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My client recently died leaving a widow, two children, three grandchildren and a will that was drawn up in 1990.
It provides for a ‘nil-band discretionary trust’, which of course is not now necessary after the changes to inheritance tax made in October 2007 (the client was in the process of drawing up a new will, but never completed it).
The beneficiaries of the trust are the widow, children and grandchildren.
The grandchildren are all under ten years of age.
The residue goes to the widow, so there will be no inheritance tax to pay now in any case.
Would it be possible to use the provisions of IHTA 1984 to produce the effect of an updated will, i.e. ‘all to widow, widow gets two nil-rate bands when she dies’?
I suspect that a deed of variation may not be possible or practical because the beneficiaries of the trust might have to agree to it – or would only the trustees have to agree to it?
As an alternative, could the trustees distribute everything to the spouse within two years of the death (IHTA 1984, s 144) and then everything will be treated as if the will had said ‘all to spouse’?
Are there any catches with that course of action?
Query 17,603 – Trusty.
Reply by Digby Bew
From a technical point of view, the unscrambling of such a nil-rate band discretionary will trust is achieved by winding up the trust under IHTA 1984, s 144 by an outright appointment to the surviving spouse.
Provided that this is completed before the second anniversary of the deceased’s death, s 144 enables the effect of that distribution to be ‘read back’ as if originally drawn in the deceased’s will so securing spouse relief on the first death and preserving the deceased spouse’s nil-rate band for transfer under IHTA 1984, s 8(A) on the survivor’s death.
It is not necessary to await completion of the estate’s administration, nor, indeed, issue of the grant of probate of the original will, but if an early appointment is to be made on absolute interest terms to the survivor, then this should not be undertaken in the first three months of the deceased’s death as such an appointment would not be the inheritance tax chargeable event required as a condition for the operation of s 144 (see Frankland v CIR [1997] STC 1450).
Subject to that, it is not necessary for the trustees of the nil-rate band will trust to wait for the trust fund/assets to be released to them from the estate, as the trustees can simply appoint their rights to whatever they are entitled to under the deceased’s will.
Section 144 does not impose any particular requirements as to the form that the chargeable event should take, but generally this is achieved by a formal trustee appointment by deed in accordance with the express terms provided for in this respect by the will; certainly, use of such documentation will simplify the later claim for transfer of the unused nil-rate band at the survivor’s death.
The capital gains tax implications of a s 144 appointment are summarised in HMRC’s Capital Gains Tax Manual at paragraph CG31432.
As there is no corresponding provision to s 144 for capital gains tax purposes, the appointment from a trust would ordinarily amount to a deemed disposal by the trustees which would give rise to capital gains tax to the extent that assets comprised within the appointment have increased in value since death.
However, paragraph CG31432 confirms HMRC’s pre-existing practice which is to accept that the appointee takes such assets from the estate as legatee, rather than as a beneficiary of the trust, provided that the appointment is made before the personal representatives have completed the administration of the deceased’s estate and vested the assets in the trustees.
However, the estate planning implications should not be overlooked; the issues were recently examined by Stephen Haggett in ‘Enigmatic Variations’, which highlighted the advantages of having the equivalent of the value of the first nil-rate band held in a discrete trust arrangement.
As such a trust can exist as an independent taxable entity the value can remain sheltered from taxation within the survivor’s estate even though the survivor can benefit from the trust for her life; equally ‘asset protection’ advantages accrue in respect of that value in terms of care fee planning, divorce, second marriages, financial concerns, etc. with decisions being taken by the trustees according to the prevailing fiscal, financial and personal circumstances of all of the potential beneficiaries.
In light of current political uncertainties, might there not be something to be said for ‘banking’ the first nil-rate band, using the will’s discretionary trust, as opposed to trying to second-guess the future level of the nil-rate band and the continued availability of the facility to transfer an unused nil-rate band?
Reply by Terry 'Lacuna' Jordan, BKL Tax.
As Trusty has identified, following the introduction of transferable nil-rate bands in October 2007 it is no longer imperative for spouses to utilise the inheritance tax nil-rate band on the first death.
As Trusty is aware, a variation under IHTA 1984, s 142 would require the sanction of the court on behalf of the minor (and possibly also unborn) beneficiaries.
Provided that the discretionary trust contains the requisite power, a much more straightforward approach will be for the trustees to appoint the fund in favour of the widow either outright or on immediate post-death interest (IPDI) trusts so as to secure the spouse exemption and preserve the late husband’s nil-rate band so that it transfers to the widow.
To avoid the ‘Frankland’ trap (see Frankland v CIR [1997] STC 1450) the appointment must be made within the period from three months to two years from the date of death (IHTA 1984, s 144).
An IPDI might be preferable to an outright appointment if asset protection is a concern.
Reply by Doc
The topic of nil-rate band discretionary trusts is becoming popular with a related query raised last week.
The device was popular before the tax changes in October 2007 which introduced the transferable nil rate band to a surviving spouse or civil partner.
It was a means of maximising the IHT exemptions for a married couple whilst allowing the survivng spouse access to funds from the deceased.
The ability to transfer a nil-rate band simplifies the situation, although trusts may still be of relevance for non-tax reasons, such as a desire to protect funds in the event of a second marriage.
If a will contains a nil-rate band clause prima facie this means there is no nil-rate band to transfer.
This could be a tax disadvantage if the nil-rate band increases considerably since the date of death. At the time of writing there is indecision about the outcome of the election but the Conservatives had planned to increase the nil-rate band to £1 million.
Within two years of death the provisions of IHTA 1984, s 144 can be used to restore the nil rate band by appointing the capital to the spouse, which is treated as having been made by the will.
This relief was discussed in the Readers’ Forum query ‘Transferable nil rate' in Taxation, 5 March 2009, page 230.
The deed of variation route is more problematic and HMRC are likely to raise questions when assets are varied back to a spouse.
A closer look at the ‘Frankland trap’
The ‘Frankland trap’ refers to Frankland v CIR [1997] STC 1450.
There, a married woman died on 26 September 1997 and left property on discretionary trusts for the benefit of her husband and children.
On 22 December 1997, this property was transferred to a trust from which the income would be paid to the husband for the rest of his life.
Because of this interest in the property, this was treated as part of his estate and the aim of the transfer was to ensure that the spouse exemption in IHTA 1984, s 18(1) would then be given.
The Inland Revenue contended that the spouse exemption would not apply because the transfer was not made by the deceased.
The trustee appealed and contended that the effect of IHTA 1984, s 144 was that the husband’s interest in possession should be treated as having been created by the deceased’s will.
The Court of Appeal held that the effect of IHTA 1984, s 65(4) was that
s 144 did not apply.
This is because settled property (i.e. as comprised in the original discretionary trust) is subject to a tax charge when it ceases to be settled property or at ten-yearly intervals.
Section 65(1) states that a charge will arise when property ceases to be relevant property.
However, s 65(4) then goes on to say that such a charge will not arise if a transfer is made within the quarter beginning with the commencement of the trust or a ten-year anniversary.
In Frankland, because the December 1997 transfer was made within three months of death, there was no ‘event on which tax would … be chargeable …’ as required by s 144(2).
Consequently, the provision in s 144(4) that ‘where this subsection applies by virtue of an event … this act shall have effect as if the will had provided that on the testator’s death the property should be held as it is held after the event’ was not satisfied.
N.B. Since FA 2006, the Frankland trap will not apply where an appointment is made within three months of death on an immediate post-death interest.
