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Black & White

29 September 2004 / Richard Curtis
Issue: 3977 / Categories:


Black & White

RICHARD CURTIS reports on an apparent recent change of view by the Capital Taxes Office of the Revenue that may be of benefit to the disabled and offer some comfort to their families.


Black & White

RICHARD CURTIS reports on an apparent recent change of view by the Capital Taxes Office of the Revenue that may be of benefit to the disabled and offer some comfort to their families.

THERE IS ALWAYS the danger that if something is repeated often enough, then it will be accepted without question. 'I read it in the newspaper, so it must be true. It's there in black and white.' The longer this goes on, the less the particular proposition is challenged; that is, until someone comes along and perhaps looks at the point from a different angle. In taxation, we tend to want certainty so that we can advise clients with confidence; even when we use those rules to design tax 'mitigation' schemes, which often depend on the certainty of the individual relevant provisions. Does the Revenue conspire in this dependency by asserting the meaning of taxation provisions in the face of questioning or persisting with its interpretation of statute? The Revenue feels that it has a moral duty to protect the nation's income so that the burden of taxation falls fairly on all; and is now engaged in a war against 'abusive tax avoidance'; but others have questioned, in these pages and elsewhere, whether the Revenue's interpretation and tax collection is always fair. It is in a position of great power with regard to the resources that it can bring to bear and these can weigh even more heavily on the smaller firms and practitioners who do not have national resources to call upon in their defence.

Disabled taxpayers

Gillian McClenahan established her sole practice, Willplantax, last year to offer a tax trust and estate planning service for solicitors, financial advisers and accountants to enhance the service they provide for their clients. She has recently been approached for advice in relation to several clients who have mentally disabled children. It is natural for a parent to want to help his or her child; but the parent of a disabled child will have more reason than most to want to try to ensure that the future of the child is as secure as possible while the parent is alive and after the parent's death. The Taxes Acts recognise this and may seem to be an example of the normally impartial and impersonal legislation acting with some sympathy and understanding. But it is the actual extent of that sympathy and understanding that has been the cause of lengthy discussions and some correspondence between Gillian and the Revenue.

The legislation

The first mention of disability in the Inheritance Tax Act 1984 appears in section 3A, 'Potentially exempt transfers'. This defines a potentially exempt transfer as a transfer of value that is:

* made by an individual on or after 18 March 1986; and

* which would otherwise be a chargeable transfer; and

* is a gift to another individual or a gift into an accumulation and maintenance trust or a disabled trust.

So a transfer into a disabled trust is a potentially exempt transfer; this has been the Revenue's opinion until recently, but it seems the Revenue may have omitted to consider the sentence at the foot of section 3A(1)(c ), Inheritance Tax Act 1984 which reads as follows:

'but this subsection has effect subject to any provision of this Act which provides that a disposition (or a transfer of value) of a particular description is not a potentially exempt transfer' [my italics].

Section 11, Inheritance Tax Act 1984 is entitled 'Dispositions for maintenance of family' and gifts that fall within section 11 are not 'transfers of value' and thus not potentially exempt transfers. Included within section 11 (at subsection 3) is:

'a disposition … in favour of a dependent relative of the person making the disposition … [if it] is a reasonable provision for his care and maintenance.'

A dependent relative is defined in section 11(6) and includes a relative of the donor or his spouse who is incapacitated by old age or infirmity. So section 11 does allow a parent to make a disposition free of inheritance tax. Unfortunately, the Revenue's view has always been that section 11 does not work in conjunction with section 89, Inheritance Tax Act 1984, 'Trusts for disabled persons', and will only apply to gifts between the parent and the disabled child, which would not be practical with, for example, a mentally disabled dependent.

Gillian had previously questioned this approach and had been rebutted by the Revenue who had argued that the fact that the sections were mutually incompatible was supported by Dymond's Capital Taxes (at paragraph 21.715) and by section 3A(1)(c) referred to above and without reading its important final sentence also referred to earlier.

One possible factor in favour of the Revenue and against the small practitioner in this scenario, was the fact that Dymond's Capital Taxes currently retails at about £500. One might safely assume that whilst it may be found in the Revenue's head office, it is probably absent from the offices of most high street practitioners.

Paragraph 21.715 of Dymond's states:

'If the settlement is made by an individual after 17 March 1986 and is not exempt from tax (e.g., as a disposition for maintenance of the family) it is a potentially exempt transfer: section 3A(I)(c).'

Now, on first reading, my thoughts were that this sentence actually supports what Gillian was saying. However, could it be read that the words in parentheses are an example of something that is not exempt from tax rather than (as set out in section 11) something that is exempt from tax? For whatever reason — a misreading here or a failure to link the wording of the final sentence of section 3A(1)(c) with section 11 and section 89 — it seems to have become an accepted fact over the years that the section 11 exemption could not be used with section 89.

Possibly this 'official view' was based on the three critical words of section 11 that the disposition must be 'in favour of' the dependent relative. Perhaps this had been read as meaning that the gift must be made to the dependent relative. Gillian's argument was that there was nothing to say that section 11 and section 89 were mutually exclusive and why could not 'in favour of' also refer to a transfer into a settlement 'in favour of' the disabled person?

So what is a 'disabled trust'? As mentioned above, section 89, Inheritance Tax Act 1984 deals with 'trusts for disabled persons', and:

'applies to settled property transferred into settlement after 9 March 1981 and held on trusts:

(a) under which, during the life of the disabled person, no interest in possession in the settled property subsists; and

(b) which secure that not less than half of the settled property which is applied during his life is applied for his benefit.'

A disabled person is defined in section 89(4) as one who, when the property was transferred into the settlement, was:

* 'incapable by reason of mental disorder within the meaning of the Mental Health Act 1983 of administering his property or managing his affairs; or

* in receipt of an attendance allowance under section 64, Social Security Contributions and Benefits Act 1992 or section 64, Social Security Contributions and Benefits (Northern Ireland) Act 1992; or

* in receipt of a disability living allowance under section 71, Social Security Contributions and Benefits Act 1992 [or its Northern Ireland equivalent] by virtue of an entitlement to the care component at the highest or middle rate'.

If the conditions in section 89(1) regarding the nature of the settlement are satisfied, then section 89(2) provides that the disabled person is treated (for inheritance tax) as beneficially entitled to an interest in possession in the whole fund. The effect of this is that the charge to inheritance tax on discretionary trusts at ten-yearly intervals (and other times) under section 64, Inheritance Tax Act 1984 et seq, will not apply, as the trust is no longer a 'settlement without an interest in possession'. So we now have a tax advantageous trust for disadvantaged people, but what is the practical use of this? Well, it is fine if the parent of the disabled child is wealthy enough to make a substantial settlement during his own lifetime, but these people will be the exceptions.

More likely, the parents will not be able to afford to make a settlement during their life and will endeavour to support the child from their personal income through their joint lifetimes. They will only be able to make a settlement on their (the parents') death. The obvious 'downside' here is that the parents' estate will be liable to inheritance tax.

A change of view

After several verbal refusals, Gillian wrote to the Revenue's Capital Taxes in August asking for confirmation that a settlement of £100,000 into a discretionary trust — set out in the terms of section 89 as to 80 per cent for the benefit of a disabled son during his life and thereafter for another son and grandchildren — would be an exempt transfer under section 11(3).

On 7 September, the Revenue confirmed that Mr Peter Twiddy, an assistant director and head of litigation at Capital Taxes, had confirmed that Gillian's view was correct.

'Lifetime transfers into settlements for the disabled, that satisfy the conditions laid down in section 89, Inheritance Tax Act 1984, are indeed covered by provisions of section 11, Inheritance Tax Act 1984. Accordingly such dispositions are not transfers of value if these conditions — depending on which apply — are satisfied. It follows that such dispositions do not require to be reported, at any time, to any office of Capital Taxes.'

However, the Revenue did go on to draw attention to section 11(3), which qualifies a disposition in such cases as being 'reasonable provision for his care or maintenance'.

There is obviously therefore a limit to the amount of the capital that can be settled and which will qualify under this provision. Gillian's 'test case' was for £100,000. This seems a not unreasonable amount.

As a side issue, Gillian points out that for Department of Social Security nursing home funding purposes (in Northern Ireland), capital of up to £12,250 is left out of account and help with funding for care is still available to a limited degree where the person's capital does not exceed £20,000. When considering the means tested benefit entitlements of any person, such as housing benefit, £3,000 is the lower capital limit for people under 60 and £6,000 for the over 60s up to a maximum capital limit of £16,000.

If the disabled person is a beneficiary of a discretionary trust or a disabled trust, the capital of that trust is not taken into account; instead, the income received from the trust is treated as a capital amount.

So what is 'reasonable provision'? A settlement of £160,000 if used, say, to purchase an investment yielding five per cent, would produce an annual income of up to £8,000 or a maximum of £4,000 if trustees use their discretion under section 89(1)(b) to benefit others in the same year; so that might be a useful initial guideline. Reasonable provision will ultimately depend on the needs of the particular person. Many would require specialist equipment and nursing and the 'reasonable provision' could therefore be substantially more.

In its letter, the Revenue states:

'As I am sure you can appreciate, the words used here "and is a reasonable provision" could very well be open to many interpretations and hence I can only assume that in contentious case(s), what figure/value was appropriate would probably have to be declared by the courts, and would very likely be decided on the facts of a particular case(s).'

It is also worth noting that the whole of the transfer into the trust, not just the 50 per cent or — in Gillian's case — the 80 per cent that will be used for the disabled child, will apparently be an exempt transfer. Does this seem illogical? No, because section 89 — which applies subject to the condition that not less than half of the settled property is applied for the benefit of the disabled person — deems that the disabled person is beneficially entitled to an interest in possession in the settled property; i.e. in the whole fund, not just that proportion earmarked for him. This means that in the event of the death of the disabled person, the value of the fund will be added to the free estate for the purposes of calculating the inheritance tax liability. There would thus be a potential for double taxation if the whole amount was not exempt, as part (20 per cent in this case) would otherwise also be subject to the ten-yearly charge.

How does this square with the 'reasonable provision' condition of section 11? It is understood that it is the whole transfer that must be considered in this regard, not the element that is reserved for the disabled child.

The future

It is perhaps unfortunate that the Revenue's current work on 'Modernising The Tax System For Trusts' is looking at income tax and capital gains tax issues, but not inheritance tax. On the other hand, it is refreshing to see that the Revenue, in the face of some persistent questioning by Gillian McClenahan, has reviewed its position — which has previously been supported by heavyweight texts — and has been prepared to accept a fairer, more sympathetic and, ultimately, a clear and logical interpretation of sections 11 and 89, Inheritance Tax Act 1984. One, relatively easy, step has therefore been taken to assist parents of disabled children. However, as Gillian says, this will mainly help the wealthier of those parents. It also raises other questions.

What about those less wealthy parents who cannot afford to pass large amounts of money to a disabled trust during their lifetimes? On one hand, it would seem equitable that such trusts set up in a will should also benefit from a transfer that is exempt from tax, but Foster's Inheritance Tax (at D1.01) states that 'since death is not a disposition, provisions that certain dispositions, for example for the maintenance of a person's family ... are not to be transfers of value, do not apply on death'. Or has the Revenue had a change of view in this regard as well?

Perhaps it is now time for some Revenue guidance on the interaction and operation of sections 3A, 4, 11 and 89 of Inheritance Tax Act 1984.

Gillian McClenahan at Willplantax can be contacted on 028 9127 4634 or by e-mail: on her return from holiday in early October.


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