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

Matthew Hutton MA, CTA (fellow), AIIT, TEP author and presenter of Monthly Tax Review, outlines a potential trap in an estate planning strategy commonly adopted by married couples.

Context

There is a well known (in general) trap, provided by FA 1986 s 103 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 s 103 does not arise on the second death.

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 s 103: it seems that s 103 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 s 103 is a problem only if it is the donor spouse who survives. The classic scenario caught by s 103 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.

December 2005

Matthew Hutton MA, CTA (fellow), AIIT, TEP

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About The Author

Mark McLaughlin is a Fellow of the Chartered Institute of Taxation, a Fellow of the Association of Taxation Technicians, and a member of the Society of Trust and Estate Practitioners. From January 1998 until December 2018, Mark was a consultant in his own tax practice, Mark McLaughlin Associates, which provided tax consultancy and support services to professional firms throughout the UK.

He is a member of the Chartered Institute of Taxation’s Capital Gains Tax & Investment Income and Succession Taxes Sub-Committees.

Mark is editor and a co-author of HMRC Investigations Handbook (Bloomsbury Professional).

Mark is Chief Contributor to McLaughlin’s Tax Case Review, a monthly journal published by Tax Insider.

Mark is the Editor of the Core Tax Annuals (Bloomsbury Professional), and is a co-author of the ‘Inheritance Tax’ Annuals (Bloomsbury Professional).

Mark is Editor and a co-author of ‘Tax Planning’ (Bloomsbury Professional).

He is a co-author of ‘Ray & McLaughlin’s Practical IHT Planning’ (Bloomsbury Professional)

Mark is a Consultant Editor with Bloomsbury Professional, and co-author of ‘Incorporating and Disincorporating a Business’.

Mark has also written numerous articles for professional publications, including ‘Taxation’, ‘Tax Adviser’, ‘Tolley’s Practical Tax Newsletter’ and ‘Tax Journal’.

Mark is a Director of Tax Insider, and Editor of Tax Insider, Property Tax Insider and Business Tax Insider, which are monthly publications aimed at providing tax tips and tax saving ideas for taxpayers and professional advisers. He is also Editor of Tax Insider Professional, a monthly publication for professional practitioners.

Mark is also a tax lecturer, and has featured in online tax lectures for Tolley Seminars Online.

Mark co-founded TaxationWeb (www.taxationweb.co.uk) in 2002.