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Tottel's Trusts and Estates Annual 2006-07 by Matthew Hutton MA, CTA (fellow), AIIT, TEPMatthew Hutton MA, CTA (fellow), AIIT, TEP author of Tottel’s Trusts and Estates Annual 2006-07, outlines some important tax considerations in connection with the estates of deceased individuals.
Written variationsA beneficiary (or indeed all the beneficiaries taken together) can re-write the provisions of a will (or intestacy) as long as they do so in writing within two years after the death. For deeds made before 1 August 2002, notice had to be given to HMRC within six months after the date of execution. For deeds made on or after that date, however, the deed must simply contain a statement by all the parties that the IHT and/or CGT reliefs are intended to apply. Generally, the effect of such a variation is to regard for IHT purposes the terms of the variation as written into the will; see example 1 (IHTA 1984, s 142). The Conservative Government tried to repeal this facility in 1989, though the offending Finance Bill clauses were withdrawn. Five years later, the Labour Party said that when elected they would re-introduce such a repeal. To date, the Labour Government have not done so, however.
Some points to watch The deed of variation will not be effective if it purports to take away value from minors or unborn beneficiaries.
The deed will be ineffective if made for consideration, ie there must be a genuine gift from the original to the new beneficiary.
If the effect of the deed is to create a life interest trust, that trust must last for at least two years (unless terminated by death of the beneficiary).
Passing on growth, tax freeThe value of the whole estate, or perhaps that of one or two assets may increase in the two years following death. Such value could be passed under variation to chargeable beneficiaries; see example 2.
An election made for IHT purposes will ensure that the value of the asset at the date of death is treated as passing under the will to the new chargeable beneficiary. That will also be the acquisition cost for CGT purposes.
Income tax and CGTA variation has no effect for income tax or CGT. Although it is possible to make a CGT election, this has the simple effect of avoiding the variation itself from being a disposal. However, all the other consequences of the CGT legislation will apply. The particular point here, for both income tax and CGT, is that if the original beneficiary by the variation creates a settlement under which they or their spouse can benefit, the settlement will be ‘settlor-interested’.
Example 1Under James’ will there is a nil-rate band gift to a discretionary trust with residue left to his wife. The trustees appoint within two years after James’ death £50,000 to each of James’ children, Bill and Ben. Bill wishes to benefit his own children, Thomas and Serena, and transfers the £50,000 to them again within two years after his father’s death. It is open to Bill to make an election under s 142, within six months after the transfer to his own children. This will have the effect of avoiding a gift for IHT purposes by Bill and treating the gift to Thomas and Serena as made direct to them under their grandfather’s will.
Example 2Marcus died on 1 December 2005, with an estate of £1 million all of which is left to Antonia, his wife, who survives him. 23 months after his death, the value of the estate has increased to £1.5 million, the whole of which increase is attributable to quoted shares worth £275,000 at his death. Antonia could make a deed of variation under which there is a specific gift of those shares, either to her children, or to a nil-rate band discretionary trust.
Alternatively, if perhaps Marcus had made chargeable transfers of £275,000 in the seven years before he died, the deed of variation could have Antonia take a legacy of £1 million with residue to the children. The effect of the IHT legislation would be to attribute the whole of the estate to the exempt specific gift to Antonia.
In either case, the result would be to have the uplift in value of £500,000 passing to the children free of tax.
DisclaimersA disclaimer is a slightly curious animal, which can apply to any property, but which is particularly apt to wills. It is not enough for a gift to be made, it has to be received. Suppose a will leaves Blackacre to X, and X turns round and says, ‘I don’t want it’: there is no obligation on him to receive Blackacre, and the will is effectively read as if X had died before the testator. The effect is that Blackacre falls to be divided as part of the residue of the estate. If instead, X had been entitled to part of residue and had disclaimed that, the disclaimed share of residue would fall into intestacy. If X had been entitled to receive income under a will trust and had disclaimed his right to income, the will trust would be read as if the next succeeding life interest (or an outright capital gift) came into being.
The IHT effectWhere the disclaimer is made within two years after the death, the property is treated as passing under the will to the person entitled under the disclaimer (IHTA 1984, s 142).
The no benefit ruleThe important point with disclaimers is that an assert cannot be disclaimed if a benefit has already been taken from it. Further, there is no right to disclaim in part unless the will (or other instrument) gives power to do so.
Disclaimers can be of use in simple cases. They came into their own in 1989 when everyone thought that the Finance Bill provisions outlawing deeds of variation (and incidentally, appointments under two-year discretionary will trusts) would be enacted. When the threat passed, people got less excited about disclaimers.
Where more than two years have elapsedLike a variation, a disclaimer, to be effective, must be made within two years. If more than two years have elapsed since the date of death, and no benefit has been taken from the asset concerned, there is a possible line of escape if it is desired to avoid a particular asset coming into a beneficiary’s estate for IHT purposes. There is a separate provision (in IHTA 1984, s 93) that deals with settled property. Generally a person given a right under a trust who has taken no benefit from it can disclaim that right whatever the length of time has elapsed and the trust deed will be read as if he had never become entitled.
Example 3A will gives to Benedict all the furniture in the testator’s house and a life interest in residue. The will provides that, subject to Benedict’s life interest, residue is to be divided equally between Benedict’s two (adult) children. Benedict wants to take neither of the benefits under the will. He can, therefore, execute a disclaimer. The effect of the disclaimer will be:
to pass the legacy of the furniture into residue, viz subject to the trust; and
to treat the interest of Benedict’s children as coming into effect immediately, ie to presume Benedict to have died.
Accordingly, given notice of the disclaimer, the executors can simply distribute both the furniture and the residue of the estate direct to Benedict’s two children.
Discretionary will trustsThe provisions relating to deeds of variation and disclaimers are contained in IHTA 1984, s 142. There is a parallel, albeit different, provision in s 144. This provides that where a person has left all or part of his estate on discretionary will trusts, and the trustees make an appointment out of those trusts within two years after his death, the terms of the appointment are read back into the will with no exit charge under the discretionary trust regime. This could apply where there was simply a nil-rate band discretionary will trust or a discretionary will trust of residue. The terms of the appointment may be to give absolute interests or they may create a life interest.
It is vital that the trustees do not make their appointment within three months after the death; this was established by a Court of Appeal decision in a case called Frankland v IRC in 1997. The appointment, therefore, must be made at least three months, but less than two years, after the death.
This device is commonly used in circumstances where a testator does not know exactly what the circumstances as to assets and/or children are likely to be at the date of his death, but anticipates leaving a surviving spouse. He might choose to write the whole of his estate under a discretionary will trust giving power to the trustees to make an appointment before probate has been granted or residue ascertained. Given survivorship by his wife, the idea would be that at the same time as putting in HMRC account, the trustees would make and submit their appointment, which would set up a nil-rate band discretionary trust giving residue to the surviving spouse, either for life or absolutely. In other words, there would be no IHT charge on the death because the will would be read as though the terms of the appointment were the provisions.
Capital gains taxNote that if the effect of the appointment is to create an absolute interest in residue on the part of the surviving spouse and there has been significant growth in the value of the assets since death, the whole of the growth will be assessed on the trustees at 40%. In other words, although assets are coming out of a discretionary trust, there can be no hold over of the gain under TCGA 1992, s 260 because s 260 requires there to be a chargeable transfer and this is expressly precluded by s 144. By careful ordering of events, however, there may be a way round this problem: see the example below.
Example 4Suppose that Gerald dies on 1 June 2006 leaving an estate worth £600,000 at his death. His will is written under discretionary trusts. He is survived by his wife and three minor children. The trustees intend to make an appointment under s 144, creating a nil-rate band discretionary trust as to £285,000, the beneficiaries to include the widow, three children and their future spouses and children and give residue to the wife absolutely. When they are considering this, a year or so after the death, the assets in the estate have appreciated by £100,000. If, therefore, they simply proceed with their plan, they will, on distributing the assets to the spouse, make a gain of £100,000. Deducting the annual exemption of £8,800, this gives rise to a taxable gain of £91,200, which with tax @ 40% produces a tax bill of £36,480.
We have said already that a beneficiary under a will has no right to specific assets, only the ‘chose in action’. The beneficiary of the estate is the trustee, albeit to hold on the trusts provided in the will. The conventional order of things is that the PRs wind up the estate by distributing the £600,000 (now worth £700,000) to the trustees to use as they see fit. Suppose on the other hand, that before the distribution of the estate, the trustees make their appointment on the nil-rate band trust and the gift of residue to the surviving spouse. HMRC helpfully take the view that at that stage nothing happens for CGT purposes. As and when the PRs appropriate the assets in the estate to the trustees and bring the administration to an end, the trustees are bound by their appointment. They hold assets worth £285,000 on the discretionary trusts, and the balance worth £315,000 they hold for the widow as ‘bare trustees’. Normally it would be the acquisition date and acquisition cost of the trustees that would be related back to the date of death. In this case, however, it is the acquisition circumstances of the widow who is the ultimate beneficiary, which are related back to the date of death. Accordingly, there is no chargeable gain, no tax to pay and she is simply treated as having inherited assets now worth £315,000, with a base cost of £215,000, ie an inherited gain of £100,000, but at least with time to plan the disposals in a tax efficient manner.
IHTA 1984, ss 142 and 144 interactionA decided case called ‘Russell’ in 1988 established that you cannot vary the same property twice, ie you cannot have two bites at the same cherry. However, there is no reason in principle why within the same estate there should not be two or more variations.
Section 144 followed by s 142An appointment by trustees under s 144 can also in principle be the subject of a subsequent variation under s 142. See example 5.
Section 142 followed by s 144This situation envisages the original beneficiary, say the surviving spouse who is left the whole estate, varying her interest to create a nil-rate band trust including herself as a beneficiary. This would be on the footing that the property put into the trust was within the nil-rate band. If subsequently, the assets concerned turn out to be worth rather more than originally envisaged, the trustees could, within two years of the death, appoint back to the widow the excess over the nil-rate band reducing the chargeable value on death to nil. See example 6.
Example 5Jeremy, a bachelor, has just died, leaving his entire estate subject to a discretionary trust. A year after Jeremy’s death, the trustees make appointments within s 144 passing the whole trust fund absolutely to Jeremy’s three nieces. One of the nieces varies her entitlement, within two years after her uncle’s death, into an accumulation and maintenance trust for her children. Subject to making the appropriate election for s 142 purposes within six months of making the settlement, the transfer into trust will not be a PET made by the niece, but will be treated as a new will trust made by Jeremy. Hence, if the niece settlor were to die within seven years after the settlement was made, there would be no IHT implications of her death for the will trust.
Example 6Malcolm dies in 2006/07, leaving his estate worth £400,000 to his wife, Jill. Jill varies the will to put specific assets worth, as she thinks, £285,000 into a nil-rate band discretionary trust. It turns out six months later that the assets put into the trust are in fact worth £295,000. This produces an IHT liability in Malcolm’s estate of £10,000 × 40% = £4,000. Given that Jill is a beneficiary under the trust, the trustees could, within two years after Malcolm’s death, appoint £10,000 back to her to restore the status quo and to restrict the chargeable transfer on Malcolm’s death to £285,000, viz the nil-rate band.
Matthew Hutton MA, CTA (fellow), AIIT, TEP
Matthew Hutton is author of ‘Tottel’s Trusts and Estates Annual 2006-07’, from which the above article is extracted. The book is one of ‘Tottel’s Core Tax Annuals 2006-07’. The series is due to be launched in September 2006. Each of the new Core Tax Annuals costs just £19.95, or all six cost just £99.50! The Core Set comprises:
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