Deed of Variation Case Study

Susan is a seventy-five-year-old widow. She has four children and several grandchildren. 
Her second husband, Robert, died recently and she has therefore been widowed twice. On both occasions she fully inherited, meaning that the NRB of each deceased husband was 100% unused. In situations such as this where there is more than one marriage, the survivor’s NRB (i.e. Susan’s) can never be increased by more than 100%.

Susan is domiciled within the UK for IHT purposes, with estate and Inheritance Tax (IHT) planning high on her agenda. 

In general law, a variation takes effect from the date of the ‘instrument’ and if it gives rise to a loss to Susan’s estate, there is a transfer of value. However, provided that the conditions of IHTA84/S142 are satisfied, then it will be treated for IHT purposes as if the redirection had been made by the deceased (Robert), and therefore the redirection of property is not a transfer of value by Susan. In other words, she is not making a gift subject to the seven-year rule.

The only stipulation in tax law about the form of an instrument is that it must be in writing. It does not have to be a formal Deed. HMRC can accept a letter or note from the beneficiary (Susan) redirecting her inheritance as a valid variation, so long as the document conforms to the guidelines and otherwise meets the conditions of S142.

Susan decides to ‘vary away’ the following into a discretionary trust:

For IHT purposes, Robert’s NRB will now be fully utilised meaning that there is no unused NRB to transfer to Susan. Remember, however that Susan has been widowed twice. On the first occasion she fully inherited, meaning that the NRB of her first husband was 100% unused. This will give rise to a double NRB on Susan’s death. In short, if Susan varies away £325,000 inherited from Robert into a discretionary trust, then:

• She can be a potential beneficiary of that discretionary trust.
   
• Her estate is reduced by £325,000, but for IHT purposes only it is treated as if Robert had set up the trust.
   
• Susan’s estate will still benefit from a double NRB on her death (due to the fact her first husband’s NRB was 100% unused).
   
• In effect three NRBs will be utilised.

Are there Capital Gains Tax (CGT) implications to consider?

CGT legislation (S62(6)-(9) TCGA 1992) states that the beneficiary (Susan) will not be making a disposal for CGT purposes if the instrument contains a statement that S62(6) applies. It is possible however to exclude S62(6) from applying.

Consider Susan. She varied away shares worth £315,000, and let’s assume those shares had a probate value of £304,500. How is that post death gain dealt with?

Susan can incorporate wording into the DOV stating that she is not making a disposal for CGT purposes. This would mean for future CGT purposes the trustees base cost will be £304,500. In this case however, assume that Susan has an unused CGT exemption meaning that the £10,500 post death gain falls within her annual exemption. She can therefore exclude S62(6) from applying. Consequently: 

• Her disposal to the trustees triggers a gain which is tax free within her annual exemption.
   
• The trustees acquire a CGT base cost of £315,000 for future disposals (rather than £304,500).
   
• This will reduce any future capital gain on a later disposal of the shares by the trustees.

The trustees can continue to hold the shares remembering that any interest or dividend income will be taxed at trustee rates. The trust will be ‘settlor interested’ for income tax purposes because Susan is a potential beneficiary. This means that Susan is taxable on the income arising even if she doesn’t receive it. The trustees will receive the income and be taxed on it, and then Susan will get credit for that tax paid to set against her own income tax liability.

There are no ‘settlor interested rules for CGT. Instead, the trustees are simply liable to CGT at 20% for gains above the trustees’ annual exemption.

If Susan considers the ‘settlor interested’ income tax rules cumbersome from a self-assessment perspective, this might partly influence consideration of a non-income producing Insurance Bond as a trustee investment rather than income producing investments.

• No tax due until a chargeable event occurs and a gain is calculated on it.
   
• While Susan is alive, chargeable event gains fall back on her for tax purposes. She has a statutory right to recover any tax from the trustees.
   
• Trustees can take 5% cumulative (tax deferred) withdrawals and pay this capital out to a beneficiary.
   
• Trustees could assign (i.e. gift) segments to beneficiaries (children and adult grandchildren) to access their personal tax position upon a subsequent encashment. The gift from the trustees would not trigger a chargeable event.