INHERITANCE TAX PLANNING IN CONTEXT

At the time of writing, when an estate incurs a liability to inheritance tax, the tax takes a substantial bite out of the taxable estate (20% in the case of lifetime transfers of value and 40% in the case of transfers which take place on death). This situation is not likely to improve and could get worse. In spite of this it is important to take a long-term view and keep in mind the bigger picture. Although reducing the tax liability is important for the sake of those who will be left behind, it is essential to bear in mind the effect of possible future inflation rates and not impoverish oneself. Do not go overboard on the subject or let the tail wag the dog!

The basic principle of taxation is that if you have it you shall pay your fair share. The principle is vividly illustrated by the pre-owned assets charge and the disclosure of tax-avoidance scheme rules introduced by the Finance Act 2004 to clamp down upon the evermore ingenious and artificial schemes produced by a growing army of tax advisers to avoid or reduce the inheritance tax take. As always the question is the interpretation of the word ‘fair’, with the judiciary on the one hand insisting that tax avoidance (the arranging of one’s financial affairs within the law and for legitimate reasons so as to incur as little tax as possible) is to be upheld, and increasingly frustrated and frequently outwitted governments considering it ‘unfair’ and seemingly attempting to obliterate the concept and phrase ‘tax avoidance’ from the English psyche and language.

In spite of the conflict there is much that both parties agree can properly and safely be done between the battle lines that have been drawn up which will reduce inheritance tax liability. However, if you have read the preceding chapters, you will realise that inheritance tax is an extremely complicated subject and the path of tax avoidance is strewn with traps for the unwary and for the uninitiated. It is therefore only sensible (and one might say essential) to obtain a second opinion from a tax professional on any plan or step you envisage to check that it:

• has been approved by HM Revenue and Customs
• will reduce your inheritance tax
• is right for you

before taking action – but take some action you probably should and before it is too late. To check whether you need to take action, or are likely to need to take action, value your taxable estate in accordance using the principles and information set out on pages 23–31, make allowance for any reliefs referred to in Chapter 5, deduct the current nil-rate band and, if the result is a positive figure, read on.

SAVING INHERITANCE TAX BY MAKING GIFTS DURING YOUR LIFE

If the basic principle of taxation is that if you have it you pay, the basic principles of tax planning are to try to ensure that you do not have it at the relevant time, that what you do have consists as far as possible of assets that are favoured by tax exemptions or reliefs and that you have made provision for the payment of payable tax out of assets which are outside your estate.

Overcoming reluctance to give and early giving

Unfortunately it is necessary to retain a reasonable amount during one’s lifetime and for any number of reasons, many people have a strong reluctance to giving. If you are one of them it will help if you remember that once your estate crosses the inheritance tax exemption threshold, your beneficiaries will be paying tax at a very high rate indeed on the excess and that any non-taxable gift you make, either in your lifetime or by your will, will only cost your estate £60 of every £100 given because the other £40 would have been payable to the Revenue as inheritance tax. It is important to make the best use possible of the inheritance tax gift exemptions. From a tax point of view, provided you do not impoverish yourself, it is an excellent idea to give away as much as you can in your lifetime and the sooner you give it, the more tax you will save. Non-taxable gifts of income-producing assets reduce both the donor’s inheritance and income tax liabilities and if made at the appropriate time and judiciously chosen can also reduce future capital gains tax liability. Moreover, immediately taxable gifts made in the taxpayer’s lifetime suffer inheritance tax at only one-half of the tax rate suffered by taxable gifts occurring on death, and gifts made during the taxpayer’s lifetime which were not then immediately chargeable might escape tax altogether as PETs, or if they become taxable on his death might be taxable at a lower rate by reason of taper relief. The giver of a lifetime gift might also have the pleasure of seeing the recipient enjoy the gift and perhaps even make good use of it, something that it is debatable that he will be able to do after his death!

Using non-taxable dispositions, inheritance tax-exempt gifts and excluded property

The first thing to do when considering inheritance tax planning is to review the lists of non-taxable dispositions, inheritance tax-exempt gifts and excluded property set out on pages 7–10 and 12–15 and to see if the moment is ripe for using any of them.

Most reversionary interests are excluded property and therefore not included in the taxpayer’s estate when calculating his inheritance tax liability. A taxpayer who is moderately well off and who is to inherit assets from a trust fund on the death of another person might wish to consider whether he is likely to need them or whether it might be better to transfer his reversionary interest in the fund while it is still reversionary (and therefore before it becomes taxable) to those he would wish to benefit in the future. Such a transfer (being a transfer of excluded property) does not give rise to any inheritance tax liability even if the transferor dies within seven years of making it.

When considering a gift always weigh up and balance the inheritance tax saving against the cost of any legal fees and consider the capital gains tax and income tax implications. Lifetime transfers by way of gift are exempt from stamp duty. Also remember that you cannot have your cake and eat it. To be a tax-effective gift it must go pretty well completely and you cannot retain any significant benefit from it either directly or indirectly, even by a behind-the-scenes arrangement.

Remember that both parties to a marriage or to a registered civil partnership have their own set of gift exemptions and that asset transfers to a spouse or registered civil partner are exempt from capital gains tax and stamp duty. Sharing assets with, or giving assets to, a spouse or registered civil partner who owns less than the inheritance tax threshold might enable the spouse or partner to make tax-free gifts to others from the assets which she might otherwise be unable to make and in this way use her otherwise unusable exemptions and at the same assist the person who makes the gift to his spouse or partner to reduce his own potential tax liabilities.

Making non-exempt gifts in excess of the inheritance tax threshold

When making a non-exempt gift in excess of the nil-rate band the hope is always to survive for more than seven years from the date of the gift so that the gift will be exempt, unless it is a gift to a trust which is subject to the relevant property taxation regime, in which case it will be subject to an entry charge at one-half of the rate which would be charged if the gift were made on death. If the donor does not survive for the requisite period some comfort can be taken from the facts that although the applicable rate of tax will be the rate at the date of death, the gift will be valued for the purposes of inheritance tax and capital gains tax at the value it had when it was made and taper relief will be available on the gift if the donor survived for at least three years. Moreover, the relevant tax exemption threshold is the one which exists at the date of death and that is usually higher than the one which existed when the gift was made.

A decreasing term insurance policy on the life of the donor to cover a period of seven years can be taken out as a precaution against the possibility of inheritance tax becoming payable on PETs. The insurance company should be asked to write the policy upon trust for the person who has the potential liability for the tax. This person is not necessarily the person who received the gift because gifts are set against and eat up the nil-rate band in chronological order. If the premiums on the policy are paid by the donor it is likely that payment of the premiums will be exempt from inheritance tax as being regular payment made out of the donor’s income without decreasing his standard of living or that they can form part of the small gifts or annual gifts exemptions. If the donor does not take out insurance against the potential liability for tax, the donee or other person with the potential liability can take out cover because he will have an insurable interest in the life of the donor. Most inheritance tax is payable before the grant of representation to the estate can be obtained by the deceased’s personal representatives and it is necessary for the personal representatives to obtain the grant to realise most assets, for example non-trust life or endowment policies taken out by the deceased. If the policy is written upon trust it will not be part of the deceased’s estate and the policy monies will be available fairly quickly upon production of a death certificate without the necessity to produce a grant of representation to obtain them. They can then be temporarily loaned to the personal representatives of the deceased to pay probate fees and inheritance tax payable before the assets of the estate can be realised.

Although insurance costs can be high in the case of an elderly donor, decreasing term insurance is much cheaper than full life cover and if the donee does not have funds to pay any payable inheritance tax he might have to sell the asset given to raise the money needed to meet the tax bill.

Lifetime giving by spouses and civil partners who are terminally ill

If one spouse or partner becomes terminally ill, try to make use of the exempt lifetime gifts to the maximum as each tax year passes. Also use the fact that lifetime gifts between spouses or registered civil partners are exempt from both inheritance and capital gains taxes to ensure that any estate of the spouse or partner who is likely to die first which is not to be left to the survivor will exceed the exempt threshold by as little as possible; the survivor can then use his or her own lifetime gift exemptions to make gifts from the estate he or she inherits to the intended beneficiaries which would have been taxable if made on the first death.

Timing gifts into discretionary trusts and other gifts during lifetime

If possible it is better to make lifetime gifts to individuals after and not before transferring assets to a discretionary trust because if the gifts are made before the transfer of assets into the discretionary trust, the gifts will be counted in the settlor’s cumulative total of transfers made in the seven years prior to the commencement of the trust when calculating the ten-year charge.

Choosing which assets to give and the beneficiaries

When deciding which assets to give, consider giving the asset which has the greatest growth potential because the asset given will be valued as at the date the gift is made and the gift of assets with the greatest growth between the date of the gift and the date of death will bring about the greatest reduction in the value of the estate for inheritance tax purposes. If it is possible to make such gifts to younger rather than older individuals, so much the better because in the normal course of things they will have longer to live before inheritance tax is payable on the recipients’ death. If assets already have a large capital gain it might be worth retaining them and giving alternative assets (bearing in mind that there is no capital gains tax liability on death), unless they can be given away under the annual capital gains tax exemption limit.

Some think that whenever possible one should tend to retain assets which receive some inheritance tax relief, such as gifts of shares in unquoted companies which have been held for two years or more, business property, agricultural property and commercial woodlands, especially if they are producing a good income. Others consider that the reliefs accorded to these assets are over-generous and that they are the assets to give, bearing in mind that future legislation could revoke or modify them at any time. If they are given and there is a choice of beneficiaries, is it also preferable to give them to recipients who are likely to continue them and themselves benefit from the reliefs.

When choosing beneficiaries bear in mind the effect on any social security benefits they are receiving.

USING THE FAMILY HOME

Downsizing, equity release schemes, roll-up mortgages and home reversionary schemes

A taxpayer who wishes to make gifts while he is still alive in an effort to reduce the amount of inheritance tax payable on his death and who has insufficient liquid assets because his wealth is tied up in a family home, might wish to consider ‘downsizing’, or raising money upon the security of the home by means of an equity release scheme such as a roll-up mortgage (sometimes called a lifetime mortgage) or a home reversionary scheme.

To downsize is to sell the property and to move into a cheaper property. A roll-up mortgage is a mortgage in respect of which the borrower is not required to make repayments until the property is sold or the owner dies. In a home reversionary scheme the owner sells part or the entirety of the home and in either case on the understanding that he will be allowed to remain in it until he sells the fraction he had previously retained (if he has only sold a share in the property) or until he either goes into long-term care or dies. If he is married or has a partner, the property should be jointly owned and any roll-up mortgage or other equity release scheme should be entered into jointly so that the survivor will have the benefit of remaining in the property after the first death.

In any mortgage-based scheme a careful check should be made as to what interest rate is being charged and whether the interest rate is fixed or variable. The interest rates are usually higher in the case of roll-up mortgages than those charged on other types of mortgage. Check also whether the interest is calculated with daily, monthly, quarterly or yearly rests because over a period of years it can make a considerable difference to the amount of interest paid or the amount outstanding at the end of a roll-up mortgage. The effect of compounding interest can be alarming. In any scheme that involves an annuity, check whether the annuity is fixed or variable.

Anyone who proposes to enter into any of these schemes should also check:

• that he will be able to sell and move into another suitable property without terminating the scheme if, as a result of a change in circumstances, the existing property becomes unsuitable
• whether he will incur any, and if so what, penalty charge, if he wishes to terminate the scheme early for any reason
• that there is a guarantee that he (or his estate when he dies) will not be required to make up any deficiency if the value of the property becomes lower than the outstanding debt
• what effect any income he receives from the scheme or from investing any capital he obtains from it will have on his income tax position or means-tested benefits.

He should also remember that entering into an equity release scheme will possibly prevent a third party, such as a child or other carer, living with him. If it did not do so it would almost certainly necessitate the child or carer leaving and perhaps becoming homeless when the scheme terminated upon the homeowner’s death or when it became necessary for the homeowner to enter into care.

Throughout the entire period of the scheme or of a roll-up mortgage, the homeowner will remain responsible for paying Council Tax and maintaining and insuring the property.

A homeowner who gives away cash which he received from an equity release scheme could possibly affect the chance of having his care home fees paid for him in the future and incur the pre-owned assets income tax charge on benefits he receives, at the time or in the future, from assets acquired by the donee by the use of the money.

Using the schemes provides liquidity and releases money which can then be used to make gifts or spend and thus reduce the inheritance tax bill. At the same time, in the case of a reversionary interest scheme, the value attributable to the property in the homeowner’s estate is less and therefore the tax bill is further reduced; in the case of a roll-up mortgage a new deductible liability is created and the bill reduced. If a roll-up mortgage is used the householder retains ownership of his home and benefits from the entirety of any subsequent gain in value.

It is essential to obtain independent legal and financial advice before entering into any such arrangements and to note that legal and surveyor’s fees will be charged, although some, but not all, companies will reimburse the fees if the scheme is completed.

Financial risks and dangers of other possible solutions based upon the family home

With the high prices of homes today a common problem for many people is that the home forms a substantial proportion of the taxpayer’s wealth. There is insufficient cash or investments which can be given away to make full use of the tax-exempt lifetime gifts and the nil-rate band without impoverishing the taxpayer and/or his spouse/partner and there is a great temptation to try to reduce the value of the taxable estate that the taxpayer would leave on his death by making lifetime gifts of the entirety or a share of the family home but to continue to live there.

The financial services industry has dreamt up ingenious and complex schemes to permit the taxpayer to continue to occupy his home as long as he wishes but at the same time reduce or eliminate its value for inheritance tax purposes on his death. Such schemes are fraught with potential problems and if they are to be entered into they should be entered into in the full knowledge that they may well not succeed and if they do not do so it is the taxpayer’s estate and not the financial service provider that will bear the loss. One has only to remember the introduction of the pre-owned assets charge which was brought in to counter artificial transactions solely entered into for the purpose of reducing tax and took effect retrospectively to upset transactions that had been effected, sometimes 19 years earlier, to realise that if such schemes do succeed they can be overturned by any government.

When considering any idea of disposing of the family home or a share in the home and residing there after the disposition (even if the taxpayer is to leave the home and return much later and whether the disposal be by way of gift or by sale), careful attention must be paid to the gift with a reservation and the pre-owned assets rules discussed in Chapter 4 and it is essential to take advice from a tax lawyer or tax accountant before acting. Traps for the unwary permeate this subject.

The government has stated that the pre-owned asset charge will not be considered to apply if the enjoyment of the benefit is only incidental, including cases where an out-and-out gift of the taxpayer’s home to a family member comes to benefit the giver as a result in a change in the parties’ circumstances. For example, if an elderly parent who gave the family home to a child and moved to separate accommodation is later compelled to return to the property which had been given by the need to be cared for by the child as the result of subsequent ill health or infirmity.

Former owners are not regarded as enjoying a taxable benefit if they retain an interest which is consistent with their ongoing enjoyment of the property. For example, the charge will not arise if an elderly parent who is the sole owner of his home passes a 50% interest to a child who continues to live with the parent and continues to pay a 50% share of the outgoings: a tax liability might well arise if the share were, say, 80% or the child did not live with the parent or the running costs were not shared proportionately. The proportions should probably be proportionate to the parties’ use of the property as opposed to their shares of the ownership but this has not as yet been authoritatively decided.

Other possible solutions

Giving and leasing back

A possible partial solution to the problem for a taxpayer who wishes to dispose of his home but continue to live in it might be to make an outright gift of the property, followed by a leaseback of the property to the taxpayer at a full market rent or full market premium for seven years, but this idea has still to be tested in the courts. Even if it works, whether it is worthwhile must be judged by weighing the potential inheritance tax saving against the legal and rental costs of the operation and the loss of the capital gains tax exemption for the taxpayer’s principal private residence. It should also be noted that the rent paid (out of the donor’s taxed income) would be taxable in the hands of the donee.

Mortgaging and giving the mortgage monies

A taxpayer with a large amount of equity in his house who wishes to raise cash from the house for his own use or to give away with the object of reducing inheritance tax might wish to consider a mortgage, a remortgage or a further charge upon the security of the property. To do so (unless the mortgage is a roll-up mortgage) he will need to be able to show how he proposes to repay the mortgage or further charge by supplying evidence of sufficient income sources which are likely to continue or producing an acceptable guarantor (perhaps an intended donee or a family member).

After making the gifts (if they are not covered by the gift exemptions or his unused nil-rate band) the taxpayer will hope to live for seven years from the date of the gifts so that they benefit from being PETs and he will perhaps take out term assurance to cover the risk of dying earlier. Such a course will reduce the tax on the estate if the taxpayer survives for three years or more (taper relief) and dies before repaying the mortgage, but it should be noted that unless a roll-up mortgage is used, the mortgage repayments, including interest, will be an additional living expense to the taxpayer who should take care not to impoverish himself. A roll-up mortgage will produce the greatest reduction in the taxpayer’s estate.

Such a scheme might be open to attack by the Revenue under the rule against associated operations as defined in section 268(1) of the Inheritance Tax Act 1984, which is discussed later in this chapter in connection with the purchase of an annuity and life policies.

Selling subject to a right to occupy

In the unusual case of children who have sufficient funds which have not been provided either directly or indirectly by the parent, it is possible for the children to purchase the family home from the parent at the full market price and for the parent to continue to live there by reserving a right to do so from the sale. This transaction relies upon section 10(1) of Schedule 15 of the Finance Act 2004 which reads:

• 10 (1). . . the disposal of any property is an ‘excluded transaction’ in relation to any person. . . if– . . . it was a disposal of his whole interest in the property, except for any right expressly reserved by him over the property, either–
  • (i)by a transaction made at arm’s length with a person not connected with him, or
  • (ii)by a transaction such as might be expected to be made at arm’s length by persons not connected with each other.

Note that this exclusion only applies to a disposal of the seller’s whole interest in the property and the scheme will not succeed if only a part of his interest is sold. Moreover, the transaction must be ‘such as might be expected to be made at arm’s length by persons not connected with each other’ so that the full market price must be paid. The purchase money must be from the purchaser’s own resources and not by money provided previously or contemporaneously by the parent, otherwise the pre-owned assets charge will apply.

The parent could then give the purchase money away to, say, grandchildren (or even to a child if it was clear that there was no prior agreement to do so) and benefit from one or other of the lifetime gift exemptions, from using an unused portion of the nil-rate band, or hope to survive for at least three years so as to benefit from taper relief. There can be no prior arrangement to make gifts from the purchase price, otherwise the associated operations rules will apply to negate any tax benefit. Neither can any part of the price be left outstanding on loan unless the terms are such that a commercial lender would require. After the purchase the property will no longer have the benefit of the principal private residence capital gains tax exemption and as usual, the cost of the legal fees and disbursements such as stamp duty land tax must be weighed against inheritance tax savings.

Discretionary trusts

A taxpayer might consider creating a discretionary trust in respect of part or the entirety of his share of the family home in his will and this is discussed in the following chapter.

Non-financial risks and dangers

In addition to any fiscal risks of a scheme involving the family home failing there can be other dangers and problems. Consider, for example, the case of a parent who wishes to give or sell a share of the family home to a daughter. After the gift the parent and the daughter would both own and be entitled to use the house. This might not be a good idea, especially if a daughter were to:

• give her share of the house away in the joint lifetimes of the parent and the daughter, or
• marry, or
• predecease the parent married but intestate or with a will which left her estate to the daughter’s husband/partner who remarried, or to any third party, or
• become bankrupt.

Apart from any question of problems that might arise from sharing the use of the home, the new part-owner might wish to cash in the share of the house and attempt to force a sale. While a parent may justifiably think he can rely upon his daughter not attempting to force a sale, can he rely upon her future husband who he may not even have met or her trustee in bankruptcy?

What would happen if after making the gift the parent decided that he wished to move elsewhere? Would this necessitate a sale of the property, perhaps against the co-owner’s wishes? Would the parent’s share of the net proceeds of the sale and any other funds he had be sufficient for him to acquire another property?

A lifetime gift of a share of the family home to a child who lives with the parent can create particular problems if the donor has several children, all of whom he wishes to benefit equally and he intends to compensate the others by bequests in his will. When considering the provision to be made in the will, account will have to be taken of the fact that neither the size of the estate at the unpredictable date of death nor the variation in the value of the share in the house between the date of the gift and that date can be calculated in advance with any certainty. Furthermore, if the parent does not survive the making of the gift by seven years, the lifetime gift will swallow up most, if not all, of the nil-rate band with the result that the effective tax rate on the death estate and the bequests made by the will will be higher than that on the lifetime gift of the share of the house.

A factor which sometimes influences a taxpayer to give away his home during his lifetime is liability to contribute to possible future residential or nursing home fees. Readers should be aware that gifts made with the intention of depriving a taxpayer of assets which would otherwise be included in the value of assets used to determine his liability to pay or contribute to residential home fees can be ignored by a local authority and the local authority will pursue the donee with a view to including the gifts in the assessable assets and if necessary claiming them.

Conclusion

Any scheme to reduce inheritance tax involving the family home which fails can result in disastrous consequences all round: there will be no saving of inheritance tax, in many cases an income tax liability under the pre-owned assets charge will arise and unless the recipients of the home occupy it as their principal private residence, any gain that they make when they dispose of the property will be taken into account when assessing their liability to capital gains tax.

In my opinion it is advisable for a taxpayer to attempt to keep a roof over his head irrespective of the effect it will have on the inheritance tax payable on his death or home fees payable during his lifetime. Too often has a child whose business is in financial difficulties decided that it would be better for an elderly parent to pass the family home to him to avoid inheritance tax on the parent’s death or future home fees and incidentally allow him to use it as collateral security for the failing business. It is not worth taking the risk that you or your spouse or civil partner could be made homeless merely to save inheritance tax or home fees and anyone who is reasonably able to care for himself should be given independence and security by retaining the family home rather than having to rely upon the goodwill of the family.

PENSION SCHEME BENEFITS

Most pension schemes provide death-in-service benefits which are payable to beneficiaries chosen at the discretion of the scheme’s trustees. The trustees will normally take into account the wishes of the scheme member who can write to the trustees or fill in a letter of request expressing his wishes. The member should request that the benefits are not paid into his estate but paid directly to specified persons so that they do not swell his taxable estate.

USING ANNUITIES AND TRUSTS OF LIFE POLICIES

If a reasonably large sum is surplus to the taxpayer’s likely requirements it might be a good idea for the taxpayer to purchase an annuity and use the annuity to fund the premiums on a whole life policy on his life written in trust for intended beneficiaries. The premiums would probably be exempt under the gift exemptions for normal gifts out of income or the annual or small gifts allowances and the policy proceeds, being written on trust for the intended beneficiaries, would be outside the taxpayer’s taxable estate.

The scheme will only work to save inheritance tax if it can be shown that the purchase of the annuity and the effecting of the life policy are not ‘associated operations’. Associated operations, as defined in section 268(1) of the Inheritance Tax Act 1984 in this context are, in essence, two or more operations or transactions ‘one of which is effected with reference to the other, or with a view to enabling the other to be effected or facilitating its being effected. . . whether those operations are effected by the same persons or different persons and whether or not they are simultaneous’. It is therefore more likely that it will be possible to save inheritance tax in this way if the annuity and the life policy are purchased from different companies and it almost always pays to shop around to obtain the best value at the relevant time. Such a scheme would have to be carefully checked out in the light of the individual taxpayer’s particular circumstances including his income tax position and the rates available at the relevant time to see if it is likely to prove worthwhile. The life policy should be one with fixed premiums. Once entered into there is no going back upon such a scheme. It must also be remembered that the trust of the life policy will be a relevant property trust subject to the ten-year periodic and exit charges unless it qualifies as a trust for the disabled.

EQUALISING ESTATES BETWEEN PARTNERS OTHER THAN SPOUSES AND CIVIL PARTNERS

For parties to a happy and stable relationship, an effective way of reducing inheritance tax is to share their respective taxable wealth with a view to enabling each to make full use of their individual lifetime gift exemptions and nil-rate band in favour of others. This can be important for partners of different sex who have children but have not married and same sex partners who have adopted children but have not entered into a civil partnership, if one partner does not have assets in excess of the nil-rate band, but the other is wealthier and can afford to make some provision for the children without impoverishing the surviving partner on the wealthier partner’s death. However, transfer of assets other than cash between them might incur stamp duty or capital gains tax and inheritance tax if the donor partner does not survive for seven years and the gift causes his nil-rate band to be exceeded.

DISCLAIMING AND VARYING INHERITANCES BY DEEDS OF FAMILY ARRANGEMENT

What Deeds of Family Arrangement are and how they work

It is sometimes possible for anyone who receives an unwanted inheritance to change the situation to make it more tax efficient or appropriate to the needs of all concerned. This is done by all who are affected by the inheritance entering into either a document called a deed of variation or a document called a deed of disclaimer, both of which are sometimes referred to as a Deed of Family Arrangement. If this is done within two years of the death and the statutory requirements adhered to, the variation or disclaimer can be considered for inheritance tax purposes as having been made by the deceased on his death and will not be a transfer of value by the person who gives up or surrenders the inheritance. For income tax purposes, the deeds are not retrospective to the date of death, and income which is distributed between the date of the death and the date of the deed will be taxed as that of the original beneficiary. Deeds of Family Arrangement can be used to vary inheritance rights that are given by a will or which arise on intestacy and in spite of their name need not be by deed as long as they are made in writing.

The change in the situation is effected by the beneficiary disclaiming the inheritance or by all concerned agreeing in the deed to vary the dispositions of the estate. If one of the parties concerned has died, provided all who benefit under his will or intestacy consent, his personal representatives can enter into the deed on his behalf. If minors or others who do not have full legal capacity are involved it is necessary to make an application to a court to approve the rearrangement on their behalf but the court will only give its approval if it considers that the rearrangement is for the benefit of the minor or other person who is lacking full legal capacity.

The difference between a disclaimer and a variation

The difference between disclaiming something inherited from a will or under the laws of intestacy and varying the provisions of a will or the laws of intestacy must be clearly understood.

To disclaim a benefit under a will or an entitlement under an intestacy is to refuse to accept it and although a disclaimer can be retracted, it can only be retracted if no other person has relied upon it to his detriment. An inheritance can only be disclaimed if the person seeking to disclaim has not already benefited from it. The inherited benefit cannot be accepted as to part and refused as to part; it is all or nothing, although if more than one gift is made to the same beneficiary in a will or inherited on intestacy, one gift may be accepted and the other may be refused and disclaimed, provided they are clearly separate gifts.

On the other hand, to effect a variation the beneficiary first accepts the gift and then varies it so that another or others benefit, either in addition to, or to the exclusion of the original beneficiary. This point is very important because it necessarily follows that having accepted the inheritance in the case of a variation, the original beneficiary can decide its further devolution and who is to benefit from it, but having refused the inheritance in the case of a disclaimer he has no further control over it and it must devolve according to the other provisions of the will or the laws of intestacy as the case may be. Although it is possible to effect a variation of the devolution of jointly owned property which is inherited as the result of being a surviving joint tenant, it is not possible to disclaim survivorship rights.

There are different inheritance, capital gains and income tax consequences that result from the difference in the nature of a disclaimer and a variation and before making a decision it is essential that specialist tax advice be sought.

If an asset has been redirected once to a different beneficiary by a deed of variation, it is not permissible to redirect it a second time, but more than one deed of variation can be entered into in respect of an estate as long as they relate to different assets.

Redirection of assets is not always a sure-fire way to protect them from claims by the trustee of a bankrupt beneficiary.

Making the deed tax effective

If the deed is to be effective for tax purposes and the Revenue is to consider the change as having been made by the deceased so that there is to be a saving of inheritance and/or capital gains tax, the following conditions must be complied with.

• The change must be made in writing and in the case of a variation all the parties affected must be parties to the document to show they consent to the changes; but in the case of a disclaimer, only the person making the disclaimer is necessarily a party to the document.
• The disclaimer or variation must be made within two years of the death.
• The document that makes the variation must contain a statement made by all parties to it as to whether they intend it to have effect for the purposes of inheritance tax and/or capital gains tax. If they do so intend it will take effect for the chosen purpose(s) as if any variation had been made by the deceased, or as the case may be, any disclaimed benefit had not been conferred by the will or the intestacy laws.

If the variation results in more tax becoming payable, the personal representatives must be parties to the document unless, in that capacity, they hold no or insufficient funds to pay the additional tax. If additional tax is payable a fine can be imposed upon all parties to the document unless a copy of the document and a note of the additional tax payable is supplied to the Revenue within six months of the date of the document.

There is no necessity for a disclaimer to state that it is intended to take effect from the date of death; it does so automatically.

The effect of the deed

In the case of any estate where the residue is either partially or wholly exempt from inheritance tax, it is necessary to carefully consider whether any proposed disclaimer or variation will cause the total value of the non-exempt gifts to exceed the nil-rate band as a result of the grossing-up rules which are explained on page 28.

Some changes to the provisions of a will or to the devolution of an estate under the laws of intestacy can save very considerable amounts of tax if the estate is large, but others increase the amount of tax payable. The changes can affect not only inheritance tax, but also capital gains tax, income tax and means-tested social security benefit payments and may cost not insignificant legal fees to implement, but in the right circumstances and if carefully and knowledgeably done, they can be very worthwhile. The formalities for tax-effective Deeds of Family Arrangement have to be strictly observed and it is essential that advice should be taken from a solicitor or accountant who is knowledgeable about tax law before such a course of action is finally embarked upon.

It is not possible to disclaim an inheritance which is expected from the estate of someone who has not yet died.

CHOOSING INVESTMENTS

The type of investments held at death can make a considerable difference to the amount of inheritance payable because of the various reliefs (such as business relief and agricultural relief) which may be available. However, it must also be remembered that the type of investment chosen during one’s lifetime can also make a vast difference to one’s wealth at the time of death and investments should be chosen on their merits as investments and never be chosen solely with a view to obtaining any form of tax relief. The investments which attract the most tax relief are usually those with the greatest risk and the amount lost by market fluctuations is sometimes greater than the tax saved.

MAKING A WILL

An effective step that can be taken in life to reduce or avoid inheritance tax on death is to make a tax-efficient will. A good will will not only protect the testator’s loved ones after his death and ensure that his estate goes to the people he wishes to benefit from the efforts he has made during his life; it will ensure that there is more estate to go to them. If you have persevered so far, read on.