Settlements Legislation (ITTOIA 2005) - variation of life interest for benefit of spouse

Will a spouse who varys the life interest they receive under a Will (by way of Deed of Variation) in order to redirect their interest to their spouse fall foul of the Settlements legislation (ITTOIA 2005)? The purpose of the redirection is because the spouse who currently is entitled to the life interest is a high rate tax payer so if the the income will be treated as there own income anyway, this would defeat the point of the exercise.

The wording of Section 636 (Exception for outright gifts between spouses) only applies if the right is not wholly income so I am not sure whether or not that prevents the legislation applying given the life interest is a right to income.

Hannah Sawyer
Furley Page

If s.62(6) TCGA 1992 applies to a variation of property settled by the will, s.685D ITTOIA 2005 results in the deceased being the settlor of the varied interest for income tax purposes.

Whilst I cannot see that this should not apply where the variation is in favour of a spouse of the original beneficiary, have any contributors had experience of HMRC‘s attitude towards this?

Paul Saunders

I’m not sure that the legislation on this point raised is all that definitive.

Paul refers to ITTOIA 2005 s685D but i think he means ITTOIA ss472/473 (formerly s685D).

However, ITTOIA 2005 s473 only applies where the consequence of the DoV is that property originally comprised in a settlement becomes comprised in another settlement. This is not the position postulated which is simply that the original life tenant varies his interest under the trust (with no transference of property to a new trust).

The legislation does not therefore, it seems to me, resolve this matter in a definitive manner.

However, in practice it would seem that in the overall context of the legislation of ss. 472 and 473 together with TCGA 1992 s62(6), post 2006, that where the life tenant simply varies his interest under the existing will trust that the deceased remains the settlor (irrespective of whether or not the new life tenant is the spouse of the original life tenant). Some support for this may be taken from ITA 2007 s467.

Malcolm Finney

My view is that sections 472/3 ITA 2007 (rather
than ITTOIA 2005), which were previously section 685D ICTA 1988 are ‘red
herrings’ which it should also be noted are subject to “(except where the
context otherwise requires)” which do not apply for income tax purposes.

A gift can be income (as in the scenario
being described by Hannah) as well as capital.

I consider that in accordance with the
decision in Marshall v Kerr 67 TC 56 and Chapter 5 ITTOIA 2005 the spouse
making the variation will be a settlor of income and will be assessable to
income tax on the trust income under section 624 ITTOIA 2005.

My understanding being that whilst section
685D ICTA 1988 is relevant for capital gains tax it has no relevance for income
tax purposes.

The exception offered by section 626 ITTOIA
2005 being overridden by condition B in section 626(3).

I also consider that for income tax
purposes the spouse making the variation will be worse off than had the
variation not been made. Whereas allowable trust management expenses would have
previously reduced the assessable income they will no longer do so in view of section
624 (1A).

M Mortimer

Both Malcolm and Andrew raise interesting points.

I agree with Malcolm that s.473 Income Tax Act 2007 limits the income tax position to where the variation results in the trust fund being held in “another settlement”, and the mere assignment of a life interest to anther individual is unlikely to be construed as such. However, if the beneficiaries are all ascertainable and of age, in reliance upon the “rule” in Saunders. Vautier, might they join together and vary the terms of the trust sufficiently to cause it to be a different settlement (mindful of what was said in Swires v. Renton, 1991).

With regard to Andrew’s comments, I am a little at a loss with regard to his comments on s.685D ITTOIA, not applying for income tax, only CGT. s.686D was introduced into the Income Tax (Trading and Other Income) Act 2005 by Schedule 13 FA 2206, alongside the introduction (by Schedule 12 FA 2006) of a new s.68C TCGA 1992, the latter repeating the provision and applying it for CGT. Have I missed something obvious?

Paul Saunders

I apologise for referring to “ITTOIA 2005” re ss. 472/473 instead of “ITA 2007” ss. 472/473 as rightly pointed out by Andrew Mortimer.

On re-reading my post in the light of Andrew’s comments perhaps I could have been a little clearer.

The legislation post Marshall v Kerr , namely ITA 2007 ss.472/473, identifies who is the settlor following execution of a DoV for CGT (on the assumption s.62(6) TCGA 1992) applies in relation to the DoV.

S472 deals with the scenario where property becomes settled following the DoV which was not originally settled. S473 deals with the scenario where the property was originally settled (pre the DoV) but following it the property becomes settled on another settlement.

Under the former the settlor under the DoV is the beneficiary executing the DoV. Under the latter it is the deceased.

However, as stated under my earlier post, I do not think the above covers the situation where the DoV simply varies the life interest under the settlement. I believe in this situation HMRC would need to ascertain whether a new trust has been created or not but it seems difficult to me to argue successfully on the facts that a new trust has been created, which if correct, would suggest that the settlor remains the deceased.

I believe that it was always intended that the identification of the settlor under the legislation post Marshall re DoVs was to be the same for both CGT and income tax.This is achieved, for income tax purposes, under ITA 2007 s.467 as mentioned in my earlier post.

Hence, i still feel that in Hannah’s case the settlor is the deceased, not the life tenant.

Malcolm Finney

Mea Culpa, I stand corrected.

As Paul correctly says as part of he modernisation
of trusts effective from 6 April 2006 section 68C TCGA 1992 became effective
for the identification of a settlor for CGT purposes on a post death variation within
2 years.

For reasons I am now at a loss to
understand (old age!?), I was clearly incorrect in saying section 685D ICTA
1988, which was in place prior to the 2006 modernisation of trusts, dealt with
CGT settlor identification and was not relevant for income tax purposes.

Malcolm is correct in saying section 472
ITA 2007 deals with the situation where, provided section 62(6) TCGA 1992
applies, if on death there is no settled property but following the variation a
settled property trust comes into being. In these circumstances the person
making the variation is the settlor

Section 473 ITA 2007 covers situations,
provided section 62(6) TCGA 1992 applies, where settled property comes into
being on death. Where in accordance with
a variation that settled property enters another settlement the deceased is
treated as the settlor of the other settlement.

Paul also correctly raises the question of
whether the identity of the post death Will trust beneficiaries and their
capacity will allow a variation to create another settlement that comes within
section 62(6) TCGA 1992 and section 473 ITA 2007.

If not then whether an income assignment
(redirection) via a deed of variation, which it seems to me could only be pur autre
vie i.e. only during the life of the original spouse, can come within section 62(6) TCGA 1992 and
section 473 ITA 2007 so as to allow the deceased (rather than the original life
tenant spouse) to be treated as the settlor of that income. I also doubt that it can.

In my younger days I recall the Inland
Revenue Claims Branch taking the that view persons redirecting trust income via
deeds of variation executed within 2 years of death were settlors of that
income redirection and could fall foul of the income tax settlor assessable

If a deed of variation can be executed within
2 years of death and validly create another settlement with a different life tenant so as to fall within
section 62(6) TCGA 1992 and includes confirmation that section is intended to
apply then section 473 ITA 2007 will apply and the settlor retained interest legislation will not
apply. Section 626 ITTOIA 2005 need not then be considered.

Depending upon the likely amount of trust
income and potential income tax saving it may well be worth seeking an Opinion
from Counsel

However, It should also be remembered that a
deed cannot have retrospective effect for income tax purposes. If my memory has not failed me this time the
relevant case law being the decision in Waddington v O’Callaghan

Andrew M Mortimer

I agree with Andrew that Waddington v. O’Callaghan, 1931 confirms that a deed can only be effective from its own date, or such later date as might be provided for within the deed. However, for income tax purposes with an instrument of variation the provisions of ss671/676 ITTOIA 2005 – “Special rules for successive interests” – will apply so that, in some circumstances, income arising before the date of the variation may be the income of the new income beneficiary - see s 674 in relation to successive limited interests.

If, for example, a variation merely seeks to replace the name of one life tenant with that of another, without more, the effect of Waddington v. O’Callaghan is that the new life tenant will be entitled to the income only from the date of the variation, the income to that date being payable to, and taxable as the income of, the original life tenant.

If the variation specifically states that it is to take effect as at the date of death, this affects the quantum of the gift and the new life tenant will be entitled to all of the income of the trust fund from the date of death. If any distribution in relation to the income entitlement has been made to the original life tenant, and notwithstanding that they will need to account for it to the new life tenant, under s.674 such distributions will still form a part of their taxable income.

Paul Saunders

As Paul succinctly and clearly points out there are specific income tax provisions which deal with income arising on limited interests in residue (ITTOIA 2005 s.654). However, s654 does not apply to limited interests where successive such interests arise (s654(5)); instead, but s.674 applies.

Under s.674 the basis of the charge is “entitlement” irrespective of payment date. Hence, under a DoV if an original interest in possession beneficiary (X) re-directs his interest to beneficiary (Y) then from the date of the DoV income arising thereafter is that of Y (ie the date of the DoV is the date from which Y’s entitlement to income commences) unless any such payment relates to income arising in the period prior to the date of the DoV (in which case the liability falls on X).

It would therefore, other things being equal, be ill advised for X under the DoV to agree that Y receive income from the date of death because for income tax purposes it is X who was so entitled pre the DoV; were such to be provided this would mean that X is not only required to discharge the income tax liability for income related to that period but then has also to hand over the net amount to Y.

Malcolm Finney