Deeds of Variation – Excessive tax planning?

Tax planning continues to be a ‘hot topic’. The government is committed to clamping down on “aggressive tax planning”. In addition, these days the term “excessive” tax planning is often used, sometimes in the same or a similar context as “aggressive”. What constitutes excessive tax planning is not altogether clear. A cynic might argue that excessive tax planning is whatever the government and HM Revenue and Customs (HMRC) deem it to be from one day to the next!

On what side of the tax planning fence (ie acceptable or excessive) do deeds of variation (DOVs) fall? The government and HMRC are apparently unsure. The government announced at summer Budget 2015 that it intended reviewing the use of DOVs for tax purposes, following concerns that the tax rules are being abused. A consultation document (‘Review looking at the use of Deeds of Variation (DOVs) for tax purposes’) was published on 15 July 2015 (www.gov.uk/government/consultations/review-of-deeds-of-variation-for-tax-purposes-call-for-evidence).

It is important to appreciate from the outset that a DOV is a legal instrument, with implications extending far beyond tax. The above review covers the use of DOVs for tax purposes only, and not their use as a legal instrument. 

DOVs and tax 

The tax provisions apparently causing HMRC concern relate to inheritance tax (IHT) and capital gains tax (CGT). The IHT provision allowing for the alteration of dispositions taking effect on death (IHTA 1984, s 142) has been, and continues to be, one of the more helpful and flexible sections of the IHT legislation. It offers a two-year breathing space in which to allow an adult beneficiary to rewrite the provisions of the deceased’s will, or the passing of property on intestacy. A variation within s 142 is not treated as a transfer of value for IHT purposes, but as if the redirection of property that formed part of the deceased's estate had been made by the deceased. 

A detailed analysis of the provisions of IHTA 1984, s 142 (or the capital gains tax (CGT) provisions of TCGA 1992, s 62(6) – see below) is beyond the scope of this article. However, in broad terms the IHT provisions operate where:

  • within a period of two years after the individual’s death;
  • the destination of any of the assets of his estate (excluding assets charged under the reservation of benefit rules);
  • passing by will, intestacy or ‘otherwise’;
  • is varied/altered or the benefits disclaimed by an instrument in writing made by one or more of the original beneficiaries; and
  • the instrument of variation contains a ‘statement’ by all the relevant persons that it is to apply for IHT purposes (ie for variations (but not disclaimers) from 1 August 2002). 

The ‘instrument’ referred to in the legislation is usually effected by way of a DOV. However, this is not essential, although it is helpful as it ensures that the variation is binding as between the original beneficiary and the donee. 

If the variation increases the IHT payable, the instrument of variation must be sent to HMRC within six months of the variation. However, if the variation does not affect the IHT payable, a copy of the variation does not need to be submitted to HMRC (see HMRC’s Instrument of Variation Checklist (IOV2)). 

The CGT provisions in respect of instruments of variation are subject to similar conditions as apply for IHT purposes (see TCGA 1992, s 62(6)-(8)). Where the CGT conditions are satisfied, the effect is broadly that the variation is not treated as a disposal for CGT purposes, and it is treated as if the variation had been effected by the deceased. Thus the effects of the variation are treated as being retrospective to the date of death for most CGT purposes.    

It is possible for a DOV to apply for both IHT and CGT purposes, and it will usually be beneficial for the terms of a DOV to be treated as made by the deceased. However, it is possible to opt for the special tax treatment (afforded by IHTA 1984, s 142 or TCGA 1992, s 62(6)) to apply to either or both. 

The end is nigh? 

The above review was instigated to explore the circumstances and frequency of DOVs for tax purposes, and to examine how the tax provisions around DOVs operate, with a view to establishing what role tax advantages play in making a decision to vary a will by DOV, and whether any tax changes should be made. HMRC claim to have only limited information about the use of DOVs, as deeds are not always submitted to HMRC. 

The consultation document acknowledges that DOVs can be used for a number of good non-tax reasons, such as to clarify uncertainty in a poorly drafted will, or to take account of the differing fortunes of beneficiaries under the will. However, the government is concerned here about DOVs which are tax motivated. 

There can be no doubt that many DOVs are undertaken for tax purposes. In fact, the courts will rectify a DOV in certain circumstances if it does not have the intended tax effect: for example, see Giles v The Royal National Institute for the Blind & Ors [2014] EWHC 1373 (Ch). More recently, in Vaughan-Jones & Anor v Vaughan-Jones & Anor [2015] EWHC 1086 (Ch), The High Court accepted evidence that it was the intention of all parties to the DOV, and its draftsman, that it should be backdated to the date of death for IHT purposes (although the court was not satisfied, on the evidence, that there was any intention to also include a ‘reading-back’ statement for CGT purposes).

It would be worrying if the government considered that any DOV used for tax planning purposes should be regarded as excessive tax planning and legislated against them in some way. For example, in the Giles case above, two sisters (H and E) both had wills. E was a beneficiary of H’s will, and E’s will left the residue of her estate to four charities. H died in February 2006 (the IHT initially calculated on H’s estate was £254,595), and E died in September 2007. The combined effect of the two wills was that assets passed first to E on H’s death, and only on E’s death did these pass to the charities. Thus the gifts which ultimately benefited the charities indirectly attracted IHT. 

A deed of variation was therefore executed to take advantage of IHTA 1984, s 142 by redirecting E’s entitlement under H’s will to the charities. The intended effect was that the redirected gifts would be subject to the exemption from IHT for gifts to charity (under IHTA 1984, s 23), and the sums otherwise due by way of IHT would accrue to the four charities under H’s will (as deemed to be amended by the DOV). Unfortunately, the DOV as originally executed did not have the intended effect, and actually achieved no IHT saving. However, the High Court accepted an application to exercise its discretion and rectify the DOV, so that it reflected the intention of the claimant when it was made. 

The rectified DOV therefore achieved an IHT saving in the above case. However, the ultimate beneficiaries of this IHT saving were four charities. This is (at least in my view) an example of a DOV used for an acceptable tax purpose, and was not excessive. 

It is not the first time that changes to the tax provisions relating to DOVs have been mooted; it is understood that previous governments considered introducing anti-avoidance provisions to prevent abuse of the rules. However, the fact that no such changes were introduced is hopefully a sign that DOVs should fall on the ‘acceptable’ side of the tax planning fence. 

The consultation period ends on 7 October 2015. 

For detailed commentary on variations (and disclaimers) and post-death planning for IHT purposes, see the latest version of Ray and McLaughlin's Practical IHT planning (Bloomsbury Professional). See also Capital Gains Tax (Bloomsbury Professional) as to the CGT aspects.

 

Mark McLaughlin CTA (Fellow) ATT (Fellow) TEP is a consultant to professional firms with Mark McLaughlin Associates Ltd (www.markmclaughlin.co.uk). Mark is also Managing Editor of TaxationWeb (www.taxationweb.co.uk). He can also be contacted via Twitter https://twitter.com/charteredtax and LinkedIn http://www.linkedin.com/pub/mark-mclaughlin/11/811/12.

Written by Ellie MacKenzie

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