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Mark McLaughlin highlights a recent Inheritance Tax case concerning pension rights.

Introduction

For Inheritance Tax (IHT) purposes, the general rule is that a transfer of value requires positive action by the person making it, such as the gift of an asset. However, in certain circumstances a failure to take positive action is treated as a disposition as well. In particular, the deliberate omission to exercise a right can be treated in this way. (IHTA 1984 s 3(3)).

Deferring Retirement Benefits

A recent tax case considered this provision, in the context of pension rights. In DM Fryer & Others (Personal Representatives of Patricia Arnold Deceased) v HMRC FTT [2010] UKFTT 87 (TC) TC00398, the executors appealed against a determination by HMRC that the deceased, Mrs Arnold, had made a disposition under IHTA 1984 s 3(3) by deferring her retirement benefits under a pension policy. The normal retirement date under the policy was 8 September 2002 (her 60th birthday), but she was entitled to take benefits at any time between her 50th and 75th birthdays. In April 2002, Mrs Arnold was diagnosed with a serious illness, and died on 30 July 2003 without having taken retirement benefits under the policy.

Tribunal Finds That Deferring Benefits Reduced the Value of the Estate

The tribunal held on the particular facts of the case that Mrs Arnold had omitted, throughout her lifetime, to exercise her pension rights, and that the omission had therefore continued until her death. The burden of proof was on the executors to show that the omission had not been deliberate. However, it was held that the deceased’s omission was deliberate, and had diminished her estate. Furthermore, the tribunal considered that Mrs Arnold’s estate had been diminished by her omission to exercise the pension rights, which increased the value of settled property (i.e., the payment of death benefits to the trustees of a discretionary trust).

Gratuitous Benefit

For IHT purposes, a disposition is not a transfer of value if it is not intended to confer a gratuitous benefit (i.e., within IHTA 1984 s 10). However, the tribunal held that s 10 did not operate in Mrs Arnold’s case to exempt her omission to exercise a right from an IHT charge (under IHTA 1984 s 3(3)). There was, among other reasons, an intention to confer a gratuitous benefit on the beneficiaries of the trust, in the form of death benefits.

The tribunal assessed the value of the right to take the retirement benefits at 30 July 2003, being the latest date at which Mrs Arnold could have exercised the right. Subject to certain variations in HMRC’s Notices of Determination (including a change in the date of omission to exercise the rights from 8 September 2002 to 30 July 2003), the PR’s appeal was dismissed.

Practical Issues

The Arnold case raises some interesting IHT issues. It would seem that the pension policyholder is effectively ‘on risk’ from the date when he could first have drawn the pension until death. Each passing day that the pension is not drawn is a new occasion of omission.

The case also perhaps highlights the potential difficulty in valuing the amount of the disposition for IHT purposes as a result of the omission. As the tribunal pointed out in the above case, it was not the increase in the value of the trust property that mattered, but the reduction in the value of the estate.

It should be noted that there is potential relief from an IHT charge under s IHTA 1984 3(3) in respect of registered pension schemes in IHTA 1984 s 12 (‘Dispositions allowable for Income Tax or conferring benefits under pension scheme') at sub-ss (2A)-(2G) if certain conditions are satisfied. However, the IHT rule on the omission to exercise a right is generally wide ranging, and care is needed when dealing with possible omissions.

Facing the Tribunal

As an aside, it is also interesting to note that in the Arnold case the deceased’s PRs were represented by an Independent Financial Adviser (IFA). The tribunal observed out that the IFA had no previous experience of appearing before tax tribunals, and commented: “This is a case where quite clearly it would have been appropriate for the Executors to be represented by counsel, or by someone else equally experienced in representing parties before the tribunal.” It is probably fair to say that the tribunal’s comments could equally apply in all but the most straightforward of cases.   

The above article is reproduced from Practice Update (May/June 2010), a tax Newsletter produced by Mark McLaughlin Associates Limited. To download current and past copies, visit: Practice Update.