I’m going to phrase this as carefully as I can, so as not to prejudice any answer by indicating what I think!
Suppose Person A leaves their large estate by a will trust for Person B for life. Person A dies. Person B is still alive.
The trustees have the power to appoint capital to Persons B, C, D or E. They want to exercise that power in favour of Person C. (NB Person B wants this to happen too.)
My question is: is there any difference in the tax treatment if they exercise this power:
- before two years have elapsed since the death of Person A; and
- after two years have elapsed since the death of Person A?
You can ignore planning points other than the trustees using the power of appointment (e.g. the availability of variations or disclaimers in the two year period). But feel free to speculate on how the answer might differ depending upon whether person A and person B were married to one another, or not.
Alternatively, a pointer to a book or article where this is discussed would be much appreciated.
As there is an immediate post death interest in the estate, s.144 IHTA 1984 does not apply. Accordingly, there would seem to be no difference in tax treatment if the appointment to C takes place during, or after, the 2 years from the death of A.
However, if the estate is still under administration, the trustees could consider exercising the power of appointment before any assets are appropriated in satisfaction of the trust fund. Whilst B would still be making a PET to the value of the trust fund, C would acquire as “legatee” for CGT purposes which would avoid a CGT charge arising on the appointment.
HMRC has previously confirmed that s.142 IHTA 1984 and s.144 IHTA 1984 can validly apply to the same interest, although does not comment upon the potential for the exercise of a power of appointment followed by a variation to be void as a fraud on a power.
In this instance, provided that B, C, D and E are the only persons who could ever be entitled to the trust fund, they could enter into a variation to the effect that the entire estate passes to C, although this would require the agreement of all. If A and B were married to each other, this could result in a significant IHT charge, mindful that the estate is “large”.
Paul Saunders FCIB TEP
Independent Trust Consultant
Providing support and advice to fellow professionals
I infer that person A was not married to any of B or the other potential beneficiaries of the trust.
Suppose the intention is to appoint the whole trust fund to C.
The two year point is irrelevant, if there is an IPDI which is not “varied” or “disclaimed”. The best you can do is a deemed PET to C, unless you are going to consider disclaimers/variations. If B and C are married, then spouse exemption should apply to exempt the distribution.
I do think variation/disclaimer is worth considering.
If within two years, could person B perhaps vary their life interest, so that the income is to be held on discretionary trust terms (for B, C, D and E and anyone else who is a potential beneficiary of the power of appointment referred to - in fact, it is not terribly important who)? The terms of the variation could be that the trustees are to have discretionary powers over the distribution/accumulation of the trust income during the period that B’s life interest would otherwise have subsisted, but subject to the exercise of the said power of appointment.
Essentially, this will convert the trust to a discretionary trust, with effect from the date of death (by virtue of s142), then s144 could apply to the subsequent appointment to C.
I can foresee a few subtleties in the drafting of the variation.
The same effect should be possible if B were to disclaim their life interest within two years of death and then the trustees exercise their power of appointment within two years of death, to take advantage of s144.
After two years, B cannot do a deed of variation, so there would be a deemed PET in that situation.
If B has not taken any benefit from the trust fund, theoretically, B could still disclaim (s93 IHTA) after two years, with the result that he is treated as having not become entitled to his life interest. In that way, the IHT on the estate would be the same, but there would be a small IHT exit charge in respect of the distribution from the trust (as s144 would no longer apply, because the two year time limit will have expired). The toss up would then be to decide whether it is better for B to make the deemed PET to C (possibly covered by 7 year life insurance), or for B to disclaim, but for there to be a modest IHT exit charge.
If A and B were married, it will most likely be better for B to take his life interest and then make the deemed PET to C, as that carries the possibility of avoiding IHT altogether (again, this could be protected against by insurance).
Note also Paul Saunders’ point re CGT.
Great answers. Thank you @paul and @pddavidoff.
Applying these answers to a different situation where there is no discretion: suppose Person X and person Y are married or civil partners. Person X dies leaving their large estate on trust to pay the income to Person Y for six months and then to pay the capital to Person Z.
My reading of this is:
- Whole estate spouse exempt on death of Person X.
- Deemed PET made by Person Y six months thereafter.
- Assuming we are still in the administration period when assets are appropriated to Person Z, no CGT payable, Person Z taking on the date of death value as their base cost.
What troubles me is that person X appears to have achieved a gift to a non-exempt beneficiary, Person Z, without suffering inheritance tax. Indeed that tax might be escaped altogether if Person Y survives a further 7 years. Is that correct or is there some further risk I am missing?
I think that is correct. In the same way that X can leave everything to his wife Y, and she can “the very next day” give it away. (Ignore the speech marks… my attempt at a subliminal Xmas theme.)
On further thought, I guess you are querying the fact that there is no discretion and would that lead to a potential tax charge. I don’t believe so, but would need to research further, usually an IPDI with discretion would be used.
Great, thank you @Haroon.
And I liked your Christmas theme.