Planning Ahead For Post Death Events - Elderly Client Adviser

Feature

posted 1 Jul 1998 in Volume 3 Issue 5

Planning Ahead For Post-Death Events

The last three issues of "Elderly Client Adviser" have carried articles about the ways in which the provision made in a will or on intestacy can be varied after death. Such a variation might take place because of a change in circumstances since the will was written, the need to settle claims made against the estate or simply in order to save inheritance tax ("IHT").

In some cases a variation will mean that the testator's estate is distributed in a manner never contemplated by him, and perhaps even against his wishes. Indeed, most testators have very strong ideas about who should benefit from their assets after their death. However, some are more willing to introduce some flexibility into the ultimate destination of their estate because, for example, they are uncertain about their future financial position, the health of a child or whether their marriage may break down. In such circumstances they may be prepared to surrender their discretion to their executors; or make a gift to one person on the understanding that, if appropriate, it should be passed on to another.

Section 144

Under section 144 of the Inheritance Tax Act 1984 a testator can provide for all or part of his estate to be held by his executors or trustees on a discretionary trust, giving them a power to appoint property or establish trusts in favour of one or more of a class of named beneficiaries. Provided the powers of the executors or trustees are exercised within two years of the testator's death, the dispositions they make will be treated for IHT purposes as if they were made in accordance with the testator's will.

Effect of Section 144

Distributions out of discretionary trusts are usually subject to an "exit" charge under section 65 of the IHTA 1984. If section 144 applies then no such "exit" charge will arise. What is more, the remainder of the IHT legislation will also have effect as if the distributions made by the trustees were made in accordance with the testator's will.

As a result, distributions out of the discretionary trust can be used in much the same way as an instrument of variation under section 142 of IHTA 1984 or, indeed, any of the other methods of "tax effective" post-death variation. For example, appointments can be made to use up the nil-rate band, giving the balance to the testator's spouse. The executors or trustees are not limited to making outright distributions from the discretionary trust, since section 144 applies to any distribution which would otherwise give rise to an "exit" charge, including the creation of interest in possession trusts of property which remains in the discretionary settlement.

Indeed, in at least one respect section 144 is more flexible than section 142. Unlike the situation where a post-death variation is contemplated, the powers of the executors or trustees under the discretionary trust can be formulated so that the dispositions can be made regardless of the inability of minor beneficiaries to give their consent or the refusal of adult beneficiaries to do so. Nor is it necessary to make any election to the Revenue - the effect of section 144 is automatic.

Of course, undistributed property remaining in the discretionary trust will not be exempt from the ten year charge made on all such trusts, although no charge will fall due in the two years after death unless the testator's will added property to an existing discretionary settlement and a ten year anniversary occurs during that period.

Also note that section 144 does not have any effect on the Capital Gains Tax ("CGT") or Income Tax legislation. The distribution is not treated as if it had been made by the testator for CGT purposes, and there may therefore be a CGT liability if the relevant assets have substantially increased in value in the period since death.

Property Covered by Section 144

Section 144 only applies to property comprised in the testator's estate and "settled by his will". It does not cover property governed by the intestacy rules or passing by the right of survivorship under a joint tenancy. However, it does include property previously settled on discretionary trust by an instrument of variation within section 142 of IHTA 1984. In appropriate circumstances section 144 could therefore provide an opportunity to re-vary the provisions of the will in circumstances where a further instrument of variation is prohibited.

Section 144 does not apply where the property in question has been subject to an interest in possession after death but before the creation of the discretionary trust. An example of this might be a trust under which property is held subject to a life interest defeasible by the exercise of a power and then on discretionary trusts. If the life interest is terminated (as opposed to being disclaimed) then the discretionary trust would come into existence, but section 144 will not cover any dispositions made by the trustees out of the trust.

Timing

Section 144 only applies if the disposition out of the discretionary trust is made within two years of the testator's death. Like the position under section 142, the Revenue has no discretion to extend this period.

The two year limit could cause difficulties where the discretionary trust does not come into existence until the completion of administration, and there has been some delay in obtaining probate. Furthermore, upon applying for probate the executors must calculate and pay the IHT due from the estate. That part of the estate held on discretionary trust will be chargeable, albeit the IHT can be recovered if a distribution within section 144 is subsequently made.

Ideally, therefore, the distribution out of the discretionary trust should be made before the application for probate. It is now accepted that a will can confer power on executors to make a distribution, or a transfer to trustees, before administration is complete and even before probate has been obtained. Indeed, the distribution will fall within section 144 even if the property concerned is still in the course of administration. However, to avoid any difficulty over the construction of the will it makes sense to ensure that it expressly provides that named executors are authorised to make a distribution even before the grant of probate, and the appropriate powers and discretions vest in the executors in the period prior to the completion of the administration.

It is also important to note that the executors or trustees should not make any distribution in the first three months after death. This is because section 144 only operates where the distribution would otherwise attract the "exit" charge under section 65. Under section 65(4) no "exit" charge is due when a distribution is made within three months of the creation of a settlement, and in the case of a will trust the settlement is created at the date of death.

Section 143

As stated above, a discretionary trust is one way of introducing some flexibility into a will. An alternative is what is called a "precatory trust", that is, a gift to a person together with a request by the testator that the property should be transferred to another. In fact, the gift to the original legatee is absolute, and he is under no legal obligation to follow the testator's wishes. Indeed, no "trust" in the true sense arises. However, section 143 of IHTA 1984 provides that if the onwards gift is made it is not treated as a transfer of value and will not attract IHT.

Section 143 applies "where a testator expresses a wish that property bequeathed by his will should be transferred by the legatee to other persons, and the legatee transfers any of the property in accordance with that wish within the period of two years after the death of the testator". Provided those conditions are met, the IHTA legislation has effect as if the property transferred had been bequeath-ed by the will to the transferee.

No election is required and the effect of section 143 is automatic provided the onward gift takes place within two years of death. This period cannot be extended. Unfortunately, however, there is no means of disapplying the section if in fact it results in an increase in IHT, although the original legatee may decide to avoid its automatic effect by postponing his onward gift until after the expiry of the two year period. It must also be remembered that, like section 144, section 143 has no impact on the CGT or Income Tax legislation.

Finally, it is worth noting that the wish expressed by the testator does not have to be set out in his will, and could be found in a memorandum or other document. I am not aware of any case in which wishes expressed orally have been considered adequate by the Revenue, but I see no reason why they should not be expressed as being conditional upon a certain event (such as the testator ceasing to live with his wife before death) or ceasing to operate in certain circumstances (such as the testator calling off his engagement).

Sarah Lacey, Barrister, 3 Stone Buildings