Spill the beans: How the DOTAS rules apply for inheritance tax

Key points

The disclosure of tax avoidance schemes (DOTAS) rules were introduced by FA 2004, Part 7 and have applied to inheritance tax since 6 April 2011
The existence of a promoter can determine who needs to make a disclosure
An arrangement is notifiable under the DOTAS regime if it is expected to provide an inheritance tax advantage
Arrangements that may have been exempted from disclosure between 2011 and 2018 now need to be tested against the current rules
A promoter has only five days within which to disclose the arrangements to HMRC.

The disclosure of tax avoidance schemes (DOTAS) regime is intended to provide HMRC with early information about potential tax avoidance arrangements. This information allows HMRC to investigate potential tax loss more rapidly and, where necessary, to introduce suitable countermeasures. Practitioners who advise on inheritance tax (IHT) planning need to be aware of the rules and their potential application, even in scenarios some may regard as very basic tax planning, or ‘established practice’. This is particularly because the notification and disclosure timeframes are extremely short.

The DOTAS rules were introduced by FA 2004, Part 7 and have applied to IHT since 6 April 2011. The scope of these rules for IHT was significantly extended with effect from 1 April 2018 by the Inheritance Tax Avoidance Schemes (Prescribed Description of Arrangements) Regulations SI 1172/2017.

The DOTAS rules generally are concerned with ‘notifiable proposals and arrangements’ and impose duties to provide information to HMRC. These duties fall primarily upon ‘promoters’, but may also apply to users, ‘introducers’ and other parties in relation to the proposals or arrangements in question. The disclosure deadline for a promoter may be as little as five business days from the earliest of a number of prescribed trigger events. Failure to comply with the DOTAS regime gives rise to penalties, but is not a criminal offence.

Who is a promoter?

Most private client practitioners won’t consider themselves to be promoters of tax avoidance, but in the context of DOTAS many of us will potentially fall within the definition. Promoters are central to the DOTAS rules, and the existence of a promoter can determine who needs to make a disclosure, or even if a disclosure if necessary.

Broadly a promoter is anybody who, in the course of their business, is responsible for the design of tax avoidance arrangements, markets tax avoidance arrangements, makes a tax avoidance arrangement available for implementation by others, or is themselves involved in organising or managing the arrangements.

Suggesting to a client that they might like to consider making lifetime gifts to their spouse when they consult you about IHT planning, or regular gifts out of income, means you could fall within the definition of a promoter: you then need to consider whether the proposal you have made is notifiable. So a promoter is not just somebody who dreams up clever schemes which rely on obscure areas of the tax code to achieve their tax saving aims. There is no need to advertise innovative schemes to the general public. The full details covering promoters are set out in FA 2004, s 307 and the Tax Avoidance Schemes (Promoters and Prescribed Circumstances) Regulations 2004.

Notifiability test and the IHT hallmark

A proposal or arrangement is notifiable under the DOTAS regime for IHT if:

It is expected to provide an IHT advantage;
This advantage is expected to be one of its main benefits; and
It falls within one of three ‘hallmarks’ which are relevant for IHT.

Two of these hallmarks – ‘confidentiality in cases involving a promoter’ and the ‘premium fee hallmark’ – apply to other taxes. Further information about these hallmarks can be found in section 5 of HMRC’s guidance on DOTAS (tinyurl.com/hmrcdotasguidance). This article will focus on the hallmark that is specific to IHT.

The original IHT-only hallmark brought in during 2011 targeted arrangements designed to obtain an advantage in relation to relevant property trust entry charges. Since 2018, this hallmark has been widened considerably so as to provide that ‘arrangements’ (including any scheme, transaction or series of transactions) are notifiable if it would be reasonable to expect an ‘informed observer’ to conclude that both of the following conditions are met.

Condition 1

The main purpose, or one of the main purposes, of the arrangements is to secure one or more of the IHT advantages listed below, namely:

a) The avoidance or reduction of a relevant property trust entry charge

b) The avoidance or reduction of relevant property trust ten-year anniversary and exit charges, charges on property leaving employee or newspaper trusts or charges in connection with close company transfers

c) The avoidance or reduction of an IHT charge that arises from an application of the gifts with reservation of benefit rules, in circumstances where there is also no pre-owned assets charge to income tax

d) A reduction in the value of a person’s estate without giving rise to a chargeable transfer or a potentially exempt transfer.

Condition 2

The arrangements involve one or more contrived or abnormal steps without which the tax advantage could not be obtained.

Characteristics of the informed observer

The ‘informed observer’ is not taken to be an expert or even a tax practitioner, but someone who is independent, has all relevant information about the scheme and understands both the scheme and the relevant statutory context. Assessing the application of conditions 1 and 2 against the informed observer test is key. As HMRC’s DOTAS guidance states:

‘The inclusion of the words ‘contrived or abnormal’ in condition 2 and the requirement for them to be considered by the hypothetical informed observer mean that normal and straightforward inheritance tax planning will not be notifiable. Inheritance tax planning that requires greater complexity or contrivance to achieve the intended tax advantage though is likely to be notifiable.’

Established practice exception

Until April 2018, grandfathering provisions provided an exemption from the requirement to notify HMRC where arrangements were similar to those already in existence. This meant that only new or inventive arrangements were notifiable.

Since April 2018 there has been a more limited exception to the requirement to notify, which covers arrangements that are substantially the same as ‘related arrangements’. These are ones that:

Were entered into before 1 April 2018
At the time they were entered into, accorded with established practice of which HMRC has indicated its acceptance
The ‘substantially the same’ requirement relates to arrangements that implement a proposal or scheme (being the combination of elements or steps designed to achieve the intended tax advantage) that is in substance identical to the proposal or scheme implemented by the ‘related arrangements’. So minor changes reflecting, for example, the personal details of users, their chosen beneficiaries and the monetary amounts committed, may be disregarded. HMRC’s acceptance of established practice may be evidenced by a clear statement in its published tax bulletins or internal manuals or in correspondence with a representative body such as STEP or CIOT.

The April 2018 changes mean that arrangements that may have been exempted from disclosure between 2011 and 2018 now need to be tested against the current rules.

Are the arrangements notifiable?

Practitioners may want to look at examples to help them understand which arrangements HMRC views as not notifiable, and which are notifiable.

These examples are referred to in HMRC’s guidance on the DOTAS regime as it applies to IHT, and also in correspondence from HMRC to STEP dated 5 August 2019 (the 2019 letter) and 3 October 2022 (the 2022 letter).

Arrangements that are not notifiable:

Lifetime gift to spouse or civil partner: Although condition 1(d) applies, condition 2 does not because there is nothing contrived or abnormal. The gift is simply the use of an exemption provided by the legislation.
Regular gifts out of income to an individual or to a trust: Condition 1(d) or 1(a) is likely to apply, but condition 2 will not because the arrangements are not contrived or abnormal.
Nil rate band gifts into trust repeated every seven years: Condition 1 is not met because these gifts are chargeable, albeit taxed at nil per cent. As condition 1 is not met, there is no need to consider condition 2.
Executing a will that leaves property to an exempt beneficiary: As there is no reduction in the deceased person’s estate, condition 1(d) is not met. Since condition 1 is not met, there is no need to consider condition 2.
Executing a deed of variation to transfer assets on death to an exempt beneficiary: Condition 1 is not met as there is no reduction in the deceased person’s estate, and the person making the variation is treated as never having received the assets for IHT purposes. There is, therefore, no need to consider condition 2.
However, in the 2019 letter, HMRC did not accept that deeds of variation could never be disclosable under the DOTAS rules, particularly if the deed were only one step in arrangements seeking one of the tax advantages in condition 1. It is the overall arrangements that may or may not be notifiable, not merely one step in those arrangements.
It is also understood that, while HMRC accept that condition 1(d) cannot apply to a deed of variation, condition 1(a) and 1(c) may be in point. Nevertheless, it would still be necessary for condition 2 to be met for the arrangements to become notifiable.
Purchase of shares that qualify for business relief after two years: This does not reduce the value of the purchaser’s estate. As condition 1 is not met, there is no need to consider condition 2.
Gift of land where the donor pays full consideration for continued use: Although condition 1(c) is met, the arrangements are not contrived or abnormal and so condition 2 is not.
Gift of an undivided share of land which is subsequently used by both the donor and the donee: It is reasonable to conclude that condition 1(c) is met. However, the arrangements could not be said to be contrived or abnormal unless the donor only retained a very small proportion of the property in comparison to the donor’s level of occupation. Quoting from the 2019 letter:
‘In HMRC’s view an informed observer is likely to conclude that being able to have use of a property which is proportionate to the share of ownership is neither unusual nor contrived. However, we take the view that an informed observer is likely to conclude that having the use of a property which is significantly disproportionate to the level of ownership is abnormal and/or contrived. Ultimately, it falls to the promoter to determine whether they consider that their particular arrangements are caught by conditions 1 and 2.’
A non-UK domiciled individual transfers funds from a sterling to a US-denominated UK bank account: Condition 1 is not met, so there is no need to consider condition 2.
A non-UK domiciled individual transfers non-UK situs property into a trust from which he can benefit, just before becoming deemed UK domiciled: Condition 1(d) is met but the arrangements are not contrived or abnormal and so are not within condition 2.
Immediately before a ten-year anniversary a distribution is made from a relevant property trust to reduce the charge on the subsequent ten-year anniversary: Although condition 1(b) is met, the arrangements do not contain any contrived or abnormal steps.
Loan trusts and gift and loan trusts: The person’s estate is not reduced by the loan and so condition 1(d) is not met nor are conditions 1(a), (b) or (c) relevant. There is no need to consider 2.
In the 2019 letter HMRC suggested that freezer arrangements for shares in family companies – involving the creation of A shares carrying growth and B shares carrying dividend rights – will not be notifiable if they do not result in any of the tax advantages set out in condition 1.

Arrangements that might be notifiable

The DOTAS guidance gives the example of a gift of shares which qualifies for business relief into a trust which subsequently sells those shares back to the transferor. It states that in such circumstances it is reasonable to conclude that condition 1(a) and condition 2 are met if these steps are part of a single overall arrangement. However, the position would be different if the subsequent sale of shares was an independent decision of the trustees, unforeseen at the time of transfer into the trust.

In the 2019 letter and the 2022 letter HMRC responded to a question concerning a variant of the above case, where the planned sale of shares is to a third party. It suggested that such arrangements may or may not be notifiable depending on the particular circumstances. The point was also made that arrangements designed to achieve this outcome will generally be bespoke and are therefore unlikely to fall within the established practice exception.

Arrangements that are notifiable

The example given in the DOTAS guidance is the creation of a reversionary lease where it is reasonable to conclude that conditions 1(c) and 2 are met. The 2019 letter confirmed that reversionary lease schemes can only be caught by condition 1(c) where they do not give rise to a pre-owned assets charge to income tax. In that letter, HMRC considered that reversionary lease arrangements are unlikely to fall within the established practice exception because they will tend to be bespoke in nature.

Finally, in the 2019 letter, HMRC commented on trust fragmentation schemes where company shares are split between several Settlements in order to reduce share value at the ten-year anniversaries. HMRC considered that condition 1(b) and condition 2 were likely to be met and that, for these arrangements as well, the established practice exception is unlikely to apply because of their bespoke nature.

Notification process

The deadlines for notification are tight. A promoter is required to disclose the arrangements to HMRC within five days after the earliest of:

The promoter making a firm approach to another person with a view to making the scheme available (this is to cover marketing a scheme)
The promoter making a scheme available for implementation by another person
The promoter becoming aware of a transaction forming part of the scheme (in practice, one of the earlier dates is likely to apply first, this would only generally arise in relation to a very bespoke proposal).

The relevant forms for notification can be found through HMRC’s DOTAS guidance, but where the duty to disclose is on the promoter, it will be on form AAG1 (and it is a requirement to use HMRC’s forms).

This article first appeared in Taxation Magazine.