Deed of Variation Intestacy - Income Tax

Trusts Discussion
1

I am dealing with an intestacy estate. The beneficiaries are husband and two children, A and B.

There has been estate income which has not been distributed by the PRs since death.

Just before the 2-year date of death anniversary, a Deed of Variation has been prepared to distribute the entire estate along with any income which has arisen from death, to husband and A. (B not inheriting at all.)

I understand a DoV is not retrospective for income tax purposes. However, TSEM1815 states: ‘For the purposes of Chapter 6, Part 5 ITTOIA the deed may have the effect of changing the identity of the person who will be deemed to have received income.’

Does this mean that if the PRs distribute income after the Deed of Variation, then this can be distributed to the new beneficiaries only and declared on their tax returns, and B has no reporting obligations? Further, presumably all the income is treated as having been paid in one go.

Ihsan Ali

2

Where any distribution has been made to a residuary beneficiary (even chattels), it is treated as a distribution of income arising within that tax year.

If any distribution had been made to a beneficiary before the date of the deed, the beneficiary will be deemed to have received income during that tax year, to the lesser value of the distribution(s) and their share of the estate income that is not deemed to have been distributed during that tax year and any preceding tax year.

If no distributions had been made before the variation was made, for income tax purposes the estate income will be shared only by the husband and A.

It is irrelevant when the PRs decide to distribute “income”, ANY distribution from the estate has income tax implications.

Paul Saunders FCIB TEP

Independent Trust Consultant

Providing support and advice to fellow professionals

3

You do not say what type of income and whether tax has been deducted.

The income has presumably become taxable at basic rate, by deduction or assessment, on the PRs and is “estate income” for Chapter 6 of Part 5 ITTOIA 2005. TSEM7450-7756.

The difficulty arises in allocating that income to the beneficiaries entitled to it under the rules set out in those statutory provisions.

It is necessary to:
(a) classify the interest of each beneficiary and their entitlements to estate income; and
(b) identify payments to them, if any, in the relevant tax period.

An initial problem is not just that an intestacy is not mentioned in the rules but that therefore we are not told how to classify the statutory legacy. Is it like a pecuniary legacy in a Will? That would not carry a right to income (as opposed to interest) so it is not apparently a “specific disposition” which under the rules is taxed on the beneficiary entitled to the income attributable to it.

But what if debts exhaust residue so that estate income is actually paid to a pecuniary legatee? I would expect HMRC to tax him on it. The statutory legacy is like that but is payable in priority to residue, which makes it more likely it will include income where there is no residue, so surely it cannot be taxed on those who in the event receive nothing. TSEM7800-7868 is silent on treatment of income.

I assume that the statutory legacy is an absolute interest and that so are the interests in residue of H A and B. You have to assume that residue is ascertained and identify who would then be entitled to the income. In the first instance it will be residuary income so divisible 50% to H and 25% to each of A and B.

Now one identifies payments. I understand that there will have been none before the variation. Payments will occur later during the rest of the admin period or at its end. Under s.650(4) a payment is made not just to a person direct but to another in right of the person or for their benefit. Thus a bankrupt remains taxable personally on income which vests in his trustee.

The variation has assigned pre-variation income differently to its strict entitlement but when payments are made they should be taxed ultimately in the above proportions. (In an exceptional case on the statutory legatee if there is no residue). Income arising after the variation will be taxable on the persons to whom the document allocates it (it is no longer allocated per the Will).

It is quite common for a variation to not re-allocate income arising before its execution but to delay payment because the income is not taxable on the beneficiaries until paid. But for absolute interests income has to be ultimately allocated to tax years and liabilities adjusted if different to those charged by reference to tax years of payments.

TSEM7400 deals with small estates and informal procedures. In my experience the Chapter 6 rules can be applied with a sensible broad brush as long as no liberties are taken in arriving at the tax outcome of the allocations e.g. payments of income are made to repayment claim beneficiaries in excess of what they are entitled to under the rules.

Jack Harper

4

I think I disagree with Paul in that if income is ultimately attributable to H A and B in a pre-variation period it is taxable on them even if paid to H and A only. To avoid that either the DOV would have not disturbed the pre-execution entitlements or ensured the payments corresponded with them.

Jack Harper

5

My understanding is based upon an explanation of s.671 Income Tax (Trading and Other Income) Act 2005 provided by HMRC.

Paul Saunders FCIB TEP

Independent Trust Consultant

Providing support and advice to fellow professionals

6

I am not able to find any HMRC commentary on s.671. But this section is anyway about “successive” absolute interests. The interest of an absolute interest under a will/intestacy followed by an absolute interest under a DOV are chalk and cheese. S.671 is only applicable to two absolute interests in an estate which are enjoyed by different beneficiaries in the same estate in succession so that “aggregate income” must be apportioned between them.

The scheme of the estate income rules as regards absolute interests is to identify the aggregate income of the estate for each tax year. In the first instance a relevant beneficiary is taxed on what is paid to him in any tax year, grossed up, but with an upper limit of his share of the gross aggregate income for that tax year. At the end of the AP he is finally taxed on his share of the gross aggregate income for each tax year, with credit for tax already paid on earlier payments made to him. The PRs plainly should not pay him more than he is entitled to in any given tax year but, if they do, credit for any tax overpaid will be sorted out in the final reckoning.

In the OP up to the date of the DOV the aggregate income is to be attributed to H A and B in the ratio 50; 25; 25. Assume for simplicity that no payments are made before the DOV is executed. At the end of the AP the estate income of this period will be taxed on these persons in this ratio. The DOV however has validly diverted this income to H and A only but this cannot affect the tax charge on that prior income; it can properly charge income arising after the DOV on H and A only. Can B be taxed on a share of prior income he did not and never does receive? The answer is Yes: because he has by the DOV assigned his share of that income to H and A AFTER that income arose and the subsequent payment of it to them is in the words of s.650(4) “a payment to another” in right of B. So the statute actually deems it to have been paid to B.

This is an example, somewhat complicated by the estate income scheme of initially charging interim payments with a final adjustment to tax on aggregate income per tax year, of any individual who assigns his right to taxable income AFTER it has arisen. The assignor remains chargeable to income tax.

It behoves him to assign only the net of tax income if he wishes to avoid a deficit. If however he assigns the gross income prima facie he remains assessable on it and must pay the tax due and payable out of his other funds.

This is what happens if as here B agrees to a DOV which assigns his right to income which has already become taxable on him (albeit assessment of it is deferred, possibly well past the ending of the AP) to someone else. This is why most drafters will draft a DOV, given the absence of reading back for income tax, so that entitlement to income arising before execution of the DOV is preserved unchanged; and in due course, if not earlier, is paid net of tax to the beneficiary who is so entitled.

A mistake may well have been made here. If so it is one which has been state of the art technical knowledge since s.47 FA 1975 enacted on 13 March that year. B could of course still apparently disclaim the income in question as it has not been paid to him nor has he accepted any other part of the estate.

Jack Harper