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Capital Tax Review by Matthew Hutton, MA, CTA (Fellow), AIIT, TEP

Matthew Hutton MA, CTA (fellow), AIIT, TEP author of Capital Tax Review, highlights a potential pitfall in IHT planning involving the family home.

Context

There is a well known (in general) trap, provided by FA 1986 s103 which in certain circumstances disallows a deduction for IHT purposes for a debt on death. In broad terms, where money is owed by the deceased under a debt arising on or after 18.3.86 to somebody to whom the deceased had made a gift (at any time), no allowance is given for the debt, except to the extent that it exceeds the value of the gift or gifts. HMRC Capital Taxes are known to apply the section widely – and seem to disregard the apparent limitation of the section to the case where there is some connection between the gift and the debt, as suggested by the use of the word ‘consideration’ which surely imports the concept of contract.

Significantly, there is no exception from the rules for dispositions between husband and wife. The trap therefore, in the context of the simple IOU Scheme, is that the surviving spouse had made a gift to the first to die during their joint lifetimes and so a deduction claimed for the debt on the second death is disallowed to the extent of that gift. There is also no de minimis provision in the section.

In the case where there have been gifts by the deceased to the first to die, the gift of residue under the Will of the first to die needs to be on life interest trusts rather than an absolute gift. Further, if there is a possibility that the family home will be sold and the whole of the sale proceeds required to buy a replacement property (ie the survivor cannot ‘afford’ to have the nil-rate sum repaid to the trustees), the Charge (rather than the Debt) Scheme should be employed, to ensure that the spectre of s103 does not arise on the second death.

The surviving spouse must not be a party to the creation of the charge

However, to ensure absolute safety, it is important that the surviving spouse should not be one of the Will executors or trustees in such circumstances, given the wide wording of FA 1986 s103: it seems that s103 could apply even if the spouse had been a party to the charge in a fiduciary rather than a beneficial capacity.

Section 103(1) applies where inter alia account would be taken on the second death of ‘an incumbrance’ created by a disposition made by the second to die. Note that the word is ‘disposition’ and not ‘disposition by way of gift’ (which is the general concept behind the GWR regime in s102). Although there is some limitation provided by s103(4) where the disposition was not a transfer of value, this will not apply where in particular the disposition was part of associated operations, which included a reduction in the value of the property of the deceased, which is precisely what the creation of the charge does.

The word of warning, therefore (which I must confess is new to me), is, in the language of the Encyclopaedia of Forms and Precedents: ‘… because the surviving spouse must not on a strict reading of section 103 be a party to the disposition creating the encumbrance, he or she must not be one of the executors of the estate (or if appointed in the will should not take out a grant). If this problem only materialises after a grant has been taken out, then the problem may be circumvented if the charge is inserted after the administration of the estate has been completed, and at a time when the executors have become bare trustees for the beneficiaries entitled under the Will. Before the charge is created the surviving spouse can resign as a trustee so that he or she is not involved in imposing the charge. In imposing the charge it is, of course, important to ensure that the conditions for the retirement of a trustee are met.

(Encyclopaedia of Forms and Precedents, Wills and Administration (Volume 42) Para [2154] as sections 268/270)

Application

Given this warning, a note should be put on the client’s Will file that, in appropriate cases where the Charge Scheme is adopted, the surviving spouse should not be an executor or (given the replacement property point) trustee.

Generally, note that s103 is a problem only if it is the donor spouse who survives. The classic scenario caught by s103 is where, ‘to equalise’ the estates, or at least to ensure that each spouse has within his/her estate value not less than the nil-rate band, the spouse who turns out to be the survivor puts the house into joint names, as tenants in common in say equal shares.

Comment

Generally, delegates at my Monthly Tax Review sessions have found the point made in the Encyclopaedia of Forms and Precedents a new one. One argument which might be used to counter it (if raised by Capital Taxes) is the proposition that PRs are a single continuing body of persons, subsuming the individuality of any one of them. Thus, while a charge may be created by the PRs together, it would not (for purposes of s103 at least) be created by any one of them, viz specifically a surviving spouse who had made a gift to the first to die.

January 2006

Matthew Hutton

More Information

The above article has been taken from Matthew Hutton’s Capital Tax Review, a quarterly update for professional advisers of private clients. For more information, visit http://www.taxationweb.co.uk/books/capital_tax_review.php.

About the Author

Matthew Hutton is a non-practising solicitor (admitted 1979), who has specialised in tax for over 25 years. Having run his own consultancy (latterly through Matthew Hutton Ltd) until 30th September 2000, he now devotes his professional time to writing and lecturing.

THE FIFTH ESTATE PLANNING CONFERENCE: CURRENT ISSUES 2006

East
Tuesday 13 June
Cambridge Belfry Hotel

Midlands
Tuesday 20 June
Sketchley Grange
Burbage, Hinckley

South
Tuesday 27 June
Norton Manor Hotel,
Sutton Scotney,
nr Winchester

West
Thursday 14 September
Bailbrook House, Bath

North
Tuesday 3 October
Weetwood Hall, Leeds

London
Tuesday 31 October
The Law Society’s Hall

For further details, brochures and booking forms please contact Matthew Hutton: email – mhutton@paston.co.uk or telephone – 01508 528388 (Ref: TaxationWeb).