Usufructs and Inheritance Tax after UK Finance Act 2025.
This concerns the coming into force of the Finance Act 2025 yesterday and the change in the rules relating to non-domiciliaries and Settled Property, it does not address the changes in the Income Tax and Capital Gains Tax provisions.
There is a long-standing disagreement over HMRC’s continuing attempts to apply s.43 (2) Inheritance Tax Act 1984 to Civil Law usufructuary dismemberments and to treat these as a form of settlement. HMRC admit that this is purely fictional.
This fiction arose during the period prior to the Finance Act 2006 when settled property was considered to remain within the taxable estate of the settlor. The change to relevant property has considerably changed the application of the law as, in a relevant property context situation, the supposedly settled property is treated as leaving the deceased’s estate.
The problem is that there is no trust involved in a civil law dismemberment. It is almost axiomatic in English law that you cannot have a settlement of property without a trust. In the absence of a trust, the rights are not relevant property and their legal status are that these remain either within the estate, here the usufruit, or leave it in the case of a lifetime gift, here, the nue-propriété.
This misconception has therefore been amplified since 2006 by the introduction of the concept of Relevant Property with its penalisation of property considered to be settled property and therefore subject to an entrance charge, a ten-year charge and an exit charge.
The domestic advantage in the relevant property regime is that the settled property leaves the deceased’s estate in the absence of any retained interest in possession in settled property. If there is an interest in possession retained in the property settled by the Settlor, that interest remains within the Settlor’s chargeable estate and the relevant property regime does not apply.
HMRC currently take the position that a usufructuary dismemberment created after 2006 creates “relevant property”.
However, in order to be “relevant property” the “property” has to be settled property under s.43(2) ITA 1984. If it is not so “settled”, the relevant property regime cannot be applied to it as it falls outside the definition in s.58 –
Relevant property:
(1) In this Chapter “relevant property” means settled property in which no qualifying interest in possession subsists, other than - ...
There is no doubt at all that a usufructuary dismemberment does not involve the creation of any form of trust which falls within a). or b) of s.43(2) ITA 1984.
By way of a domestic illustration, the constitution of a Scottish Proper Liferent does not create a form of trust as each interest, the Liferent and the Fee are real interests, not personal interests.
Following substantial criticism in Parliament of the attempt to subvert Scottish property law by the Money Bill creating IHT’s predecessor Capital Transfer Tax, the only solution that was found was not to legislate directly in what is now s.43(4) ITA 1984and s.46 to treat the Fee and the Proper Liferent as settled property, but only to provide that any deed or similar creating a Proper Liferent was itself a settlement. That did not render the Liferent or the Fee settled property in themselves. S.46 completed the fiction by treating the benefit of the proper liferent as a chargeable interest in possession.
However, s. 5 defines the estate for Inheritance Tax purposes as comprising:
(1A) An interest in possession falls within this subsection if–
(a) it is an interest in possession in settled property,
It does not comprise an interest in possession which is not an interest in settled property. The usufruit in any civil la jurisdiction extinguishes at nil value on the decease of the usufruitier and cannot survive the usufruitier, unless it is defined as successive, in which case, it extinguishes at nil value on the decease of the last usufructuary. Extinguishes means ends or terminates definitively.
That did not prevent HMRC from taking the position that they could treat civil law dismemberments as creating “interests in possession” despite the total incongruity of that position with the conflict of law and private international law principles in place.
It did not prevent HMRC arguing that if the usufruct was not an interest in possession, the whole property was subject to a fictional settlement under the last paragraph of s.43(2) ITA 1984 despite there being none of the active or passive ingredients constituting any trust within any part of the United Kingdom.
I quote from correspondence with HMRC:
“In response to your letter of 26th September, HMRC is not suggesting that French immoveable property can, in the real world, be subject to English property or trust law. Nothing in the IHTA or English law generally could achieve that. But s.43(2) does provide that any disposition which, if it were regulated by the law of any part of the UK, would meet any of the conditions listed in that subsection, then that disposition is to be treated as a 'settlement' for the purposes of the I HTA.
This enables HMRC to look at the position that exists once a disposition of foreign property has been made and then consider how, if that disposition had been subject to UK law, it would have been brought about under UK law. In other words, it enables HMRC to hypothesise what the effect of the disposition would be if UK law applied to it. And if, under that hypothesis, the disposition would be treated as settlement for IHT purposes, then for IHT purposes (but no other) that is how it will be treated and the relevant tax consequences will flow.”
Firstly, there is no such thing as “UK law”, the section refers to the law of any part of the United Kingdom and therefore includes the conflict of law and private international law principles inherent with in the United Kingdom, as those concerned with interactions between the separate and several jurisdictions of Northern Ireland, Scotland and England & Wales will be familiar. Scottish land is not English land.
“… or would be so held or charged or burdened if the disposition or dispositions were regulated by the law of any part of the United Kingdom, or ….”
The term “regulated by” does not mean “governed by”. The “or” following this phrase makes that clear in ordinary English. Those familiar with the minutes of Standing Committee A in February 1975 will be mindful that the “or” prefaced the separate introduction of a change in governing law so as to include corporate anstalts and foreign foundations which were not otherwise settlements in the general term “settlements”. It was not intended to achieve more. HMRC have accepted in correspondence that that they should not attempt to employ a fictional change in governing law outside that scope.
Those who have read further will note that Dr. Gilbert who was by no means at ease with the legal background stated at §1736
“I assure the hon. Gentleman that the aim is not to impose tax on foundations set up by foreign settlors for the benefit of their families. Those will be right outside the tax except as regards any property situated in the United Kingdom.”
That means that the principle underlying the last paragraph of s.43(2) ITA is that a dismemberment of a French asset by a French “domiciled” or now non-resident individual cannot be assimilated to a settlement under that provision.
That leaves us to question how on earth is it possible to imagine a fictional settlement over land outside any equitable jurisdiction of the English courts as defined in the Law of Property Act 1925, the subsequent Trust of Land and Appointment of Trustees Act 1986 and the Administration of Estates Act 1925.
The somewhat far-fetched response to that is apparently that under s.1(1) Law of Property Act 1925, if the usufruit retained or the nue-propriété gifted or devised is neither a fee simple absolute or a term of years, it can only take effect in equity as an equitable estate or interest, not at law. That clearly is only applicable to English land, and under the principles of Conflict of laws and private internation law, does not apply where the lex situs states otherwise, as it did in Scotland.
That is countered by the simple fact that an equitable interest or estate subsists is not sufficient to create a settlement under s.43(2) ITA which requires that the property be held in trust a). in succession or subject to a contingency, or b). on trust to accumulate income. The trust arising now under joint ownership is not a settlement. Neither is that the case with a civil law dismemberment.
In Marisa Lincoln v The Commissioners for HMRC [2024] UKFTT 886 (TC), the FTT has already pointed out in dismissing a taxpayer’s contention that there was a continuing settlement, that any trust inherent in joint ownership, whether that be under the LPA as amended or TOLATA does not create a settlement under s.43(2) ITA 1984.
“[59]. Settled property
59. For the reasons below, we do not accept the foreign properties were settled property. While we accept HMRC’s argument that there was no trust under Maltese law (below at [60] to [66]), we differ from HMRC in finding that there would have been a trust under UK law (below at [67] to [68]). However, such a trust would not be one that met the definition of settlement (below at [69] and [70]). Neither was the foreign property charged or burdened in a way that would create a settlement (below at [71] to [75]).”
However, that judgment did not address whether the assimilation of a foreign estate in land to an equitable interest or estate could be assimilated to a settlement. It cannot be as the usufruit as a matter of law extinguishes on death with no element of succession.
The nu-propriétaire accedes to the property as a matter of law and entitlement, not by way of succession, in the same manner as the Fiar in a Scottish Proper Liferent accedes to the full fee on the decease of the Proper Liferenter as the only person entitled.
Accession to property excludes succession. S.43 (2) ITA is expressly limited to dispositions, not to devolution. As the House of Lords held in Philipson-Stow the terms disposition and devolution are mutually exclusive.
Those cases relate to land and HMRC’s pretentions rely upon the distinction between equitable estates and interests and legal estates and interests laid down in relation to English land and a false assumption that where there is an equitable estate there must be a trust leading to a settlement.
That is not the case.
What has apparently eluded most commentators is that that principle, even were it valid, can only apply to land as defined in England.
It does not apply without violence to land outside the English jurisdiction.
The definition of land and legal equitable estates in s. 205 (ix) and (x) LPA 1925 is purely related to English land, not foreign immovable property rights. The application of that definition is excluded by reference to the conflict of laws and principles of private international law in relation to foreign land and immovable interests or estates in rem. Those rules and principles necessarily form part of the law of any part of the United Kingdom to which s.43(2) ITA refers.
What is also clear is that s.43(2) ITA 1984 refers only to “dispositions”, as opposed to devolution. If and where there is no disposition but a devolution, as frequently arises in a French succession involving a usufruit to the surviving spouse and the nue-propriété to issue as a result of the provisions of the Code civil, there is no disposition in the strict sense of the term.
That the terms disposition and devolution are mutually exclusive was confirmed by Viscount Simmonds in the case of Philipson-Stow [1961] AC 728 at page 742 and also by Lord Denning at page 759 in the following terms:
My Lords, it is clear to my mind that when section 28 (2) speaks of the " devolution " of property, it means a devolution by operation of law, such as heirship or kinship. When it speaks of a "disposition," it means a disposition by instrument, such as a will. And when it speaks of "the disposition under or by reason of which "property passes, it means the particular devise or bequest under which it passes.
The distinction is clear, and has not changed since the judgment in 1961.
S.43(2) ITA 1984 defines a settlement as follows:
“Settlement” means any disposition or dispositions of property, whether effected by instrument, by parol or by operation of law, or partly in one way and partly in another, whereby the property is for the time being:…
It remains unclear whether the term “disposition” now includes a devolution, but it should not. If the deceased has made no disposition by will as is frequently the case, it appears that there is no ‘settlement’ of French land possible under the Code civil which inescapably governs French land as the lex situs.
The term employed in the French Code civil is dévolue to indicate that unless there is a gift or other lifetime or testamentary disposition, the succession devolves in the same sense as in England. The term operation of law can only apply as operative ancillary to a disposition. It does not reach a pure devolution.
As to other assets than land.
After sharp exchanges, HMRC finally abandoned contending that a usufructuary dismemberment of parts (shares) in a French SCI which are movable assets could constitute a settlement and were forced to grant a tax credit to the executors of the deceased English domiciliary for the French succession duty paid.
This French duty was assessed on the reduced value of a successive usufruit over a portion of those shares which passed from the deceased usufruitier to a surviving child, the nue-propriété remaining in the nu-propriétaire. That value was determined by the French statutory table for valuing usufruits. The Treasury Solicitor therefore drew the line at attempting to assert some form of overarching general virtual settlement outside the scope of the somewhat illusory attempt to equate foreign land to English land under s.1(1) LPA 1925.
So, one can conclude that the supposed treatment of usufructuary dismemberments as settlements is restricted to land, not to movables. It also does not apply to foreign land which devolves independently of a lifetime or a testamentary disposition under the foreign law. Finally, HMRC have accepted in one case that a lifetime gift of nue-propriété over French land was a Potentially Exempt Transfer after the expiration of seven years and that the usufruit retained by the deceased extinguished on death at a negligeable value.
That position is a far cry from their assertion that they have only accepted my position where there was little difference in the IHT yield between my position and the HMRC position taken in the Manual.
In short, taking the legal perspective, there is no settlement where there is no trust and no reason to accept to go under the yoke of convenience presented by the HMRC Manuals as instituting Relevant Property settlement - all the more so where there is a devolution and no disposition under the Code civil.
This is guidance and information, not advice. Please consult me for advice on any particular circumstances and facts.
Peter Harris.
7th April, 2025