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There are special rules for valuing property that is included in an estate if there is other property that is 鈥榬elated鈥� to it, s.161 IHTA 1984. The rules apply in situations where valuing the property together with the related property produces a higher value than by valuing the property on its own.

Broadly speaking, related property is property that

• in the estate of a spouse/civil partner, or
• comprises, or has comprised within the preceding five years, property donated by either spouse or civil partner to a charity, charitable trust or to one of the political, national or public bodies to which exempt transfers may be made

The rules apply to both lifetime transfers and transfers on death.

HMRC will decide what property is to be regarded as related property.

Related property provisions apply for IHT purposes only. There are no similar provisions in CGT legislation.

The rule is intended to prevent the reduction in value, for IHT purposes, of property by fragmentation of ownership, aimed at passing the family estate within the family at minimum charge to IHT. The fact that transfers between spouses or civil partners are exempt from IHT would enable the prior fragmentation of the estate between spouses or civil partners to take place at no cost in IHT. Controlling shareholdings could be split into minority holdings, farms into isolated fields, buildings or building plots severed from essential access etc. The application of the rule has the effect of recombining the spouses鈥� or civil partners鈥� ownerships for valuation purposes.

The rule does not apply if the value arrived at by s.161 IHTA 1984 apportionment is equal to or less than the value of the transferor鈥檚 property on its own. In other words, the rule does not apply if the transferor鈥檚 property would not realise a better price by being sold with the related property.

The value to be included in the deceased/transferor鈥檚 estate is the 鈥榓ppropriate portion鈥� of the value of the aggregate of the transferors and related property.

This is a two-step process:

1. Establishing the enhanced value of the aggregate of the transferor鈥檚 property and the related property (see para 15.5).

2. Calculation of the appropriate proportion (see para 15.6).

The first step is to value the property in the transferor鈥檚 estate together with the related property (the aggregate referred to in s.161(1) IHTA 1984). For this purpose the VOA should value both interests together, as if already merged, and make no reduction in the aggregate value because the related property is owned by the spouse or civil partner and not by the transferor. If vacant possession would become available on the merging of the interests the property should be valued with vacant possession. In all cases the aggregate value should reflect the full enhancement attributable to the merging of the transferor鈥檚 property with the related property and no deduction should be made because more than one ownership is involved.

The next step is to arrive at the 鈥渁ppropriate portion鈥� of the enhanced aggregate value referred to in para 15.5 above, which is to be attributed to the transferor鈥檚 property.

There are two methods of calculating the appropriate portion:

• the 鈥榞eneral rule鈥�, s.161 (3) IHTA 1984 (see para 15.7)
• the 鈥榮pecial rule鈥�, s.161 (4) IHTA 1984 (see para 15.10)

The general rule is used where the items of property being aggregated for valuation purposes are different, such as freehold and leasehold interests in the same piece of land, or for example if the related property comprises adjacent parcels of land owned and the relationship between the two parcels of land 鈥� one has no access without the other 鈥� they together make a more valuable natural unit.

The special rule is mainly used for calculating the value of shareholdings, but also applies to undivided shares in property.

For disparate or unequal items of property the 鈥渁ppropriate portion鈥� is determined in accordance with s.161(3) IHTA 1984 by applying the :

Where;

A = the enhanced value of the aggregate of the transferor鈥檚 property and the related property, the aggregate being valued in accordance with para. 15.5,

T = the value of the transferor鈥檚 property, and

R = the value of the related property

Both T and R are valued separately as if each property did not form part of the aggregate (see para.15.8).

HMRC will calculate the appropriate portion based on the VOA鈥檚 valuations for T, R and A.

Where related property consists of a separate estate or interest in the transferor鈥檚 property (eg a freehold reversion, a leasehold or a tenancy) the principles set out in para 15.5 apply. For example, if a transferor had leased freehold premises to a spouse or civil partner the聽lease聽would be regarded as having merged with the ownership of the freehold and the s.161(1) IHTA 1984 aggregate value would be the freehold vacant possession value of the premises.

However in order to arrive at the appropriate portion under s.161(3) IHTA 1984 the value of the aggregate, the transferor鈥檚 freehold should be valued subject to the聽lease. Similarly, the spouse鈥檚 or civil partner鈥檚 leasehold interest would be valued separately. In valuing both the freehold reversion and the聽lease聽as if it did not form part of the aggregate under s.161(3) IHTA 1984 consideration should be given to the possibility that either the freeholder or leaseholder would be in the market as a special purchaser of the other interest in order to merge the interests and thus obtain vacant possession.

A house stands in 10 acres of parkland, which together are valued at 拢1,500,000. The transferor owns the house, whilst her spouse owns the surrounding parkland (the related property).

Calculation of value of wife鈥檚 interest in the house on death (or the occasion of a chargeable lifetime transfer)

A 聽聽 Aggregate value of the entirety with vacant possession is 拢1,500,000.

T 聽聽 Value of transferor鈥檚 interest in the house if not part of the aggregate:

聽聽聽鈥� say 拢1,200,000 (i.e. what the market might pay and not the arithmetical proportion)

R 聽聽 Value of husband鈥檚 related interest in the parkland as if not part of the aggregate:

聽聽聽 鈥僺ay 拢50,000

Appropriate portion of the value of the aggregate attributable to the transferor鈥檚 interest in the house:

The issue of whether s.161(4) IHTA 1984 applies to shares of land was considered by the Special Commissioners in Arkwright and another v Inland Revenue Commissioners [2003] UKSPC00392, [2004] STC (SCD) 89. There it was held that whilst s.161(4) IHTA 1984 could apply to property which had a distinct individual existence as a unit, such as unit trusts or a set of furniture (for example twelve dining chairs), it did not apply to fractions of units.

This issue was not considered further when the Revenue鈥檚 appeal against the decision was heard by the High Court. HMRC subsequently received legal advice that s.161(4) IHTA 1984 may, in fact, apply to fractional shares of units and on 27 November 2007 issued Revenue and Customs Brief 71/07. This brief stated that for all IHT cases where the account is received after the publication date, HMRC would consider applying s.161(4) IHTA 1984, where undivided shares in land are involved.

On this basis the aggregate value of the merged shares needs to be ascertained and then apportioned proportionately on an arithmetic basis. HMRC will calculate the appropriate portion based on the VOA鈥檚 valuation.

A transferor owns a 95% share in a house and his wife owns the other 5% share. The entirety is valued at 拢500,000. The relative values would be apportioned as follows:

Husband鈥檚 share 拢500,000 x 95% = 拢475,000

Wife鈥檚 share 拢500,000 x 5% = 拢 25,000

拢500,000

S.176 provides relief in cases where property, which has been valued on a death with related property, is sold within three years after the death as a separate interest, and the price realised is less than that determined for IHT purposes. (See Section 12).

Reference of cases to the VOA

15.13 HMRC to indicate Related Property when known to them

When HMRC are aware that related property is involved (normally those cases in which the transferor鈥檚 spouse or civil partner owns an undivided share or a separate estate or interest in property comprised in the transferor鈥檚 estate) they will advise the provision applies and give full details of the related property concerned.

If the VOA is aware that the transferor鈥檚 spouse or civil partner owns property (not referred by HMRC as 鈥渞elated property鈥�) and the transferor鈥檚 estate would realise a better price if sold together with the spouse鈥檚 or civil partner鈥檚 details of the 鈥渞elated property鈥� should be provided to HMRC and their instructions awaited. No enquiries should be made of the parties concerning the apparent existence of such related property unless authorised by HMRC; nor should any special search of office records be instituted for this purpose without a specific request from HMRC.

Valuations required by HMRC

In every related property case the VOA will first have to decide whether a better overall price would be realised if the transferor鈥檚 property and the related property were sold together. If not, the transferor鈥檚 property should be valued without applying the related property valuation rule of s.161 IHTA84. The report to HMRC should provide an explanation.

If the transferor鈥檚 spouse or civil partner holds a separate interest in the transferor鈥檚 property or owns other property HMRC will require:

• an aggregate valuation of the transferor鈥檚 property and the related property together
• separate valuations of the transferor鈥檚 property and the related property as if not part of the entirety or aggregate

HMRC will calculate the appropriate portion attributable to the transferor鈥檚 property in accordance with s.161(3) IHTA84. See para 15.7.

Where the transferor and spouse or civil partner own property jointly as undivided shares HMRC will require:

• an aggregate valuation of the transferor鈥檚 property and the related property together.

HMRC will calculate the appropriate portion attributable in accordance with s.161(4) IHTA84. See para 15.10.