Income tax treatment of an appointment under s144 IHTA

Residue is left to a discretionary trust. During the course of the administration of the estate, and within 2 years after the death, the trustees (before the property is assented to them) appoint a property which forms part of the residue to A and the remainder to B.

The appointment is read back to the death for IHT and there is no CGT disposal, A taking it at the probate value for CGT purposes. What is the effect so far as income tax is concerned?

There was no distribution before the Appointment. Is it like a deed of variation, so rent from the property up to the date of the appointment is part of the residuary income, and will be charged against B as the new residuary beneficiary as and when distributions are made to her, and any rent after the appointment will be assessed against A in the tax year that the property is assented to him?

If this is correct, presumably the result would be the same even if the appointment had said the property appointment would include the rent between the date of death and the date of the appointment, as you cannot backdate the income tax treatment of what was, before the deed, residuary income.

Simon Northcott

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Your thoughts were correct. There is no statutory fiction for income tax as for IHT/CGT so the rental income arising before the appointment is held on the discretionary trusts under the will and forms part of the residuary income, to be taxed accordingly.

Andrew Goodman
Osborne Clarke

If I understand correctly, the point in question relates to when is income tax payable by a beneficiary of an estate that leaves residue on a disretionary trust? If, before any distributions are made, the trustees appoint assets directly to a beneficiary, does that appointment ‘carry’ income. It would appear not on the basis that the appointment is treated like a legacy without carrying the income, but I stand to be corrected as this is my first post!

Haroon Rashid
I Will Solicitors Ltd

Thank you Andrew. So, as there was no distribution before the appointment, how is the pre-appointment residuary income taxed? In this case the property was the majority of the residue value, and the cash left (after paying debts, iht etc) will be far less than the pre-appointment residuary income. Therefore if A is not treated as receiving a distribution of residue, does this mean B’s distribution of the remainder of the residue is all treated as income, and the surplus of pre-appointment residuary income is not taxed to higher rates on anyone, or is the property (which was after all part of residue) itself treated as a distribution of residue, so part of the pre-appointment residuary income attaches to it with A being taxed accordingly.

Simon Northcott

Is the Estate still in administration or has residue been ascertained and the discretionary trust been constituted? The tone of your comments suggests that the trust has not yet been constituted and you are dealing with an Estate in the course of administration, but forgive me if I have misunderstood.suggested that the non-property assets due to B are worth considerably less).

You have suggested that A is also an residuary beneficiary (possibly the main one as you have
The Executors/Trustees should have accounted for any income tax due on the net rental income for each tax year in point and should issue a form R185 to the beneficiaries in respect of their entitlement to net income either:

*on the earlier of appointment of assets or actual net income distribution (for an Estate) (so the appointment does carry income) or

*on actual distribution of discretionary net income to a beneficiary (for a trust)

Generally any undistributed Estate income is deemed to have been distributed as part of an appointment of assets (e.g. the property) so any previously undistributed net Estate income will probably crystallise in the hands of A, if B has not had anything beforehand.

Maxine Higgins
Citroen Wells

Thanks Maxine
The estate is in the course of administration, and no distribution of income or capital assets have been made to the discretionary trust, which was the only residuary beneficiary prior to the appointment.
It seems to me that the appointment is similar to a deed of variation of residue. Instead of the trust being entitled to all of the residue, there are now 2 new residuary beneficiaries taking the place of the trust, A, who is entitled to that part of the residue comprising the property, and B, who is entitled to the rest of the residue.
The executors agree to administer the estate in accordance with the appointment, much as they normally do where there has been a deed of variation to which they are a party.
They will not want to appropriate and transfer the property to A until they are satisfied they will not need to resort to the property to pay debts/testamentary expenses. Therefore there will be a gap between the appointment and the distribution of the property to A and the remainder of the residue to B.
As I see it, if they distribute to A and B at the same time, the residuary income (which in the absence of a direction in the Deed of Appointment) will be all the income, including the rent from the property before and after the deed of Appointment, which will be apportioned according to the values of the property and the rest of the estate between A and B.
If the deed of appointment directed that any income after the deed from the property was also to go to A, then the residuary income after that would exclude the post deed rent, which would be assessed on A, in addition to his proportion of all of the rest of the residuary income.
If the deed of appointment directed that any income before the deed from the property was also to go to A, then this would increase what was due to him in cash terms from the residue, but would not affect the income tax position in relation to the pre-deed rent- it would still be residuary income, as it is not possible to backdate the effect of the deed for income tax purposes.
Is anyone able to tell me if this interpretation is correct, and if the same would apply if the change in the residuary estate had been effected by a deed of variation by an individual who was entitled to all of the residue?

Simon Northcott

I believe it is fairly well established that where assets are appointed out of a discretionary trust within 2 years, so that the trust is never funded, HMRC will not treat the income arising in the meantime as trust income and do not require trust tax returns, so the income is taxed in accordance with the appointment. I am sure I recall some discussion on the subject in Practical Wills Precedents but I don’t have access to that book any more so can’t check. I think it was down to Revenue practice rather than based on tax law, although perhaps justified on the basis that the trust has not been fully constituted and therefore has no entitlement to income.

I appreciate this is not really the question you are asking, Simon, but there may be a principle which could be applied in both cases, so if you do have access to that book, it might be worth a look.

Diana Smart
Gordons LLP

In this matter, it is necessary to look at the actual nature of what has been appointed to ascertain the income tax treatment.

If the appointment was intended to include the rents since the date of death, that would need to be specifically stated.

If the appointment is solely of the property, then it seems to me that such appointment cannot cause the appointee to be assessable to any part of the estate income (relying upon s.650(3) ITTOIA 2005). Any income arising from the property after the date of the appointment accrues to the appointee outside of the estate and so, again, cannot cause the appointee to be assessable to any of the estate income.

If the appointment includes the accrued income from the property, I believe s.650(3) ITTOIA 2005 would apply to cause only that income to be deemed to be the appointee’s income and, again, cannot cause the appointee to be assessable to any of the estate income.

Unless the appointee has further assets appointed to them, or is entitled in default of appointment, there seems no prospect of them being deemed to have received any of the residuary income for tax purposes.

That it is stated that there has been no distribution from the estate before the date of the appointment is beneficial as, otherwise, the estate income accrued to the date of that earlier distribution might have been deemed to include part of the accrued rents (although I would argue that the effect of s.650 ITTOIA 2005 would be to exclude from the calculation of the deemed residuary income the income assessable upon the appointee).

On a general note, whilst observation has been passed on the inability to back-date the effect of a deed of variation for income tax purposes, ss.671-676 ITTOIA 2005 can effectively back-date the attribution of income for tax purposes in particular circumstances.

Paul Saunders

I am not sure why the appointment of the property cannot cause the appointee (A) to be assessable to residuary income when that part of the residue is assented to him by the executors.

I believe the only effect of the appointment is that the trustees are appointing away a chose in action. The property is not part of the trust fund, they simply have the right to have it transferred to them if it forms part of the residuary estate. If after the appointment, debts pop up that no-one knew about, it might have to be sold by the executors, in which case A would not receive it at all. However, if all goes according to plan, and further down the line the residue does include the property, and the executors assent it to A, then if that is the first distribution of residue, I believe it would carry the residuary income to date.

If there had been no trust, and the residue had been split two ways, and the executors had assented the property to A as part of his entitlement before any other distributions of residue, then likewise the distribution would carry the residuary income to date, just as happens (many times inadvertently I suspect) when chattels are distributed. I do not think a distribution from the estate following a trust appointment of a chose in action is any different.

Simon Northcott

Whilst I agree with Simon Northcott that an appointment by the trustee of the discretionary trust before any assets have been appropriated to them can only take effect as the appointment of a chose in action, I am not sure that many dealing with such appointments necessarily appreciate that. I believe that most will anticipate that the appointee will receive the assets specified within the appointment, whether it be a property, shares or a cash sum, for example. My analysis of the income tax position has been based upon this approach, which I believe to be widely applied, albeit not necessary the correct legal position.

To adopt the position of treating the appointment of, say, a property (or shares) as a chose in action complicates the issue somewhat. If the appointment is treated as creating a chose in action, the appointee has no right to the asset nominally appointed, but merely has a right to a share of the estate ascertained by reference to the relative values of the “appointed” asset (the Nominated Asset) and the distributable value as at the date of the appointment. As and when the asset is available to be appropriated to the appointee, it will need to be revalued for the appropriation, which could be significantly different to the value of the appointee’s entitlement as a result of the exercise of the power of appointment.

By way of example, if, at the date of the appointment, the distributable value of the estate is £500,000, and the Nominated Asset £250,000, then the appointee will be entitled to a 50% interest in the estate, being the extent of the chose in action. If, at the time of the proposed appropriation of the Nominated Asset to the appointee, that asset is worth £400,000 and the entire distributable estate £650,000, there will be an over-distribution to the appointee if the asset is appropriated wholly to them.

Where the appointment is of a cash sum only, whilst it is arguable that the appointee would be entitled to that cash sum (no more, no less, unless the estate falls in value and is unable to satisfy the nominated sum), my understanding is that there is no real reason why it should be treated any differently from any other Nominated Asset, and so would fluctuate with changes to the distributable value of the estate from time to time.

I appreciate that there may be other views to how a chose in action should be approached in these circumstances. However, by separating out the differing stages of the appointment of a chose in action by trustees and the subsequent satisfaction of that appointment by the executors, rather than treating it as a single composite transaction, serves to create complications that I believe even HMRC is not desperate to have to address.

Paul Saunders

Paul, your analysis is I believe the only logical one and not so very complicated. However, like you, I suspect honoured more in the breach!

Simon Northcott

As Paul says, the strict legal position of an appointment directed at a specific asset, rather than being expressed as a share of residue (which in reality is what it is if the asset has not been appropriated to the trust) will normally be treated by the executors as if it was in reality a specific gift, which after the appointment carries the rent/income of that asset, but is not treated as carrying any residuary income either before or after the appointment, even if is the first part of the residue to be distributed.
This is also how most executors would treat a deed of variation, when it is made during the course of administration and no assets have been appropriated, if the deed specifies a particular asset is to be distributed to the new donee.
Likewise, if an appointment or deed of variation directs a cash sum to be paid to a beneficiary, while the estate is still being administered and no distributions have been made, it is normal to say that this will not carry any right to the payment of interest, so is not treated in this respect as a pecuniary legacy if it is paid after the executor’s year, but when it is paid, the executors treat the payment for income tax purposes as if it is a pecuniary legacy, so that it does not carry any residuary income.
In most cases this reconstruction of the income tax position after the deed of appointment/deed of variation is what the appointor/donor would want, and the structure of the relevant deed would imply this, effectively saying that the remainder of the residue left with the residuary trust/donor residuary beneficiary is to carry all the residuary income when that remainder is distributed, so that the original residuary trust/donor will be subject to higher rates of tax on all of the pre and post deed residuary income.
However, the situation where this breaks down is where there is not enough remainder to distribute to the original trust/donor to carryall of the residuary income. That is the position I find it difficult to see how to deal with, which is where I was starting from when I posted the question. HMRC are not going to be happy to accept that the residuary income has disappeared for higher rates of tax. Therefore I suppose it may be a question of the executors apportioning the surplus income amongst the new beneficiary(ies) proportionately. Not a strict legal position, but at least HMRC will get their pound of flesh, unless anyone else has a better idea.
Simon Northcott