PRs would do well first to obey the law, of which there is abundant clarity of principle, if less as to its application to any given set of facts.
Where the estate is solvent s34(3) and Sch 1 AEA 1925 apply (note that “The order of application may be varied by the will of the deceased”). This is supplemented by the doctrine of “marshalling”, which is preserved notwithstanding anything in the AEA: s2(3)(a).
The top priority fund to suffer payment out of debts and liabilities is almost always residue at number 2 in the list (undisposed of property at number 1 is a rarity). Creditors are not affected: they have to be paid and are not concerned how the PRs resort to available funds. Tax is just another liability. So the general rule is that residue suffers first whoever is entitled to it. Marshalling will not assist a residuary legatee as they can only claim reimbursement from property at number 1.
Here there is a specific gift which falls within number 6. Not number 4 as it is not charged with the payment of “debts” in general. However the testator has made a gift only of its net value after IHT by the subject to tax direction. If the gifted asset has to be sold the legatees can only seek to recoup from assets higher up the order that net value.
There is also s41(b) IHTA which applies “Notwithstanding the terms of any disposition”. This means that a share of residue going to a charity is exempt from tax so any IHT payable must be borne, one way or another, by other legatees. The charity’s gift is however a gift of residue so its share is calculated as all or part of the value of an estate net of IHT chargeable on it, with specific and pecuniary gifts taking priority but having to bear that IHT and possibly having to abate; but residue is what it says it is and such gifts are payable, if they can be, in priority to residue and in a solvent estate some residue will be left. Arguably s41(b) does not affect the operation of the AEA (which is not a “disposition”) so it leaves open the question: does it affect the statutory order and is there a conflict as to precedence? IHTM26203 sets out HMRC’s view which seems to be that the IHTA prevails. Residue, even if wholly or partly exempt, cannot avoid being calculated net of IHT on specific gifts which are not subject to tax. IHTM26000 is useful in describing the calculations so laconically ordained by the statutory provisions. HMRC see them as mandatory as regards IHT.
So if a specific gift is subject to IHT and the asset has to be sold to pay it the legatees are entitled to recoup its net value via AEA and marshalling but NOT from exempt residue or exempt specific gifts. As regards other debts such exempt residue and gifts are fully subject to the AEA and marshalling. But even exempt residue is net of IHT on gifts not bearing their own tax.
In my experience testators, and so by necessary implication their advisers, pay insufficient attention to funding the payment of tax. A direction that a gift is subject to tax in many estates is in effect tantamount a direction that the asset is to be sold, since rarely can the legatee fund the tax personally in order to facilitate a transfer to him of the asset intact. A direction that it be free of tax (or silence, which has the same outcome) may mean that the size of residue is not what the testator expected. As HMRC say in IHTM26203: “Any chargeable specific gift which is free of tax is also paid gross, without deduction of tax. The tax on such gifts is paid out of residue, even if the residue is wholly or partly exempt.” This may concern the testator less if residue goes to charity but more if it goes to a surviving spouse. Insurance held outside the estate on a lifetime trust for the beneficiary in question is always worth considering as a funding mechanism.
Jack Harper
| paul Paul Saunders
17 April |
Technically, the IHT is a charge over the whole estate – see s.211 IHTA 1984. Accordingly, I consider the PRs are entitled to pay the IHT from residue. The allocation of tax between the various interests within the estate is an administrative matter for the PRs in which HMRC has no interest (or standing). However, the charity(s) may object on the basis of the PRs’ “self-interest”, mindful that they are also beneficiaries of the land given “subject to tax”.
Although I believe that such argument may be more “bluster” than a serious concern, especially bearing in mind that if the IHT is not paid then a grant cannot be obtained, it may serve to distract the PRs from doing what is right to protect the estate (and, thereby, the charity’s interest).
Perhaps of greater concern is that the estate has only a 20% interest in the land. Questions might be raised as to the future of the land – do the trustees of the land intend to retain it indefinitely, or is there the likelihood of a sale in the foreseeable future? This will inform the extent to which residue of the estate may need to be retained to fund the future instalments of IHT (and interest), and when the administration of the estate might be completed.
Even if they distribute the residuary estate, the PRs remain personally liable for the outstanding IHT, including that on the “refusenik’s” share.
I suggest the PRs consider seeking advice from Chancery counsel to help them navigate the various issues that arise (including whether such advice should be at the expense of the estate, generally, or of any particular element).
Paul Saunders FCIB TEP
Independent Trust Consultant
Providing support and advice to fellow professionals