WILLS, PROBATE AND ADMINISTRATION Chris Whitehouse 5 Stone Buildings Lincoln s Inn WC2A 3XT Tel 0207 242 6201 Fax 0207 831 8102 Email edale@5sblaw.com These notes are intended as an aid to stimulate debate: delegates must take expert advice before taking or refraining from any action on the basis of these notes and the speaker can accept no responsibility or liability for any action or omission taken by delegates based on the information in these notes or the lectures. STEP Annual Tax Conference London September 2015
CONTENTS I INSTRUMENTS OF VARIATION 1 II INHERITING ISAs 2 III ENHANCED NIL RATE BAND (THE RESIDENTIAL NIL RATE BAND: RNRB ) 3 IV FLEXIBLE IPDIs AND TAX PLANNING 8 V ABOLITION OF THE FRANKLAND TRAP 11
I INSTRUMENTS OF VARIATION 1. Budget 2015 (published by the Treasury) at para 2.91 commented: Deeds of variation - the government will review the use of deeds of variation for tax purposes. See the Consultation document Review looking at the use of deeds of variation for tax purposes published 15 July 2015. It comments that HMRC have limited information about the use of DoV particularly for purposes other than gaining a tax advantage. 2. What sort of planning may be considered objectionable? See Vaughan Jones [2015] EWHC 1086 (Ch). The Deceased (who died in 2007) left his residuary estate to his widow and three sons in equal shares. The deed of variation provided for the residue to pass to the surviving spouse absolutely and said that the parties shall, if called upon to do so, give the notice required under the relevant Finance Acts for capital transfer tax purposes. a. The deed was rectified to include the necessary reading-back statement. b. It appears from the solicitor s attendance note that the plan is to pay as little IHT as possible at this stage and for [the widow] to transfer as much as she can and survive seven years. She subsequently made gifts of 20,000 each to two of the sons and over 73,000 to one of the sons. What of s142(3) (extraneous consideration preventing readingback)? Not decided, but see Lau v RCC [2009] STC (SCD) 352 for similar facts. 1
II INHERITING ISAs For deaths on or after 3 December 2014, a surviving spouse / civil partner has the benefit of an additional ISA allowance based on the value of the ISA investments of the deceased at the time of death: see the Individual Savings Account (Amendment) (No 2) Regs 2015 (SI 2015/869) and ISA Bulletin of 27 March 2015. Note especially: 1. the surviving spouse must have been living with the Deceased at the time of his death (i.e. the income tax rather than IHT test of whether married); 2. there are differences between cash ISAs and stocks and shares ISAs: it is necessary to inherit the latter if the spouse wants to keep the actual investments of the deceased. Inherit is defined as including inheriting under a will trust or as the result of a deed of variation. Example 1 At her death on 4 December 2014, Janice had 50,000 invested in cash ISAs. Her surviving civil partner, Julie, can invest that sum in a cash ISA (in addition to her own investment limit) provided that she does this within three years of Janice s death or (if later) 180 days after the administration of her estate ends. In this case, Janice is treated as dying (for the purposes of the three year period) on 6 April 2015. Julie does not have to inherit the cash sum. Consider the role of PRs: notify the spouse / civil partner the total value of the deceased s ISA investments and do not sell ISA stocks and shares until clear the spouse does not want them? 2
III ENHANCED NIL RATE BAND (THE RESIDENTIAL NIL RATE BAND: RNRB ) 1. The basic idea is to give an additional NRB in respect of a residential property which is left on death to direct descendants ( closely inherited ). 2. The legislation will come into effect in respect of deaths on and after 6 April 2017 but there will be provisions dealing with downsizing effective from 8 July 2015 (Budget Day) and there are similar rules to those already in force permitting an unused NRB to be used on the death of a surviving spouse / civil partner. 3. The legislation will be in F(No 2)A 2015 and there will be a consultation in the autumn on the downsizing issue with further legislation in FA 2016. Nine extra sections (s8d-s8m) will be inserted into IHTA 1984. Amount of the RNRB 4. The amount will increase as follows: 100,000 for 2017/18 125,000 for 2018/19 150,000 for 2019/2020 175,000 for 2020/21 5. BUT if the value of a person s estate (meaning assets less liabilities but ignoring exemptions and reliefs such as the spouse exemption and APR / BPR) exceeds 2m ( the taper threshold ), the RNRB is reduced at a rate of 1 for every 2 above the threshold Planning 6. Consider how to avoid the taper reduction: a. should the first spouse to die use up his NRB / RNRB in order to keep the survivor s estate below 2m (i.e. in will planning do not just assume that there is no loss of NRB if all is left to a surviving spouse); 3
Example 2 On Rufus death in 2016 he leaves his entire estate (worth 1.2m) to his wife Wilma. Included in his estate is a half share in the family home which share is worth 500,000. Wilma dies in 2021 and her total estate is then worth 2.65m so no benefit can be taken of the residence nil rate band (including that which was unused by Rufus). Contrast the position if Rufus had left his share in the property to his children when the total nil rate band available to him ( 325,000 + 175,000) would prevent a tax charge. b. the estate is a snapshot at death so can be reduced for these purposes by lifetime gifts (including death bed gifts!). What is a qualifying residential interest? 7. Whether the property is a residence will presumably be decided on the basis of the CGT main residence relief case law (see especially Goodwin v Curtis [1998] STC 475 CA and recent cases). BUT: a. the RNRB is not restricted to the main residence (the PRs are given an election to select which residence of the deceased is to be taken); b. there is no garden / grounds limitation (to half an hectare); c. no requirement that the property be occupied as a residence throughout the ownership period of the taxpayer. Example 3 Jason comes back to the UK to receive treatment for his illness. He terminates the tenancy on his flat in Putney (which he has owned and let out for over 20 years) and lives there for the final months of his life, leaving it to his daughter in his will. On death a residence nil rate band is available. The property must be closely inherited 8. This means that it must be left on death to children / grandchildren etc (issue). But note that this includes step children; adopted children (treated as children of both the natural parent and adoptive parent) and foster children. 4
9. When is property inherited? If left by will; on intestacy; passing by survivorship and also if it is settled provided that the lineal descendant: a. is the IPDI beneficiary of the trust; or b. if the trust is disabled he is the disabled person; or c. if he is a child of the deceased and the trusts fall under s71a (BMT) or s71d (18-25 trust) IHTA 1984. Presumably the condition may be met if reading-back occurs: eg under a deed of variation (s142) or under a s144 trust. 10. A descendant also meets the requirement in the following situation: Example 4 Sixtus gives his country cottage to his son but continues to occupy it thereby falling foul of the reservation of benefit rules. On his death the residential nil rate band is available in respect of the cottage since the son is treated as inheriting the property on death! Transfer of unused RNRB 11. An unused RNRB can be used on the death of a surviving spouse with similar rules to those that currently apply to an unused NRB. Accordingly (on a claim being made in the usual way) the survivor s estate may benefit from a total RNRB of 350,000 (in 2020-21). Note: a. it does not matter that the deceased did not own a residence: there is still an unused RNRB capable of being transferred on death (nor does it matter if he did own a residence but left it to (say) his sister); b. it follows that in the case of deaths before 6 April 2017, the RNRB will never have been used and hence is available for carry forward to be used on the death of the surviving spouse / civil partner; c. to make full use of two RNRBs it is necessary for the survivor to have a residential property worth at least 350,000. 5
Differences between the RNRB, the ordinary NRB and the transferred NRB 12. There are now three NRBs, all with slightly different rules: a. the ordinary NRB is available for life and death chargeable transfers on a first come first served basis; b. the unused NRB can be set against tax arising on the death of the survivor but this will include tax on failed PETs and any additional tax on an immediately chargeable lifetime transfer; c. the residential NRB is only available against tax on the death estate provided that the relevant conditions are met. Example 5 Sam gives his country cottage to his daughter Julie (a PET). He dies living in rented accommodation within seven years of the gift. Whilst the failed PET can benefit from Sam s nil rate band (and from a transferred nil rate band) the residence nil rate band is not available and so is wasted. 13. It is important to appreciate that the RNRB is not set against the gift of the residential property but applies generally to the charge on the estate (i.e. it is not focussed on the property so that there may still be a tax charge on it!). Example 6 Doris dies in January 2021. Her husband died in 2015 and left her his entire estate. Doris had made a PET of 500,000 to her sister in 2018 and established a discretionary trust of 150,000 shortly before her death. Her death estate is worth 1.9m and includes her Sloane Square flat (value 1m) which she leaves (subject to tax) to her step-daughter with the residue passing to her brother. The IHT calculation is as follows: 1. Doris nil rate band will be set against the 2018 PET leaving a chargeable amount of 175,000. 2. Her husband s unused NRB may be claimed and will be set against: 6
a. the balance of the PET ( 175,000); b. the remaining 150,000 will then be set against the extra tax due on the creation of the trust. 3. So far as the taxation of the trust is concerned, it will be necessary to recalculate the entry charge in the light of the failed PET: ignoring annual exemptions, this is 150,000 x 20% = 30,000. Note that this charge cannot be reduced by the transferred nil rate band. 4. So far as Doris estate at death is concerned, the RNRB of 350,000 will be available (that of her predeceasing husband must be claimed by her PRs) and so the tax payable is 1.9m - 325,000 = 1,575,000 x 40% = 630,000 and the share attributable to the flat is therefore 331,579. Construing gifts of the nil rate band 14. This has been a problem area since the introduction of the transferable nil The losers rate band (see Loring v Woodland Trust [2014] EWCA (Civ) 1314). Consider: I give to those of my children who survive me and if more than one in equal shares such sum as at my death equals the maximum amount which could be given to them by this will without inheritance tax becoming payable on my estate. 15. Taxpayers with no children. For instance, two sisters living together and the property is inherited by the survivor. No RNRB. 16. Taxpayers who rent a property and have chosen to invest their money eg into an investment portfolio / let properties. 17. The IHT legislation which will be an even greater shambles! 7
IV FLEXIBLE IPDIs AND TAX PLANNING Example 7 On his death in 2009, Jasper leaves the residue of his estate on a flexible IPDI trust for his surviving spouse Martha. There are continuing trusts after the IPDI for the children of the marriage. Included in the residue is the family home, Westwinds, which was solely owned by Jasper. Martha lives (and intends to go on living) in Westwinds. In 2016 the house is worth around 800,000 and Martha is in her early 70s. Her IHT nil rate band will cover her investments and so on her death Westwinds will attract an IHT charge at 40%. The following IHT planning opportunity exists: 1. the trustees carve a 20 year lease out of the property. This can be done by granting it to a nominee. No rent will be payable under the lease and its duration should not exceed 21 years because of the enfranchisement rights which would then apply to enhance its value; 1 2. having carried out Step 1 the trustees retain the lease on the IPDI trust for Martha but use their overriding power to appoint the (encumbered) freehold interest to (say) Martha s children; 3. Martha continues to occupy Westwinds because of the lease that has been retained in the IPDI trust. The tax consequences of this arrangement are as follows: a. Martha will make a PET on the termination of her interest in the freehold. Provided that she survives for seven years, an IHT charge will be avoided. Before the FA 2006 changes in the IHT treatment of settlements, the appointment in favour of the children would usually have been made on continuing trusts. However, such trusts are now relevant property settlements and Martha would therefore make not a PET but an immediately chargeable transfer. If the value of the transfer of value resulting from the ending of her interest in possession exceeded her available nil rate band, a 20% tax on the excess would result. Hence, it will commonly be desirable to make an outright appointment to the children albeit that this may have a CGT downside; 1 The length of the lease should be related to Martha s life expectancy (i.e. to how long she anticipates continuing to live in the property). For an older taxpayer, therefore, a shorter lease may be taken. Bear in mind that at the end of the lease term, if Martha is still alive and wishes to continue to occupy the property, she will have to pay a full rent to avoid a reservation of benefit (FA 1986, Sch 20, para 6(1)(a)). 8
b. main residence relief will be available to prevent a CGT charge when the freehold is appointed out of the trust to the children; 2 c. so far as reservation of benefit is concerned, Martha is treated by s102za as making a gift of the freehold interest (this is the no longer possessed property ) but she does not reserve any benefit in this property. Her continued occupation of Westwinds results from her entitlement under the lease which has, of course, been retained in the IPDI trust. The arrangement is modelled on the Ingram scheme which was stopped in the case of arrangements made by individuals by the 1999 legislation. However s102za does not apply for the purpose of these sections. 3 But what of the future, and especially CGT after Martha s death? Example 8 Assume that in Example 7 Martha s IPDI continued in the leasehold interest and in 5% of the freehold (95% of the latter having been appointed to the children). After Martha s death the trustees sell the property. CGT relief under s225 will be due given that during Martha s life it was her main residence and she was a person entitled to occupy it under the terms of the settlement. Relief is given on the entire property owned by the trustees: it is not limited to the lease occupied by Martha. What of the proposed DOTAS extension to IHT? The July 2014 Consultation paper commented: 2.45 For example, the spouse and civil partner exemption is designed to ensure that transfers between spouses and civil partners are exempt from IHT, recognising the unique legal commitment entered into. The exemption means that, for example, on the death of the first spouse the survivor does not have to sell the family home in which they have both been living. Where an individual person uses a standard Will to make use of the exemption in a straightforward way, the Government would not want sight of this transaction under DOTAS. 2.46 Equally, arrangements which are permitted by the fundamental structure of inheritance tax would not necessarily have to be disclosed. For example, where after the death of his first wife the deceased remarried, he may wish to ensure that the assets from his first marriage pass to the children of that marriage. He can achieve this by leaving that part of his estate on revocable interest in possession trusts for his second wife, with remainders to his children. 2 TCGA 1992 s225. 3 Because Martha does not dispose of an interest in land it is not thought that the pre-owned asset income tax charge applies. 9
If the life interest is brought to an end whilst the second wife is still alive, she will be treated as making a potentially exempt transfer which will be an exempt transfer on her surviving seven years. The assets pass down a generation free of inheritance tax because of the structure of the tax. However, if the surviving spouse s interest in possession was terminated after the first spouse s death but in a way that circumvented the reservation of benefit rules so that the surviving spouse obtained continuing access to the property she shared with the deceased, such a scheme would be disclosable. 4 4 This refers to Ingram and reversionary lease schemes that may be used when the residence is settled. 10
V ABOLITION OF THE FRANKLAND TRAP Will take effect for deaths on or after 10 December 2014. Example 9 Tad dies on 9 December 2014 and his residuary estate is left on a discretionary trust. 1. Within three months of his death, the trustees appoint the residue absolutely to his surviving spouse / civil partner. No reading-back under s144 so that there is no spouse exemption and Tad s estate remains fully taxable (see Frankland v IRC 5 ). 2. If the trustees had appointed an interest in possession to the surviving spouse / civil partner then this is an IPDI and is read-back so that the spouse exemption applies. But if Tad dies on 10 December 2014 or later, both the above appointments will be read-back so that the spouse exemption will prevent any IHT charge arising. 5 [1997] STC 1450 CA. 11