Hood v HM Revenue and Customs, Court of Appeal - Civil Division, October 30, 2018, [2018] EWCA Civ 2405

Resolution Date:October 30, 2018
Issuing Organization:Civil Division
Actores:Hood v HM Revenue and Customs

Neutral Citation Number: [2018] EWCA Civ 2405

Case No: A3/2017/2672



[2017] UKUT 0276 (TCC)

Royal Courts of Justice

Strand, London, WC2A 2LL

Date: 30/10/2018

Before :





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Mr Simon Taube QC (instructed by Penningtons Manches LLP) for the Appellant

Mr Jonathan Davey QC (instructed by the General Solicitor and Counsel to HMRC) for the Respondents

Hearing dates:19 June and 12 July 2018

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Approved Judgment

Lord Justice Henderson:

Introduction and Background 1. The question on this appeal is whether a reversionary long sub-lease of a valuable London residential property, granted on favourable terms by the taxpayer to her three sons in 1997, was ``property subject to a reservation'' within the meaning of section 102 of the Finance Act 1986 (``FA 1986'') when she died in 2008, as it happens some four years before the sub-lease would have fallen into possession. If the sub-lease was property subject to a reservation in the taxpayer's estate, it formed part of her estate chargeable to inheritance tax (``IHT'') on her death. If, on the other hand, the sub-lease was not property subject to a reservation in her estate, it escaped any charge to IHT on her death, because (a) it was not deemed by section 102 to remain part of her estate immediately before her death, and (b) the original grant of the sub-lease was a potentially exempt transfer (``PET'') which she had survived by more than seven years, and which consequently became an exempt transfer.

  1. The key provisions in section 102 of FA 1986 read as follows:

    ``102. Gifts with reservation.

    (1) Subject to subsections (5) and (6) below [which in the present case are agreed to be immaterial], 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 [i.e. the Inheritance Tax Act 1984] 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.''

  2. It is common ground that the grant of the sub-lease by the taxpayer was a disposition of property by way of gift made by an individual within the meaning of section 102(1). Further, the Commissioners for Her Majesty's Revenue and Customs (``HMRC'') have throughout accepted that possession and enjoyment of the sub-lease was bona fide assumed by the taxpayer's sons on the date when it was granted in 1997, even though the reversionary term was not due to commence until 25 March 2012, from when it would run until 22 December 2076, three days before the expiry of the taxpayer's own head lease of the property. Accordingly, there is no dispute that the condition in paragraph (a) of subsection (1) was not satisfied.

  3. It is also common ground that the sub-lease (albeit reversionary) was enjoyed by the sons ``to the entire exclusion, or virtually to the entire exclusion'' of the taxpayer, within the meaning of the first limb of the alternative condition in paragraph (b) of section 102(1). The case therefore turns on the second limb of paragraph (b), which poses the question whether the sons' enjoyment of the sub-lease was ``to the exclusion, or virtually to the entire exclusion, ... of any benefit [to the donor] by contract or otherwise''. HMRC's argument, in simple terms, is that this further test was not satisfied, because the sons entered into a direct covenant with their mother in the sub-lease to observe and perform the provisions in the head lease as if they had been repeated in full (subject to any necessary modifications) in the sub-lease. The benefit of this covenant, say HMRC, was a benefit by contract to the taxpayer which had no prior existence before the sub-lease was granted, and which was of substantial value to her (or, after her death, to her estate). If that is right, it follows that the requirements of paragraph (b) were satisfied throughout the relevant period, with the consequence that the sub-lease was property subject to a reservation in the taxpayer's estate.

  4. The counter-argument for the taxpayer, again much simplified, is that the covenants given by the sons in the sub-lease formed an integral part of the gift made by the taxpayer in 1997, and cannot be divorced from it. Once it is appreciated that the true subject-matter of the gift made by her was an interest in land which from its inception was subject to the sons' covenants, or had those covenants ``imprinted'' upon it, it can be seen that the sub-lease was indeed enjoyed to the entire exclusion of any benefit, whether by contract or otherwise, to the taxpayer. The covenants were part and parcel of the gift itself.

  5. The taxpayer is the executor of the late Diana Maud, Viscountess Hood (``Lady Hood''), who died on 15 March 2008, at the age of 88. Her London home was at 67 and 67A Chelsea Square, SW3 (``the Property''). The Property formed part of the Cadogan Estate, and was held by her under a lease dated 21 September 1979 for a term of 97 and three-quarter years from 25 March 1979, and so was due to expire on 25 December 2076. This was the head lease to which I have referred. The rent was a ground rent, subject to review every ten years. The lease contained tenant's covenants of a usual nature to repair, maintain and keep the demised premises in good and substantial repair and condition throughout the term, to paint the exterior of the Property every three years, and to redecorate the interior every seven years. The tenant was also obliged to keep the Property fully insured in the joint names of Cadogan Holdings Company (``the Company'') and the lessee. These were the main positive covenants upon which HMRC rely in support of their argument that the covenants to observe and perform them given by Lady Hood's sons in the sub-lease constituted a benefit by contract to Lady Hood for the purposes of section 102(1)(b).

  6. The lease also contained covenants against alienation of a usual nature, including a covenant prohibiting the underletting of the Property as a whole without the previous consent in writing of the Company, such consent not to be unreasonably withheld. By a licence to underlet dated 7 June 1997, the Company granted permission to Lady Hood to underlet the Property to her three sons, Henry, John and James ``for a term from 25 March 2012 to 22 December 2076 at the then current Headlease rent as revised from time to time''. The licence did not itself refer to the other terms of the sub-lease, but a draft of it was supplied to the Company in support of the application for permission to sub-let, in the form in which it was subsequently executed. The Company acted as agent for the head lessor, Viscount Chelsea, and for The Chelsea Land & Investment Company Limited, which together with the Company was also a party to the head lease.

  7. The sub-letting of the Property was clearly an exercise in tax planning, performed on professional advice, with the object of substantially reducing the value of Lady Hood's leasehold interest in the Property on her future death, but without falling foul of the ``gifts with reservation'' provisions in section 102 of FA 1986. The exercise was carried out as a matter of some urgency, because of fears of legislative counter-action. In the event, however, Parliament did not legislate to counter schemes of the present type until 1999: see sections 102A to 102C of FA 1986, which were added by section 104 of the Finance Act 1999 and applied to disposals by an individual of an interest in land by way of gift on or after 9 March 1999.

  8. The sub-lease was dated 19 June 1997, and made between Lady Hood (defined as ``the Landlord'') and her three sons (defined as ``the Tenant''). It was expressed to be supplemental to the head lease, and recited the wish of the Landlord to grant to the Tenant an underlease of the Property for the residue of the term granted by the head lease, less three days. The operative clause then demised the Property to the Tenant accordingly, for a yearly rent equal to that reserved by the head lease, as revised from time to time. Clauses 4 and 5 then provided as follows:

    ``4. Terms of Lease

    4.1 This lease is made upon the same terms and subject to the same covenants provisos and conditions as are contained in the Head Lease (``the...

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