash gift is not a GROB, as a result of the rent deal, then the stronger the counter argument is that S is making TOVs/PETs to F, directly or by omission depending on the precise mechanics. As there is no exemption for mutual gifts there is clearly a risk of both a GROB for F and PETs by S (which he may choose to insure or rely on surviving).
A big downside of the whole set up is that if F’s cash gift and S’s rent/cash gifts are PETs there are no reporting requirements. So HMRC’s reaction will not become known until the death of either when their PRs will have to report any then continuing effects.
7 There must be some doubt about whether F is correctly chargeable on the rental income. Unless he has a legal right to it he isn’t. It would mean that S is technically in default because he should have returned it. HMRC, if they pick up on it, may not be too put out if F’s liability equals or exceeds that of S. My cynical nature suggests to me that at least part of the motivation might well be that it is rather lower. In that case a voluntary disclosure might be a wise strategy. A consolation prize is that S’s paying income tax on the rent strengthens the IHT argument that S is making PETs to F and so (though not a slam dunk—see 6 above) there is therefore no GROB referable to F’s cash gift of the deposit amount. Even if the rent deal is seen as the indirect refunding of the amount paid by F provided that was not the mutual plan all along it is questionable whether the GROB mischief is truly engaged. After all, the PET (or 2 PETs —see 6 above) by F will cumulate for 7 years and the reverse gifts will swell F’s estate if still representing value retained at his death. Given PET treatment for S’s gifts too, a GROB claim seems rapacious. But have you met HMRC?
Jack Harper