• Usufruct arrangements do not exist under English law, but their creation and existence can, depending on the circumstances, give rise to tax and legal implications which should be considered when determining if they are an appropriate estate planning tool.

  • The creation of a usufruct arrangement by a British individual (UK resident and domiciled) during his life could give rise to inheritance tax implications in the UK, both at the point of creation and possibly also on his death. Such tax treatment will be different and, possibly more favourable, if the usufruct is created on death.

  • The creation of a usufruct arrangement may also trigger UK capital gains tax implications and, if the asset generates income, the usufruct holder will be entitled to that income and possible charges to income tax should be considered.

The aim of the article is to give a broad overview on usufruct arrangements and their UK tax implications (for IHT, capital gains and income tax purposes).  Although usufruct arrangements are an efficient estate planning tool when used in a fully domestic context, a cautious approach should be adopted in cross-border planning involving British or UK resident individuals, to establish whether they are an appropriate tool in the circumstances. 

Usufruct arrangements are widely used in civil law jurisdictions (including Italy, France, Belgium and Switzerland) and are an efficient estate planning tool in a continental European context.  They are most commonly used for real estate assets, but they can be created over any type of property including bank accounts, shares, investment portfolios and more.

Broadly speaking, a usufruct arrangement is a legal construction whereby ownership (broadly defined as the right to use, enjoy and deal with an asset) is split into two separate rights or interests. Namely, a usufruct interest and bare ownership. The ‘usufruct interest’ gives its holder the use and free enjoyment of a property belonging to someone else (ie, the bare owner), on the condition that they look after and preserve the asset with a view to it being passed to the bare owner at some point in the future.  Whilst a usufruct arrangement is in place, the bare owner will therefore have very limited rights in respect of it. A usufruct interest usually lasts for the lifetime of the usufruct holder and automatically terminates after his or her death. It does not form part of the deceased’s estate but simply ‘disappears’, thereby enabling the bare owner to acquire full ownership of the asset(s).

So, are usufruct arrangements effective and/or appropriate for use by British persons with foreign assets?

Usufruct arrangements do not exist under English law and each usufruct has to be analysed on a case-by-case basis in order to establish, as a matter of construction, how it should be viewed and construed under UK law.  This is an essential first step before considering the likely UK tax treatment of the arrangement. Therefore, the creation of a usufruct arrangement (typically over an asset situated outside of the UK) by a British individual (UK resident and domiciled) will give rise to tax implications in the UK.

Inheritance tax – a usufruct arrangement is likely to be considered as akin to an ‘interest in possession trust’.  The life tenant – similar to the usufruct holder – has an immediate right to the income arising within the trust as well as an entitlement to the free enjoyment of its property. The remainderman – akin to the bare owner – has an interest in the underlying capital.  When the person creating the usufruct arrangement (normally the owner of the asset who gifts the bare ownership of the asset while retaining a usufruct interest in it) is UK resident and domiciled, and the arrangement is created during their lifetime, a UK inheritance tax charge at 20% is triggered when the arrangement is created as well as a subsequent 6% charge every 10 years.  Furthermore, on the death of the original owner of the asset (ie, now the usufruct holder), there may be a further inheritance charge at 40%.  The position may be different if the usufruct arrangement is created on death, as it will most likely qualify as an immediate post-death interest trust and its UK tax treatment will be different and, possibly, more favourable. 

Capital Gains tax – the creation of a usufruct arrangement following the gift of the bare ownership is regarded as a disposal for UK capital gains tax (‘CGT’) purposes. Thus, potentially triggering a UK CGT liability, subject to any applicable UK capital gains annual allowances and reliefs. 

Income tax – if the asset generates income, the usufruct holder will be entitled to that income and therefore income tax should also be considered.  For instance, if the usufruct interest relates to real estate, and the property is rented out, the rental income will be taxable in the hands of the UK resident usufruct holder and will have to be reported to HMRC, with a credit for any tax levied in the country where the property is located. 

In conclusion, although a usufruct arrangement may offer interesting estate planning opportunities, careful consideration should be given to the overall UK tax and legal implications in order to establish whether it is an appropriate tool in the circumstances.  It is therefore always advisable to seek independent professional advice before setting up a usufruct arrangement.   

Mara MonteLawyer, UK