Inheritance tax - Anti-avoidance provisions

Learning Outcomes

This article explains the anti-avoidance provisions relevant to Inheritance Tax (IHT) in England and Wales, focusing on the General Anti-Abuse Rule (GAAR), the Gifts with Reservation of Benefit (GWR) rules, Business Property Relief (BPR) restrictions, and targeted rules on restricted deduction of liabilities. It examines how GAAR operates, including the double reasonableness test, the role of the GAAR Advisory Panel, and HMRC’s power to make just and reasonable counteractions where arrangements are considered abusive. It explores the Ramsay purposive approach to statutory interpretation in tax cases and how courts analyse pre-ordained schemes designed to avoid IHT. It details the operation of GWR and POAT in common lifetime planning structures, including gifts of homes, chattels, and trust arrangements, highlighting when continued enjoyment creates a reservation of benefit. It reviews the anti-avoidance limits on BPR, such as excepted assets, binding contracts for sale, associated operations, surplus cash within trading companies, and replacement property rules. It presents practical exam-focused guidance on identifying red flags in problem questions, distinguishing robust relief claims from contrived avoidance, and applying the statutory and case-law principles to typical SQE1-style fact patterns.

SQE1 Syllabus

For SQE1, you are required to understand the anti-avoidance provisions that apply to Inheritance Tax, with a focus on the following syllabus points:

• The scope and application of the General Anti-Abuse Rule (GAAR) to IHT arrangements
• The qualifying conditions and anti-avoidance restrictions for Business Property Relief (BPR)
• The operation and effect of Gifts with Reservation of Benefit (GWR) rules
• The interaction between anti-avoidance provisions and estate planning
• The impact of recent case law and legislative developments on IHT anti-avoidance
• The Ramsay principles of purposive statutory interpretation in tax cases
• Restricted deduction of liabilities on death, particularly where debts fund excluded property or relief-qualifying assets
• The POAT income tax charge as a backstop to GWR planning

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the purpose of the General Anti-Abuse Rule (GAAR) in relation to Inheritance Tax?
2. How do the Gifts with Reservation of Benefit (GWR) rules affect the IHT treatment of lifetime gifts?
3. Name two anti-avoidance restrictions that can prevent Business Property Relief (BPR) from applying.
4. True or false? Paying full market rent after gifting a property can avoid the GWR rules.

Introduction

Inheritance Tax (IHT) anti-avoidance provisions are designed to prevent individuals from using artificial arrangements to reduce or eliminate their IHT liability. These rules ensure that tax is charged as intended by Parliament and that reliefs, such as Business Property Relief (BPR), are not abused. The main statutory mechanisms include the General Anti-Abuse Rule (GAAR), the Gifts with Reservation of Benefit (GWR) rules, and specific anti-avoidance restrictions within the BPR regime. In addition, there are targeted measures across IHT designed to counter particular forms of planning, such as the restricted deduction of liabilities (to stop estate debts being used to inflate deductions) and valuation/aggregation rules that look through coordinated series of transactions.

Historically, tax planning often relied on the formal legal effect of transactions even where their commercial substance was to obtain a tax advantage. Modern IHT now operates alongside purposive techniques adopted in case law to interpret tax statutes, and with GAAR as an overarching statutory deterrent to abusive arrangements.

Key Term: Ramsay principle
The modern purposive approach in tax law, derived from case law, under which courts look at the overall effect of pre‑ordained transactions and interpret tax legislation to counter artificial schemes.

The General Anti-Abuse Rule (GAAR)

GAAR is a statutory rule that allows HMRC to counteract tax advantages arising from arrangements that are considered abusive. It applies to a range of taxes, including IHT.

Key Term: General Anti-Abuse Rule (GAAR)
A statutory rule enabling HMRC to deny tax advantages from arrangements that cannot reasonably be regarded as a reasonable course of action, targeting abusive tax avoidance.

GAAR applies where arrangements are entered into with the main purpose, or one of the main purposes, of obtaining a tax advantage, and the arrangements are abusive. The test is whether the arrangement cannot reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions. GAAR sits above specific IHT rules and takes priority over other legislation; HMRC may make a counteraction that is just and reasonable in the circumstances to neutralise the advantage. While GAAR does not itself create a penalty, other regimes may impose penalties for failing to pay tax due following counteraction, and separate “enablers of tax avoidance” provisions can sanction those who market or implement abusive schemes.

Key Term: Abusive tax avoidance arrangement
An arrangement that cannot reasonably be regarded as a reasonable course of action having regard to all the circumstances of the relevant tax provisions.

The Double Reasonableness Test

The GAAR uses a "double reasonableness" test: would a reasonable person consider that the arrangement cannot reasonably be regarded as a reasonable course of action? If so, HMRC may counteract the tax advantage.

Key Term: Double Reasonableness Test
The test under GAAR that asks whether an arrangement cannot reasonably be regarded as a reasonable course of action, judged objectively.

This test is applied to the full facts, including the commercial reality, and is informed by purposive interpretation. It aims to distinguish robust but legitimate tax planning from contrived arrangements that exploit legislative gaps. In IHT, examples include gifting assets into structures that purportedly remove them from the estate while retaining control or enjoyment through unusual rights or circular payments.

GAAR Advisory Panel

Before counteracting an arrangement under GAAR, HMRC must seek the opinion of the GAAR Advisory Panel, which issues a non-binding opinion on whether the arrangement is abusive. The panel’s view is influential and often referenced if matters proceed to tribunal.

Key Term: GAAR Advisory Panel
An independent panel that provides opinions on whether arrangements are abusive under GAAR, guiding HMRC's application of the rule.

Where GAAR is engaged, HMRC will notify the taxpayer, invite representations, and, if necessary, adjust the tax position on a just and reasonable basis. Taxpayers may appeal to the tax tribunal after HMRC issues counteraction, and professional enablers of abusive arrangements may face sanctions under separate legislation.

Practical Example

Worked Example 1.1

A transfers assets into a trust but retains the power to benefit from the trust income. HMRC reviews the arrangement and considers whether it is abusive under GAAR.

Answer:
If the main purpose is to avoid IHT and the arrangement cannot reasonably be regarded as a reasonable use of the legislation, HMRC may apply GAAR to deny the tax advantage. The trust’s terms and A’s reserved rights would be examined to see if they amount to an abusive reservation of benefit dressed up as a gift.

Gifts with Reservation of Benefit (GWR)

The GWR rules prevent individuals from making gifts but continuing to benefit from the gifted property, thereby removing it from their estate for IHT purposes while still enjoying its use.

Key Term: Gift with Reservation of Benefit (GWR)
A gift where the donor retains some benefit or enjoyment of the property, causing the asset to remain part of their estate for IHT.

If a person gives away an asset but continues to use or benefit from it (e.g., gifting a house but living in it rent-free), the asset is treated as remaining in their estate for IHT. A reservation exists if, at or after the gift, the donor continues to enjoy possession or benefit, or arrangements are made that effectively allow the donor to benefit. The rules apply both to direct gifts and to transfers into trusts, and they operate even where the gift would otherwise be a potentially exempt transfer (PET).

The consequences of a GWR are significant: on the donor’s death, the property subject to the reservation is treated as part of the donor’s estate and charged to IHT at its death value. If the reservation is fully given up at least seven years before death, the gift becomes a PET at the date the reservation ceases; dying within seven years then brings the PET back into charge.

Avoiding GWR

A GWR can be avoided if the donor pays full market rent for continued use of the asset after the gift and genuinely ceases to enjoy any benefit beyond what a third party would enjoy under a comparable arm’s‑length arrangement. For land, this means the donor must pay a full market rent regularly, funded from their own resources (not circular payments), and the rent should be reviewed and adjusted as market levels change. Any benefit retained that is more than incidental (such as continued occupation at below-market rent, use of chattels with more than token frequency, or control rights enabling use) risks a reservation.

Exam Warning

If the donor pays less than full market rent for continued use, the GWR rules will still apply. Only full market rent, paid regularly, will prevent the reservation of benefit. Circular funding (e.g., the donee paying the donor back for rent via arrangements linked to the original gift) can also undermine the effectiveness of the rent.

The interaction of GWR with other anti-avoidance rules should be remembered. HMRC may use GAAR if an arrangement is engineered solely to create the appearance of full consideration while effectively preserving enjoyment (for example, where rent is funded by a tax-motivated circular flow of cash). There is also a separate backstop regime under the income tax code:

Key Term: Pre‑Owned Assets Tax (POAT)
An income tax charge that applies where a person enjoys the use of property they previously owned (or funded) after arrangements intended to avoid IHT/GWR; POAT can be elected out of if the arrangement is treated as a GWR.

POAT may apply if someone avoids a GWR by complex arrangements but continues to benefit. If POAT applies, the individual may elect to be treated as having reserved a benefit for IHT (bringing the asset back into the estate) to avoid the ongoing income tax charge, which illustrates the policy of closing down schemes designed to sidestep GWR.

Worked Example 1.2

B gifts her home to her daughter but continues to live there without paying rent. On B's death, is the house excluded from her estate for IHT?

Answer:
No. The house is treated as part of B's estate under the GWR rules, as she retained a benefit.

Worked Example 1.3

D gifts a painting worth £200,000 to his son but leaves it hanging in his own living room and allows public exhibitions to credit him as its patron. He displays it for most of the year.

Answer:
This is a reservation of benefit. The painting is treated as remaining in D’s estate for IHT on death unless the reservation ceases and D survives seven years.

Worked Example 1.4

E gifts her home to a trust for her grandchildren. She pays rent equal to local market rates and funds it from her pension. The trustees review the rent annually and there are no side arrangements to return rent to E.

Answer:
Provided the rent is full market rent and genuinely borne by E, GWR can be avoided. If the rent falls below market levels or is funded by circular arrangements, the reservation risk re-emerges. POAT would not apply if the rent is genuinely full.

Business Property Relief (BPR) – Anti-Avoidance Restrictions

BPR is a relief that reduces or eliminates IHT on transfers of qualifying business assets. However, anti-avoidance provisions restrict relief in certain situations.

Key Term: Business Property Relief (BPR)
A relief from IHT for transfers of qualifying business assets, subject to strict conditions and anti-avoidance rules.

Qualifying Conditions

To claim BPR, the business must be a trading business (not mainly investment), and the asset must have been owned for at least two years before transfer. Unquoted shares in trading companies and interests in a trading partnership or sole trade typically qualify, often at 100%; controlling holdings in quoted trading companies may qualify at a lower rate. The “wholly or mainly” trading test is assessed across indicators such as the nature of activities, turnover, asset base, profits, and management time.

Anti-Avoidance Restrictions

Key anti-avoidance provisions include:

• Excepted Assets: No BPR is available for assets not used wholly or mainly for business purposes in the two years before transfer.
• Binding Contracts for Sale: If there is a binding contract to sell the business at the time of death or transfer, BPR is denied.
• Associated Operations: Transactions designed to artificially secure BPR are disregarded.

Key Term: Excepted Asset
An asset owned by a business but not used for business purposes in the two years before transfer, excluded from BPR.

Key Term: Associated Operations
A series of transactions or operations that are connected and intended to achieve a particular effect; for IHT these can be aggregated, and artificial steps to secure relief may be disregarded.

These restrictions target common planning devices:

• Parking surplus cash and investment portfolios within a trading company to increase the value eligible for BPR; the cash or investments may be excepted assets and carved out.
• Pre-arranging a sale of shares with put/call options or binding sale contracts that crystallise just before or at death; a binding contract at death denies BPR.
• Restructuring within two years solely to meet BPR conditions; associated operations may be examined to identify artificiality.

A further theme is the two-year ownership condition and replacement property. Relief can continue across replacement assets if the replacement is within the regime and the aggregate ownership period is at least two years, but anti‑avoidance principles still apply: if replacement assets include excepted assets or are structured via associated operations to meet the time requirement without genuine business use, relief may be denied.

Worked Example 1.5

F owns 30% of a trading company and dies. The company holds £1.5m cash from a recent property sale that is earmarked for future expansion but has sat unused for over two years.

Answer:
The portion of share value attributable to cash not used wholly or mainly for business purposes in the two years before death is an excepted asset. BPR is denied on that element; the remainder may still qualify.

Worked Example 1.6

G enters into a contract to sell his business interests with completion scheduled six months after his death under a buy-sell agreement.

Answer:
If the agreement is a binding contract for sale in existence at death, BPR is denied. Whether the contract is binding turns on its terms; a mere option may not be binding, but a firm obligation to buy/sell generally is.

Other Targeted IHT Anti-Avoidance Rules: Restricted Deduction of Liabilities

Beyond GWR and BPR, IHT employs targeted rules to prevent debt-based avoidance that inflates deductions from the estate.

Key Term: Restricted deduction of liabilities
Rules limiting the deduction of debts from the estate for IHT where liabilities are linked to acquiring excluded property or assets qualifying for relief (e.g., BPR/APR), or where debts are not realistically expected to be repaid.

In particular:

• Debts used to acquire excluded property (e.g., certain non‑UK assets held by non‑domiciled individuals) or to finance arrangements intended to secure relief cannot reduce the estate’s taxable value beyond the value they actually reduce of the asset concerned.
• Liabilities are only deductible if they are genuinely enforceable and expected to be repaid; artificial or circular debts, or those designed solely to secure a deduction without economic substance, may be restricted.
• Where a debt is matched to an asset qualifying for relief (e.g., BPR), the deduction is restricted so that the net relief reflects the actual value at risk.

These provisions work alongside GAAR and the Ramsay approach to counter debt planning intended to manufacture IHT deductions without corresponding economic burdens.

Worked Example 1.7

H borrows £2m and uses it to acquire shares in her trading company two months before death, expecting BPR. The borrowing is interest‑only and unlikely to be repaid from the estate.

Answer:
The liability deduction is restricted. If the debt funds a relief‑qualifying asset (BPR), the deduction cannot be used to create an artificial IHT advantage; HMRC may match the debt to the asset and limit any deduction to the actual net value at risk, or deny the deduction if repayment is unrealistic.

Interaction with Valuation and Aggregation Rules

While not labelled “anti‑avoidance”, valuation and aggregation provisions in IHT operate to prevent manipulative steps designed to depress taxable value. Where property is “related” in terms of ownership (for example, shares held by spouses/civil partners whose combined holdings command a higher value), the rules can increase the value of holdings to reflect the reality of control or marketability.

Key Term: Related property
Property whose value is affected by other property held by the same person or connected persons (e.g., spouses/civil partners), such that combined holdings increase value; IHT valuation aggregates related property to prevent fragmentation reducing value.

The related property rule can counter splitting shareholdings between connected persons to reduce value bands or to avoid control premiums being reflected in valuation. Combined interests may be valued on a higher basis than isolated holdings.

Summary

Key Point Checklist

This article has covered the following key knowledge points:

• The General Anti-Abuse Rule (GAAR) applies to abusive IHT avoidance arrangements, using a double reasonableness test.
• GAAR takes priority over other tax legislation, and HMRC can make a just and reasonable counteraction.
• Gifts with Reservation of Benefit (GWR) rules keep assets in the estate for IHT if the donor retains a benefit, including by circular arrangements.
• Paying full market rent after a gift can prevent GWR, but only if the rent is actually paid at market levels from the donor’s own resources and reviewed regularly.
• POAT operates as a backstop to arrangements that seek to sidestep GWR; a POAT election can bring the asset back into GWR to avoid income tax.
• Business Property Relief (BPR) is denied for excepted assets, binding sale contracts, and artificial arrangements, with associated operations examined to detect contrivance.
• Surplus cash and investment portfolios held within a trading company may be excepted assets if not used wholly or mainly for the business in the prior two years.
• Restricted deduction of liabilities limits the use of borrowings to reduce IHT where debts fund excluded property or relief-qualifying assets or are not genuinely repayable.
• Valuation rules on related property can aggregate interests to counter attempts to fragment holdings to depress value.
• Always check for anti-avoidance restrictions before advising on IHT reliefs, and consider GAAR and the Ramsay approach when appraising unusual or contrived structures.

Key Terms and Concepts

• General Anti-Abuse Rule (GAAR)
• Abusive tax avoidance arrangement
• Double Reasonableness Test
• GAAR Advisory Panel
• Ramsay principle
• Gift with Reservation of Benefit (GWR)
• Pre‑Owned Assets Tax (POAT)
• Business Property Relief (BPR)
• Excepted Asset
• Associated Operations
• Restricted deduction of liabilities
• Related property