I am instructed to prepare a DoV for some clients whose mother recently passed away. The property is in her sole name and worth circa £500K. There is about £60K of other assets. Their father is still alive. He was still married to the deceased, but they were separated and he has a new partner.
They are considering preparing the DoV to re-route their entitlement to their father, under the DoV. The idea is that the father would then gift this back to them. I am of the understanding that this falls foul of the anti-avoidance rules.
The sole purpose behind the DoV is to maximise the TNRB available on father’s death.
If they were to re-route their entitlement to their father and then the father gifted them what he received under the DoV, what would be the consequences? Is there a period by which him owing the property would not not fall foul of the rules?
Generally, when an inheritance is redirected to the surviving spouse/civil partner, HMRC will enquire as to whether there is any proposal to benefit the original beneficiaries and, if there is, will not allow s.142 IHTA (or s.62(6) TCGA) to apply.
The judge’s aside in Vaughan-Jones v Vaughan-Jones [2015] EWHC 1086 (Ch) @ paras 50-52 are instructive.
The fact that the mother and father were separated at the time of the mother’s death should be a “red flag” to all involved.
Mindful of the threat to professional advisers who are involved in tax avoidance arrangements, I wonder if once a professional has knowledge of such a proposal, they can safely prepare the documentation.
Other contributors might comment on whether such an arrangement is caught by DOTAS.
If the father fails to survive 7 years from the date of any gift to the children, his own nil rate band will be reduced (potentially to the detriment of his new partner) and any tax saving envisaged by the use of a DoV perhaps negated.
Might the position be better if the father were instead given a revocable IPDI, which may be revoked at some point in the future (certainly not within the first 12 months). Provided the trustees do not include father, that should remove the principle arguments that father has given any consideration - as he has no control or ability to return anything.
The IHT Manual (IHTM35093) contemplates this and asks:
“Where this applies, the second question above should be amended to ask whether the trustees have already exercised the power of appointment or whether an exercise of it is contemplated.”
They may therefore consider a challenge if there is a fixed plan to revoke but absent that, it is not clear how they would challenge and, even if there is a clear intent, it is not absolutely clear how HMRC would bring a challenge (they could of course refuse the exemption and force the taxpayer to bring it to tribunal).
I’m afraid I don’t have any experience of actual challenges, although I have dealt with variations creating IPDIs in the past where there was no clear intent and the interest was revoked in several tranches over 5 years. There was some justification in doing so as the assets included a number of chattels in the spouse’s home.
Andrew makes the point that a terminable IPDI may be suitable in these circumstances and this can certainly be useful (I have just such a matter at the moment), but I think Andrew meant that any termination (if one becomes desirable at a future point in time, and being in no way pre-ordained) should not take place within the first 24 months, rather than the first 12: see s.142(4).
James raises a good point, although it only applies if the IPDI is created using s.142 IHTA.
If the trust fund is appointed into the IPDI/flexible life interest trust (FLIT), using the powers in the will, s.144 IHTA applies. In which case s.142(4) has no application, and there is no similar provision applicable to s.144. Technically, the capital within the FLIT could be appointed away from the life tenant the next day. However, that could well raise questions from HMRC and lead to the arrangement being challenged.
I am open to correction but I think s142(4) is intended to catch DoVs which seek to establish an interest in possession trust for a limited period of less than 2 years from the date of death. Under such a trust, it would automatically terminate at the end of the stipulated period and pass to other beneficiaries. I do not think this section applies where a full life interest (IPDI) is created and the Trustees terminate it under a discretionary power given in the DoV. Having said that, caution dictates that it may be better to await the expiry of the 2 year period before terminating.
Graeme’s literal reading of s.142(4) is perhaps the more natural one. However, I don’t think that the point is beyond doubt and the cautious approach he proposes is for that reason the one I adopt.
The issue is that the section provides that an IPDI is to be disregarded if a variation to which s.142(1) applies “results in” property being held in trust “for a period which ends not more than two years after the death”. It doesn’t seem wholly clear to me that it is the exclusively the terms of the trust arising under the variation ab initio which must “result” in the period of less than two years: “results in” can have a wider meaning than that. A purposive construction of s.142(4) might conceivably imply the inclusion of the words “in the events that have happened” after “results”. But I am not aware of any specific authority on this question either way. IHTM35133 does not include an example on this set of facts (which might be thought helpful), but, worryingly, they highlight the word “results” in inverted commas, which might indicate that HMRC adopts the wider construction.
McCutcheon deals with this at 8-162. The authors describe s.142(4) as “unhappily worded”. They say that the literal interpretation which Graeme proposes is “optimistic” because the trusts created by a power of appointment are read back into the original settlement (see Thomas on Powers, 7-168), which must be an orthodox statement of trust law.
On balance, as I think we all agree, it will typically be prudent for trustees to wait at least two years from the death before even beginning to consider whether or not they might wish to terminate an IPDI created under a s.142 variation. If the point is overlooked by ill-advised trustees, or if circumstances require earlier action, then they might have an arguable case if/when HMRC seeks to claw back the IHT on the earlier death. But I’d rather be acting for the Revenue in that action than the taxpayer!