Taxation within the administration of an estate Liability and Protection

Feature

posted 1 Jul 1999 in Volume 4 Issue 5

Taxation within the administration of an estate - Liability and Protection

As if personal representatives did not have enough to worry about in the general administration of their estate, eg legatees demanding immediate payment of monies due to them, creditors of the estate wanting their money likewise, problems disposing of assets at the best price and possible questions arising from the interpretation of a will, personal representatives have also got to bear in mind the three main taxes and how they impact upon them during the administration of an estate.

Inheritance Tax

Inheritance tax arises as a result of death. This is not the place to discuss that liability. What is relevant for this article are the changes to the IHT position on death as a result of actions taken by the personal representatives during the course of administration.

Quoted Shares

If quoted investments are sold within a period of one year from the date of death and realise an amount less than their value at the date of death, the gross amount realised (before brokers expenses) is substituted for the value at the date of death with a consequent reduction in the IHT liability1. This relief is hedged about with restrictions; for instance, losses are reduced by the amount of gains, so if the personal representatives find themselves with some quoted securities standing at a loss and others at a gain, those standing at a loss should be sold by them but those standing at a gain should be appropriated out to the beneficiaries.

If land and buildings are sold by personal representatives within four years of the date of death at a value lower than that at which they were valued on the application for the grant of representation, then again the gross sale price can be substituted for the original valuation2. Again there are anti-avoidance provisions to be noted carefully. Remember that this relief will not apply in the event that the personal representative exchanges contracts for the sale of the property within the relevant period but for whatever reason the sale is not completed in the prescribed time3.

Deeds of Variation

IHTA 1984 s142 provides that adult beneficiaries can rewrite the bequests made to them provided this is done within a period of two years from the date of death and notice is given to the Revenue of the change within a period of six months from its being made. This is such an important relief that a whole jurisprudence has sprung up around it, together with a variety of cases.

Amongst other things these cases establish that the same property cannot be the subject of two variations but it is possible to have two variations in respect of two separate items of property owned by the deceased. The section does not apply if the variation is made for consideration. The CTO will take a great interest in the following set of circumstances: an estate is left to chargeable beneficiaries eg adult children; these children and the widow vary the will under s142 so as to give the estate to the widow; accordingly no IHT will be payable because the estate is exempt; the widow then makes gifts to the children of an amount equivalent or very close to the sums bequeathed to them by the will; is this consideration?

Note that unlike capital gains tax (see below) it is the deceased who is treated as making the variation and not the parties to the transaction. This can be very useful if you are planning a scheme which would otherwise involve a gift with a reservation because someone who is dead cannot reserve a benefit for him or herself! Thus if you are an advocate of placing the deceased's matrimonial home into a discretionary trust and the widow wants to continue remaining in the home, if she were to inherit the house absolutely and make a discretionary settlement with herself as one of the beneficiaries it would be of no effect for future IHT purposes as the widow would be treated as reserving a benefit. However if the will were rewritten under s142 with a discretionary trust and the widow were one of the beneficiaries there would be no reservation of benefit. Whether or not this can be attacked on other grounds is a separate issue.

Precatory Trusts

Note that under IHTA 1984 s143 if a testator expresses a wish that property bequeathed absolutely to an individual should be transferred by him to other persons then if the legatee carries out those wishes the bequest will be deemed to be made under the will and not be treated as an inter vivos gift by the legatee who, on the face of it, is entitled absolutely.

Discretionary Will Trust

IHTA 1984 s144 deals with property distributed from a discretionary will within two years of the date of death. If that occurs then the deceased trust is deemed to have made the appointment. But note the three month trap so that no appointments out should be made within a period of three months from the date of death4.

I(PFD)A 1975

Finally note that if the estate is subject to a claim under Inheritance (Provision for Family and Dependants) Act 1975 then any Order made under those proceedings is treated as if it were made by the will.

Capital Gains Tax

Personal representatives are deemed to acquire all assets of the deceased at their value at the date of death5. In many cases this will be straightforward to ascertain because the assets will either be cash or assets quoted on a recognised stock exchange which gives an objective value. Others will be more problematic, eg land which it is not intended to sell or shares in an unquoted company. Here the valuation at the date of death may well result only from protracted and costly negotiations with various arms of the Inland Revenue.

Once ascertained any disposals by the personal representatives (subject to the exceptions necessarily implicit in the IHT section above) will be calculated on the basis that the personal representatives make a gain or loss on disposal against value at the date of death. A disposal by way of a transfer to a legatee whether a specific legatee or a residuary legatee is not a chargeable transaction for CGT purposes6. Instead the legatee is treated as acquiring the property as at the date of death for the value established at the date of death. Subsequent gains or losses are those of the legatee as absolute owner.

If assets have to be sold during the administration and charities are among the residuary beneficiaries the personal representatives should not sell and then distribute the cash because if that is the order of events there will be a CGT liability on the personal representatives and the exemption for charities will not be available. It is preferable to assent the assets to the charities who then realise the cash themselves so that the proceeds of sale fall under the charitable exemption. The position is more complicated if there is a charge on residue which is bequeathed to charities and cash is needed within the estate7.

In the event that the personal representatives dispose of assets for cash during the administration period (for whatever reason) they have an exemption equivalent to the exemption of an individual for the first two years following the date of death and for the year in which the death takes place8. Thereafter chargeable gains are taxed at a flat rate of 34% as from 6 April 1998. Expenses of sale can be set against the gross proceeds before calculating the net chargeable gain. For what amounts to a deductible expense one needs to contrast the cases of IRC v Richards [1971] 1 All ER 755 HL on the one hand and Caton v Couch [1997] STC 970 CA on the other hand.

In general, variations of the dispositions made by the deceased are treated for CGT purposes as they are treated for IHT purposes. But, Marshall v Kerr [1994] STC 638 HL shows one important difference. The variation is treated for CGT (but not IHT) purposes as being made by the legatee, and not by the deceased.

Income Tax

Personal representatives are liable to UK income tax provided they, or one of them is resident in the UK. Their liability exists throughout the period during which the estate is being administered. It is clear that the start of the administration commences with the date of death but the end of the administration period can often be somewhat obscure. It is a factual issue but the facts may differ in individual cases. For some estates it is when a clearance certificate is issued by the Inland Revenue in respect of outstanding IHT liabilities; for others it is when assets are transferred to residuary legatees. There is no hard and fast rule. But, like an elephant, even if hard to define, it is normally clear when the end of the administration period occurs.

Interest charged on IHT during the administration is not a deductible expense from the gross income of the personal representatives but it will form a deduction from the net distributable estate and accordingly will be taken into account when computing the net income of the estate of the residuary beneficiaries. Interest charged by a bank or other provider of finance for the purpose of paying IHT will be deductible, but only if the interest is charged on a loan account. Interest arising from borrowing on current account is not allowable against the income of the personal representatives even if the purpose of the borrowing was to provide finance for payment of IHT. The nature of the account is critical.

Personal representatives have a basic rate of liability to income tax at 23%. They have no personal allowance and no liability to higher rate tax.

If, by some strange quirk, the equitable rules of apportionment apply (Howe -v- Lord Dartmouth, Allhusen -v- Whittell etc), then the income of the personal representatives will be treated as that determined by the equitable rules of apportionment. It will also be necessary to apportion on a legal basis under the Apportionment Act 1870 unless that is excluded. The need to apportion under the 1870 Act comes about first on the date of death, then, if applicable, on the date of death of any life tenant or successive life tenants before the income due to the ultimate residuary beneficiary entitled to capital can be ascertained.

When it comes to distributions of income to residuary beneficiaries there were fundamental changes in the system made from 6 April 1995. The present rules provide that income paid out in any one tax year is treated as being the income for that tax year (and is not, in accordance with former practice, spread out over the whole administration period). Likewise interest payable to residuary beneficiaries entitled to capital is treated for their income tax returns as arising in the year in which it is paid to them, not the period in which it may have arisen. Dividends accrued due but not paid at the date of death are treated as being assets of the estate for IHT purposes because the deceased was contractually entitled to them as at the date of death. Subsequently when those accrued dividends are paid, after the date of death and during the administration period, they will be taxed as income in the hands of the executors and ultimately as income in the hands of the residuary beneficiaries. There is thus the possibility of double charge to tax, inheritance tax in the first instance and subsequently income tax. In these circumstances a most complicated form of relief, but a relief nevertheless, is available against the higher rate income tax liability of the residuary beneficiary in respect of the IHT payment9.

Geoffrey Shindler, Halliwell Landau

1. IHTA 1984 ss 178 to 189.
2. IHTA 1984 Part VI Chapter IV ss 190-198.
3. Jones v IRC [1997] STC 358 ChD.
4. Frankland-v-IRC [1996] STC 735 ChD.
5. TCGA 1997 s62(1)(a)
6. TCG, 1992 S62(4).
7. Prest v Bettinson [1980] STC 607 ChDz.
7. TGCA 1992 s3(7).
9. s699 ICTA 1988.