Alright, let’s go back to basics.
Clauses like this came into existence in the era before the introduction of transferrable nil rate bands and are easiest to understand in that context. Let us suppose that you are a husband with children, at a time before there were residence nil rate bands and before nil rate bands were transferrable. You realise that if yours is the first death and you simply leave your whole estate to your wife your own nil-rate band will go unused, and she on her later death will be taxed on the entire joint assets with only one nil-rate band, her own, to set against them. So you decide to make a legacy of the nil-rate band either to the children or (more likely) to a discretionary trust, thereby ensuring that your nil-rate band is utilised on your death. Then the residue will pass to your wife. There would be no tax on your death since everything that was not nil-rated would be spouse exempt. And only the residue of your estate, plus the whole of your wife’s estate, would be taxed at her later death - therefore less overall than it would have been with the simple will.
There are a number of ways you could phrase such a legacy. For example it could be a legacy of:
- “£140,000” (or whatever the nil-rate band happened to be at the time in question) or
- “The upper limit of the nil per cent rate band in the schedule to the Inheritance Tax Act 1984”
Or similar. But the trouble with defining it in that way is that you would not know - at the time of drawing the will - what changes of circumstances there might be between the time of drawing the will and the time of your death, which could either:
- give rise to first death tax; or
- cause the legacy to be less than the optimal amount.
For example:
- the nil-rate band might rise (or, in theory, might fall)
- you might make a potentially exempt transfer
- you might make a chargeable lifetime transfer
- you might have already made a potentially exempt transfer but not know whether your death will occur within seven years of it
- you might make a codicil containing a chargeable legacy
- you might buy an asset that qualifies for business property relief or agricultural property relief
- you might sell an asset that qualifies for business property relief or agricultural property relief; or
- something else could happen that I haven’t thought to list above - perhaps something you could not possibly have thought of.
One way of drafting the legacy would be to make it along the lines of “the figure in the schedule to the IHTA as at the date of my death, minus PETs, minus CLTs, plus APR, plus BPR etc.” (if you see what I mean) and indeed many precedent books do use some variation on that structure.
However a really clever way of expressing it is something along the lines of “the maximum amount of cash I can give on the terms of this clause without incurring any liability to inheritance Tax on my death”. James Kessler’s book uses a variation on this - indeed I don’t remember seeing that formulation anywhere before the publication of his book, so it may be, for all I know, that he devised it.
Its advantages over other ways of drafting the clause are:
- It’s quite brief.
- It automatically - just by definition - resolves all the unknowns and produces an optimal result. Indeed it even works to adjust for contingencies you hadn’t thought of.
- I’ve always thought it’s reasonably easy to understand - although the first-instance judgement in RSPCA -v- Sharp proved me wrong on that point.
However…
A clause with that wording only makes sense in a context - such as that envisaged in the clause from James Kessler’s book copied-and-pasted above - where the residue of the estate passes to an exempt beneficiary. It was not designed for a situation where a legacy is made to one chargeable beneficiary and residue to another, and doesn’t really have any meaning in such a context. I believe that it comes out at “nil” as I have said above. If the testator making the will at the top of this thread had wanted to make a cash legacy to A, B, C, D and E of the amount mentioned in the schedule to the IHTA, that testator could have said so. In passing, I don’t understand why a testator would want to do that, at all: “I give to my nieces an amount which I haven’t chosen for myself but which I will let the Chancellor of the Exchequer of the day choose for me on the basis of political criteria which have nothing whatsoever to do with me, the size of my estate, or the needs or expectations of my nieces or my residuary beneficiary, and which will have no effect either way on the amount of tax my estate pays.” But to each their own, I suppose.
You’ll appreciate I feel a bit reluctant to post a “child’s guide…”-type post in an august forum like this one. I hope it’s helpful and I trust everyone will appreciate it is meant as an overview not as a detailed explanation.