Hood v HM Revenue and Customs

Factual and Procedural Background

The appeal concerns 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" under section 102 of the Finance Act 1986 ("FA 1986") at the time of her death in 2008. The sub-lease was to fall into possession some four years after her death. If the sub-lease was property subject to a reservation, it formed part of her estate chargeable to inheritance tax ("IHT"). If not, it escaped IHT because it was a potentially exempt transfer ("PET") survived by more than seven years.

The taxpayer, the executor of the late Lady Hood, held the head lease of the property from 1979 until 2076. The sub-lease was granted to her three sons for the term from 2012 to 2076. The sons assumed possession and enjoyment bona fide at the grant in 1997, though the term was reversionary. The issue centered on whether the sons' covenants in the sub-lease, obliging them to observe the head lease provisions, constituted a benefit by contract to the taxpayer, thereby creating a reservation of benefit under section 102(1)(b).

HM Revenue and Customs ("HMRC") issued IHT determinations against two of the sons, asserting liability if the sub-lease was property subject to a reservation. The appeal was dismissed by the First-tier Tribunal ("FTT") and the Upper Tribunal ("UT"). Permission to appeal to this Court was granted to address important points of law arising from the recent authority Buzzoni v Revenue and Customs Commissioners.

Legal Issues Presented

1. Whether the reversionary sub-lease granted by the taxpayer to her sons was "property subject to a reservation" within the meaning of section 102 of the Finance Act 1986 at the time of her death.
2. Whether the sons' covenants in the sub-lease constituted a benefit to the taxpayer by contract or otherwise, thus preventing the exclusion of any benefit to the donor under section 102(1)(b).
3. How to properly identify the "property" given by way of gift for the purposes of section 102, particularly whether the covenants form part of the gift or represent a reserved benefit.

Arguments of the Parties

Appellant's Arguments

• The donated property is the sub-leasehold estate subject to the sons' covenants, which were integral and "imprinted" on the sub-lease from inception.
• The covenants did not represent a separate benefit reserved by the taxpayer but formed part of the gift itself.
• The Upper Tribunal erred by focusing on the retained property rather than the gifted property, leading to a misapplication of the law.
• The sons had exclusive possession and enjoyment of the sub-lease, including the covenants, so the second limb of section 102(1)(b) was not satisfied.
• Land law principles, including the doctrine that covenants run with the land, support the view that the covenants are part of the gifted property and not a separate reserved benefit.

Respondent's (HMRC) Arguments

• The sons' covenants to observe and perform the head lease provisions constituted a benefit by contract to the taxpayer, newly created by the sub-lease.
• This benefit was of substantial value and had no prior existence before the sub-lease was granted.
• Therefore, the sub-lease was enjoyed by the sons subject to a benefit to the donor, satisfying the second limb of section 102(1)(b), making it property subject to a reservation.
• The absence of separate covenants with the head lessor by the sons distinguished this case from Buzzoni, where the covenants did not add to the donees' obligations.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Buzzoni v Revenue and Customs Commissioners [2013] EWCA Civ 1684	Consideration of whether covenants in a sub-lease constitute a reservation of benefit under section 102(1)(b).	Distinguished on facts; covenants in present case formed part of the gift, unlike Buzzoni where covenants duplicated prior obligations.
Ingram v IRC [2000] 1 AC 293	Policy and interpretation of section 102; distinction between benefit derived from the gifted property and retained proprietary interest.	Supported the view that additional covenants conferring new benefits to donor amount to reservation of benefit.
Grey v Attorney-General [1900] AC 124	Benefit reserved to donor, such as rent-charge and covenants, causes estate duty liability.	Illustrated that extensive covenants reserved to donor constitute reservation of benefit.
Commissioner for Stamp Duties of New South Wales v Perpetual Trustee Company Ltd [1943] AC 425	Identification of property subject to gift and whether donor retained benefit inconsistent with exclusion.	Confirmed that retention of some beneficial interest outside the gift does not invalidate entire exclusion of donor from gifted property.
St Aubyn v Attorney-General [1952] AC 15	Whether life tenant retained benefit after surrendering interest; focus on whether donor reserved a benefit by contract or otherwise.	Held no reservation of benefit where donor surrendered life interest without additional reserved benefits.
In re Nichols, deceased [1975] 1 WLR 534	Effect of covenants in lease-back on reservation of benefit under estate duty provisions.	Confirmed that positive covenants conferring benefit to donor constituted reservation of benefit.
Attorney-General v Worrall [1895] 1 QB 99	Contractual benefit may interfere with exclusive possession and enjoyment under reservation provisions.	Supported that contractual benefits reserved to donor can constitute reservation of benefit.
City of London Corporation v Fell [1993] QB 589	Principles of covenants running with the land and privity of estate and contract.	Clarified that covenants may be imprinted on the estate but this does not decide reservation of benefit under tax law.

Court's Reasoning and Analysis

The Court began by emphasizing the necessity of identifying the true subject matter of the gift under section 102, concluding it to be the sub-leasehold estate as a whole, including the mutual covenants given by the sons. The Court rejected any artificial distinction between the legal estate and the covenants, recognizing that neither would exist independently.

Attention was then focused on the second limb of section 102(1)(b), which requires that the donee's enjoyment of the property be to the entire exclusion, or virtually to the entire exclusion, of any benefit to the donor by contract or otherwise. The Court held that the benefit to the donor here was the positive covenants given by the sons, which had no prior existence before the sub-lease was granted and would enure for the donor's benefit upon the sub-lease falling into possession.

The Court reasoned that the benefit was substantial and newly created, thus constituting a reservation of benefit under section 102(1)(b). It rejected the appellant’s argument that the covenants formed an integral part of the gift and therefore did not constitute a reservation, distinguishing this from cases like Buzzoni where covenants duplicated existing obligations to the head lessor.

The Court acknowledged the relevance of land law principles regarding covenants running with the land but concluded that these principles do not determine whether a reservation of benefit exists for IHT purposes under section 102. The key inquiry is whether the donor retains a contractual benefit that impacts the exclusivity of the donee's enjoyment.

Precedents such as In re Nichols and Ingram were applied to affirm that positive covenants conferring new benefits on the donor are sufficient to establish a reservation. The Court noted that the benefit's lack of prior existence is critical, distinguishing the present case from situations where benefits retained by the donor pre-existed or were carved out of the gift.

The Court also rejected the appellant’s reliance on policy or hypothetical consequences, emphasizing that the issue must be resolved by reference to the statutory provisions and established case law.

Holding and Implications

The Court DISMISSED THE APPEAL, holding that the reversionary sub-lease granted by the taxpayer to her sons was property subject to a reservation within the meaning of section 102 of the Finance Act 1986 at the time of her death. The sons' covenants constituted a benefit by contract to the taxpayer, newly created and substantial, thus satisfying the second limb of section 102(1)(b).

The direct consequence is that the sub-lease forms part of the taxpayer's estate for inheritance tax purposes. The decision does not establish any new precedent but confirms the application of established legal principles to the facts, particularly the importance of identifying the property gifted and recognizing when covenants confer a reserved benefit to the donor.