A recent case highlighted a little known trap when using deeds

of variation for Inheritance Tax (IHT) planning. If you fall into it you

could lose any tax advantage and create an administrative nightmare. So how can you avoid it?

 

Retrospective IHT planning

 

Deeds of variation (DOV) allow the beneficiaries of a will

to change its terms although they have other applications,

they’re most commonly used for IHT planning. A DOV

can be made provided the property received under the will

hasn’t been sold or given away by the beneficiaries. You

have two years from the date of death in which to

make a variation.

 

Example

 

Martin dies at the age of 68 leaving his second home worth £400,000 to his children, Janet and John. The rest of his estate, worth £450,000, is left to his wife. At current rates the estate would owe IHT of around £30,000 on the children’s legacy. The balance is exempt from IHT as it’s covered by the spousal gift exemption. Martin’s widow and children decide to make a DOV to the effect that she gets a quarter share of the property and Janet and John the remainder. Now there will be no IHT liability. As a result of using a DOV they saved £30,000 tax.

 

Tip

 

Make sure the DOV is signed by all the beneficiaries of the will, otherwise it won’t be effective. The DOV is a legal document so unless you’re certain you can draw this up yourself, we would recommend you ask a solicitor to do it.

 

Consideration trap

 

In the case of Lau v HMRC 2009, Mrs Lau (L) gave £1 million to her son. Previously, he had given up a legacy of £665,000 from his step-father on which some IHT was payable. Under the terms of the DOV all the money went to L and so was IHT exempt because it was now a gift between spouses. L claimed the subsequent gift to her son wasn’t connected to him giving up his legacy under the will. But the Special Commissioner hearing the case decided that the evidence clearly showed one was made in return for the other. Therefore, because the arrangement involved monetary consideration, s.142(3) of the Inheritance Tax Act 1984 cancelled the tax benefit.

 

Tip

 

A genuine gift by one beneficiary of a will to another following a DOV will not cause the tax benefit to be lost. But proof would be needed that the DOV and the later gift were not connected. This can be difficult to show. Therefore, the longer the gap between the two transactions the better.

 

Trap

 

When using a DOV for IHT planning, an agreement to financially compensate a beneficiary for giving up their legacy could result in the IHT advantage being lost. Nevertheless, the terms of the DOV would be binding and this can lead to administrative problems and expense in reversing its terms. However, there’s a simple way to avoid this problem.

 

Uncertainty clause

 

In another case, The Personal Representatives of Mrs Gwendoline Glowacki (Deceased), the DOV included an ‘uncertainty clause’. It said that if the DOV became ineffective for IHT purposes as a result of a challenge by the Taxman, then the whole deed would be void. We recommend all DOVs should include this type of clause.