denotes premium content | Jan 9 2009 Feature
posted 1 Jan 1998 in Volume 3 Issue 2
When
Death is Not the Last Word
In the first of a series of
articles Sarah Lacey, a Chancery Barrister at 3 Stone Buildings, Lincoln's Inn,
practising in all areas of trusts, probate and tax, examines the tax
consequences of post death rearrangements, and in particular Deeds of
Variation.
In
late November it was announced by the lawyers acting for the Prince of Wales
that there would be no attempt to reduce the IHT due in relation to Princess
Diana's estate. No doubt they had an eye on public opinion, but perhaps they
were also paying heed to the Chancellor's statement that he intends to eliminate
"unacceptable tax avoidance". Indeed, there were rumours that November's Green
Paper Budget would include proposals for the repeal of the tax provisions
relating to post-death rearrangements. In fact the Chancellor steered well clear
of the subject, but advisors currently dealing with estates should bear in mind
that the April budget is only a few months away.
What Happens if I
Vary?
This article concentrates on written variations. Surprisingly, the other
ways of changing the distribution of an estate are often ignored. For example
:
i) a
beneficiary can disclaim his interest, provided he has not already accepted any
part of it (section 142 of IHTA 1984);
ii) a surviving spouse can elect to
capitalise her statutory right to a life interest on intestacy, taking a lump
sum instead; (section 47A(1) of the Administration of Estates Act
1925); or
iii)proceedings under the Inheritance (Family Provision on
Death) Act 1975 can result in either a determination by the Court or a
compromise. Both are effective to vary the manner in which the estate is
distributed, and will be the subject of an article in the next issue.
The
Attractions of a Written Variation
Section 142 of IHTA
1984 provides that where a written variation is made within two years
of death, and is followed by an election to the Revenue, the 1984
Act applies and IHT is to be charged as if the variation had been made
by the deceased.
At first glance, section 62(1) of TCGA 1992 appears to
be in similar terms. The section provides that a variation, if followed by an
election, will not be a disposal for CGT purposes. The New Beneficiary takes the
estate as if he was a legatee under the will, and is treated as having acquired
the assets from the personal representatives at the market value on the date of
death. However, it is only the remainder of section 62 (dealing with disposals
on death) and not the rest of the 1992 Act that then applies as
if the variation had been made by the deceased. So, the Original Beneficiary may
still be the "settlor" for the purposes of CGT legislation dealing with the
consequences of settling assets on a trust in which the settlor or his spouse
retain an interest : Marshall v Kerr [1994] STC 638.
There are plenty
of other areas of tax legislation in relation to which the variation will not be
retrospective, although this is not always a bad thing. An example would be a
gift to a New Beneficiary that is a charity. Provided the gift does not result
in a reduction in the IHT due from the estate as a whole, it should qualify as a
charitable gift under the "Gift Aid" scheme. The Original Beneficiary will be
treated as a donor, and can certify that he has made a payment equal to the
grossed up amount of the gift. The charity can then reclaim from the Revenue the
income tax at the basic rate : St Dunstan's v Major (Inspector of Taxes)
Simon's Weekly Tax Intelligence (1997), 796.
More generally, a written variation
(as opposed to a disclaimer) will not have any impact on the liability to pay
income tax in the period between death and variation. Income up to the date of
the variation is taxed as that of the Original Beneficiary, even though he may
have assigned the right to accrued but unpaid income. The terms of the variation
should therefore provide that the payment of interim income to the New
Beneficiary is made net of the income tax paid or owing from the Original
Beneficiary.
What if the Chancellor Gets His Way?
What would the position
be if the Chancellor repealed sections 142 and 62 ? In summary :
i) a party relinquishing
an interest under the will or intestacy ("the Original Beneficiary") would be
making a transfer of value for IHT purposes - of both the relevant asset and any
income earned by it. That transfer might be :
a) exempt (for example, if it is in
favour of a spouse, or charity; or is less than the annual exemption of
£3,000);
b)
chargeable (for example, if it is a transfer to a discretionary trust);
or
c) potentially
exempt (a "PET") (for example, if it is a gift in favour of a child, to an
Accumulation and Maintenance Trust or to a trust in which there is an interest
in possession);
ii) in certain circumstances, the Original Beneficiary may also be
making a disposal for CGT purposes - for example, of his chose in action (to
have the estate properly administered) or of the assets themselves (if the
administration and distribution of the estate had already taken place);
iii) furthermore,
the party benefiting from the compromise ("the New Beneficiary") would take the
assets at their market value on the date of the gift, not on the date of death.
In other words,
the position would be no different to that which currently arises when the
parties agree to a written variation but either the relevant elections are not
made to the Inland Revenue or the variation is made more than two years after
the deceased's death.
To Elect or not To Elect?
It is easy to make the mistake of
assuming that an election is always appropriate. In fact, it may be entirely
unnecessary. For example :
i) the variation may relate only to
the widening of administrative or investment powers in a will trust, or the
modernisation of an out of date trust;
ii) the Original Beneficiary may be
the deceased's spouse, so that a distribution in accordance with the will or
intestacy rules would be free of IHT, while a subsequent written variation by
the spouse might (subject to the anti-avoidance rules relating to "linked
transactions") be a PET; or
iii) the transaction may not attract
CGT - for example, where the Original Beneficiary and the New Beneficiary are
spouses, or there has been no increase in value between the date of death and
distribution.
Even when it is anticipated that the settlement will reduce tax
liability, its main purposes should not be forgotten. Advisors do not have a
crystal ball, but there is no point in drafting a tax efficient variation if it
leaves the widow or dependent children without adequate resources to live
comfortably - particularly as subsequent variations will not be covered by the
relevant tax-saving provisions (even if made within 2 years of death).
Similarly, the
effect on Original Beneficiaries who are involved in ancillary relief
proceedings (see section 37 of the Matrimonial Causes Act 1973)
or bankruptcy (section 423 of the Insolvency Act 1986) must be taken into
account.
Of
course, there are clearly circumstances where both a variation and election are
appropriate. Mercifully, legal advisors do not generally owe any duty to suggest
a variation in order to save IHT : Cancer Research Campaign v Ernest
Brown & Co (a firm) Simon's Weekly Tax Intelligence (1997),
27.10.97. The only likely exception to this arises where there has been
a "double death" (that is, where spouses die within two years of each other) and
the first to die leaves all of his estate to the other, thereby failing to use
any part of the nil-rate band. It has been suggested that in such circumstances
a professional personal representative would be under a duty to suggest a
variation.
Getting Caught Out
However, rearrangements to save IHT
following a "double death" are not without their problems. The will of the first
to die is frequently varied so that some of his estate goes direct to the
beneficiaries under the estate of the second to die, thereby using up the
nil-rate band. The beneficiaries involved in the rearrangement often end up
getting exactly the same interests as they would have had, in any event, from
the estate of the second to die. In other words, the parties have merely changed
the route by which the same assets reach the same beneficiaries. So far, the
Revenue appear to have accepted that section 142 of IHTA 1984
nevertheless continues to apply, but they may yet change their mind. The
potential problem can easily be avoided by incorporating a real change in the
interests taken by the beneficiaries - for example, by altering their percentage
share of an asset.
The tax position is still further complicated by "anti-avoidance" rules.
The easiest to explain is the principle that a series of connected and
pre-ordained transactions will all be treated as one transaction, and taxed as
such : IRC v Ramsey [1982] AC 300. An example would be a
rearrangement agreed between a widow and her adult child, whereby the will was
varied so that the son only received the amount of the nil-rate band, pursuant
to a separate agreement that the widow would subsequently make a PET in his
favour of the amount that he gave up. It is not unusual for the Revenue to write
to the solicitors instructed in relation to such a rearrangement, asking whether
the widow has, or has agreed to make, an onward gift.
It is therefore important to ensure
that :
i) any
rearrangement is unconditional;
ii) if there is a subsequent onward
gift, there is no obvious or implied connection (in terms of the timing and
amount etc); and
iii) an Original Beneficiary who is giving up some or all of his
interest in the estate is properly and independently advised, and appreciates
that (whatever has been informally agreed or assumed) the New Beneficiary cannot
be legally bound to make a PET or testamentary gift in his favour in the future.
A further
"anti-avoidance" rule to watch out for is set out in section 142(4) of
IHTA 1984, which applies where a variation results in property
being held in trust for a person (usually the spouse) for less than two years
after the death. As a result of the section, the short term interest will be
ignored in calculating IHT. The ultimate beneficiary (who, unlike the spouse,
will usually not be exempt) is treated as having received the property from the
date of death. The section does not apply to a valid life interest which comes
to an end within 2 years simply because the life tenant dies.
What am I
Allowed to Barter With?
It is often said that a written
variation must not be made for consideration. In fact, what is prohibited (if
sections 162 and 42 are to apply) is the introduction of any consideration other
than the variation or disclaimer of other provisions in the will or intestacy
rules. The parties therefore cannot introduce assets from outside the estate,
although a variation can validly include the deceased's severable share under a
joint tenancy, even though the interest will already have passed on
survivorship. The sections also continue to apply where the consideration is the
compromise of a 1975 Act claim.
There is no formal requirement for the
document to be a deed, although written variations are usually called "deeds of
family arrangement" or "deeds of variation". However, the usual rules of
contract apply, and the agreement will only be enforceable if either supported
by consideration or set out in a deed. A deed is therefore necessary if the
rearrangement is all "one way", with the New Beneficiary giving up neither an
interest in the estate nor a claim against the estate. Indeed, it could be
argued that if the agreement is not binding it is not a variation at all.
What Should the
Variation Include?
There is no fixed format for the
document, but certain conditions must be satisfied. In brief :
i) all those affected by
the variation must be parties. This will include those to whom joint property
would otherwise have passed by survivorship. Remember that it may be
inappropriate for personal representatives to get involved in the negotiations
between beneficiaries, and they have no power to settle on behalf of a
beneficiary who will not come to terms. This applies even where the beneficiary
is a minor, in relation to whom Court approval will be required. The personal
representatives of a beneficiary who has since died can enter into the
compromise or variation on his behalf;
ii) the document should recite
:
a) the will,
intestacy, passing of property by survivorship etc;
b) the date of death of the
deceased;
c) the
appointment of personal representatives or their intention to obtain a grant of
probate or take out letters of administration;
d) a statement to the effect that the
parties wish to vary certain (specified) dispositions of the deceased's
estate;
iii) the
document must then identify the dispositions to be varied and explain how they
are affected. The simplest way of doing this is to provide that, in lieu of the
original provisions, the will or intestacy rules should be read and construed
and the estate administered as if they contained other provisions, as set out.
If the replacement provisions are lengthy then they could be set out in a
schedule;
iv)
similarly, if the variation is to cover property previously held by the deceased
as a joint tenant then the instrument should provide that the trusts of the
property shall be executed as if the joint tenancy had been severed during the
deceased's lifetime and the will (or intestacy rules) had then disposed of the
deceased's share in the manner set out;
v) the elections to the Revenue must
be made to the Inland Revenue within six months of execution (although
extensions of the period may be allowed). There is no need to put the elections
in a separate document, but there must be a specific reference to the section(s)
relied upon and the mere submission of the written variation is not itself an
election. It is possible to make an election under one section but not under the
other;
vi) if the
variation results in an increase in IHT, the personal representatives must join
in the election. They can only refuse to do so if they do not hold sufficient
assets for discharging the additional tax. If this proves to be a problem, one
possible solution is for the New Beneficiaries to give an indemnity to the
representatives. The general view is that although this would be consideration
it would not prevent the application of sections 142 and 62 provided any
security taken is only over property passing to the New Beneficiary out of the
deceased's estate.
The parties only have "one bite at the cherry". If the first variation
proves inadequate or inappropriate (and assuming there are no grounds for
rectification), neither section 142 nor section 62 can be relied upon again. It
is therefore unfortunate that the Inland Revenue are no longer prepared to give
advance approval of proposed written variations.
Do I Have To Pay Up To Get
Probate?
The variation must be made within two years of death, regardless of
whether administration has been completed or a distribution made. This period
cannot be extended. Fortunately, although it is good practice for personal
representatives to be parties, there is no need to wait for a grant of probate
or letters of administration before a variation (as opposed to an election) can
be made. The document can recite the intention of the proposed representatives
to take out representation in the future.
Of course, as a condition of taking
out representation it will be necessary to estimate the probate value of the
estate and pay the IHT due. If neither the variation or election have been made
before the grant then the IHT will be calculated on the basis of the provisions
in the will or intestacy rules. If a subsequent variation and election reduce
the tax due the representatives must make a claim for repayment from the
Revenue. Therefore, where the compromise results in an decrease in IHT it would
be preferable for both the variation and election to take place before
representation is taken out. This is only likely to cause problems when the
variation involves an increase in the IHT due from the deceased's estate and the
personal representatives must therefore be parties to the election.
If the will
appoints executors the Revenue will accept an election before probate is
granted, provided the document recites that the executors named in the will
intend to take out a grant. This is because executors ultimately derive their
title from the will itself, not from the grant. If requested to do so, the
Revenue will also write to the relevant Probate Registry confirming that probate
may be granted, and IHT paid, on the basis that the variation is effective.
Unfortunately,
this is not possible where the deceased died intestate, since administrators
have no title (and therefore cannot sign an election) until granted letters of
administration by the Court.
Sarah Lacey, Barrister
