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05 April 2011
A mother left her 95% share of her private residence to her daughter, her daughter’s husband and their children. The will was subsequently varied and the property was placed in trust before being sold
Following her father’s death some years ago, my client’s parent’s house was owned 95% by mother and 5% by husband’s will trust. When her mother died in April 2009, the initial probate value of the whole house was set at £1.8 million and the executors tried to sell it. The will left it 70% to my client and 6.25% each to her husband and three children (total 95%).
In June 2010, just before the Budget, they executed a deed of variation to put the house into a trust, of which they were all beneficiaries. An IHT election was made, but no CGT election. The house was sold in October 2010 for £1.6 million, with costs of sale of £52,000.
The solicitor who acted as executor says that he has successfully claimed relief for the fall in value for IHT purposes, so the probate value is effectively £1.6 million. He has sent me a schedule stating that the 95% share of the property which passed into the trust should be valued for CGT purposes by applying a 10% discount, which seems reasonable.
However, he has then treated the beneficiaries of the trust as individually making capital gains on the sale.
My analysis is that the beneficiaries would have made disposals at market value in June 2010. My client, for example, would have proceeds of 70/95 of the discounted market value of 95% of the house; her cost would be 70/95 of the probate value, and she would receive no deduction for the expenses incurred later. On that basis, she would have a substantial capital loss – the probate value would not be discounted, but the CGT market value would be.
That would appear to be a ‘clogged loss’ on a disposal to a trust of which she is a settlor. On the other hand, the trustees then appear to have a substantial gain (taxable at 28%), effectively reversing the discount and then deducting the expenses.
That seems to be a bad result. Is it correct, and if it is, can anything be done to improve the situation?
Query 17,772 – Losing Side
Reply from Digby Bew
As is fairly well known, TCGA 1992, s 62(6) provides that a variation of a deceased’s will or of the intestacy rules made within two years of the deceased’s death may be treated as if the variation were not a disposal and that the provisions of s 62 apply as if the variation had been effected by the deceased. One of the applicable conditions for such retrospective treatment (see s 62(7)) is that the instrument effecting the variation should contain a statement to the effect that the provisions of section 62(6) are to apply to the variation; since 1st August 2002 it has not been necessary to make specific election for s 62(6) to apply as was previously the case.
The capital gains tax analysis of the position in the absence of a s 62(7) statement depends upon whether the ‘non-retrospective variation’, as it is termed in HMRC’s Capital Gains Manual at CG31900 onwards, was completed before or after vesting of the relative asset(s) in the original legatee. The position in that respect is not specifically addressed in the query, but generally reading back is desirable to avoid ‘chose in action’ issues that otherwise arise.
Taking the client daughter’s position (the same analysis will apply to the other beneficiaries under the deceased mother’s will mutatis mutandis), if her 70/95 property share had not vested in her at June 2010, then the effect of the variation in favour of the June 2010 trust (which it is assumed is not a ‘bare trust’) is a disposal of a chose in action, being the right to compel proper administration of the estate/asset, the disposal value being the market value of the underlying asset, but with a nil base cost because the chose in action has been acquired without a corresponding disposal (TCGA 1992, s 17(2)).
Capital gains tax holdover under TCGA 1992, s 260 of the resulting ‘pure gain’ would not be available as the June 2010 trust appears to be settlor-interested. Additionally, there is a potential issue for the executors when they transfer the daughter’s property share to the trustees of the June 2010 trust.
Because the recipient trustees are not ‘legatees’ within the definition in TCGA 1992, s 64, the normal protection under TCGA 1992, s 62(4)(b) is not available and the executors make an actual disposal, although in this case the fall in value of the varied asset makes it unlikely that a gain on that disposal would arise.
If the non-retrospective variation were completed after the asset had been vested in the daughter then:
- She makes a disposal of her 70/95 property share to the June 2010 trust.
- Her acquisition of the property share is as ‘legatee’ and at a market value for the inherited asset determined by TCGA 1992, s 274. If, as seems likely, inheritance tax was chargeable in the mother’s estate, the asset’s value under s 274 is that ‘ascertained’ for inheritance tax purposes, and this will include the process (on election under IHTA 1984, s 191) by which the ‘sale value’ of land sold within four years of the deceased’s death can be taken to be its value for inheritance tax purposes. However, sale value for these purposes does not include the costs of sale.
- Her disposal will be at the open market value of the property share at June 2010; presumably, on valuation of the property and the property share (to which the 10% joint ownership discount should apply), this would be found to be not wholly different from the acquisition cost.
It is then the June 2010 trust which disposes of the property, not the individual trust beneficiaries (unless the trust is a ‘bare trust’). The trust sells the property for £1.6 million, less allowable disposal costs, and also deducts its acquisition costs being the values applied to each settling beneficiary’s property share in June 2010.
On the face of it, therefore, the only chargeable gain is that of the June 2010 trust seemingly based on the total of the joint ownership discounts applied on each settling beneficiary’s transfer to the trust less disposal costs on the property sale.
Reply from Nicola
I am assuming that the three children referred to in this query are all adult. If not the variation will not be valid as a minor cannot give their consent.
Assuming the variation is valid, I would agree with Losing Side’s analysis of the capital gains tax position in that the first disposal takes place in June 2010 when the deed of variation is executed and the property is settled on trust by his client, her husband and three children.
The deed is not effective for capital gains tax purposes and so the client and her family are treated as having acquired the property at probate value at the date of the mother’s death. The gift into trust will be deemed to have taken place at market value. The losses incurred on this transfer are indeed ‘clogged losses’ and would not be available either against the personal gains of the donors or the gains realised by the trust.
So what can be done to improve this situation and reduce the trust’s exposure to capital gains tax? I think that the tax position above is a pretty done deal and I would therefore be looking at the market value at which the property was transferred into the trust. The figure will presumably be somewhere between the original probate value of £1.8 million and the eventual sale proceeds of £1.6 million.
I think that there may be room to argue that the value in June 2010 was higher than the eventual sale price. I also feel that, although a discount of 10% on the value of a part share in a property is usual and very welcome at times, in these circumstances a discount of a lower amount could be argued.
There is no legislative basis for taking a 10% discount – TCGA 1992, s 272(1) states that the definition of market value is ‘the price which those assets might reasonably be expected to fetch on a sale in the open market’.
In hindsight, it would have been preferable to ensure that the variation applied for capital gains tax as well as inheritance tax; however, given the situation he has, if I were Losing Side I would be consulting a valuer and asking him to place a value at the property in June 2010 and I would also be asking his opinion as to the minimum discount a 95% share in a property might attract in the open market. This may be the only way in which the gain on the eventual disposal by the trust can be mitigated.
Reply from N.K.
I think the crucial point in this query is the fact that ‘an inheritance tax election was made, but no capital gains tax election’. This leads to the possibility as to whether the client remains a settlor.
In this case although an inheritance tax election has been made under IHTA 1984, s 142(2), there will be no gift with reservation under FA 1986, s 102 because the variation will be treated as having been made by the deceased, which in this case was the mother.
Therefore, in this case, the difference between the capital gains tax and the inheritance tax consequences of a variation is the effect it has on who is a settlor for certain purposes. The beneficiaries have the testator’s disposition by settling the whole of the residuary estate upon a (discretionary) trust, and have retained an interest by being one of the objects of the trust.
In addition, because an inheritance tax election has been made there will be no gift with reservation under FA 1986, s 102 because the variation will be treated as having been effected by the deceased for all purposes of IHTA 1984 with FA 1986, s 102 being construed as one with IHTA 1984.
However, even if a capital gains tax election had been made under TCGA 1992, s 62(7) the beneficiaries will remain settlors and by reason of their retention of an interest, chargeable gains accruing to the trustees of the trust will be treated as accruing to them.
A closer look ... deeds of variation and capital gains tax
Variations or disclaimers of the dispositions (whether by a will, the intestacy rules or otherwise) of the ‘property of which the deceased was competent to dispose’ which are made by deed of family arrangement (or similar instrument in writing) within two years of death do not constitute disposals, but are related back to the date of death so that a variation is treated as having been effected by the deceased and a disclaimed benefit is treated as never having been conferred.
Section 62(6) states that:
‘subject to subsections (7) and (8) below, where within the period of two years after a person’s death any of the dispositions (whether effected by will, under the law relating to intestacy or otherwise) of the property of which he was competent to dispose are varied, or the benefit conferred by any of those dispositions is disclaimed, by an instrument in writing made by the persons or any of the persons who benefit or would benefit under the dispositions:
(a) the variation or disclaimer shall not constitute a disposal for the purposes of this Act; and
(b) this section shall apply as if the variation had been effected by the deceased or, as the case may be, the disclaimed benefit had never been conferred.’
HMRC’s Capital Gains Manual at CG31490 explains
‘the conditions that must be satisfied for a disclaimer to be retrospective for CGT purposes:
- the disclaimer must be effected by an instrument in writing made within two years of the person’s death;
- the persons who wish to disclaim all or part of their entitlement under the will or intestacy provisions must be parties to the instrument;
- there must be no consideration in money or money’s worth for the disclaimer other than consideration in the form of a disclaimer or variation of other dispositions of the same estate’.
