This week I am continuing my review of the fundamentals of deeds of variation and, in particular, the taxation aspects. In the Budget, the Chancellor announced a review into their use for tax purposes. However, the rules currently stand as such. Since 1 August 2002 a legal variation has been automatically treated as a disposition by the deceased for capital gains tax and/or inheritance tax purposes if it contains an election (referred to as a “statement”) specifying it is to have that effect. A further election to HMRC is not necessary.
Before 1 August 2002 it was necessary to make an election to the Capital Taxes office or local inspector of taxes within six months after execution of the instrument in order for the legal variation to be effective for tax purposes. The mere submission of the document of variation was not sufficient.
Now, notification to HMRC is required only if additional tax is payable as a result of the variation: for example, where a widow makes a variation above the IHT nil-rate band in favour of a non-exempt person.
The effect of a CGT election is to pass the base cost at the date of death to the new beneficiary. If an election is not made, the deed of variation will be treated as a disposal for CGT purposes by the person giving up their right to property.
Generally for CGT purposes there is an exemption on death and an uplift in the base cost to the market value. Accordingly, it may not always be appropriate to elect for both taxes (and it may even be negligent to do so). It may be advantageous to elect for IHT but not for CGT in the following situations:
- There are assets with losses
- The CGT annual exemption is available
- Non-UK residents are involved
- Where trustees own property that has been the principal private residence of a beneficiary under the terms of a settlement and the property has risen in value since death. If the value has fallen a CGT election should be made, as this will establish a higher base value at death.
It should be remembered that for income tax purposes and for the subsequent CGT treatment of any settlement, it is the person making the variation (and not the deceased) who will be treated as the settlor. This was confirmed in the House of Lords decision in the case of Marshall v Kerr (1994) and, following the Finance Act 2006, embodied in the CGT legislation.
For income tax purposes, this provision is particularly important where, as a result of a rearrangement, a minor child (who is not married or in a civil partnership) of the settlor becomes a beneficiary. In this case, if trust income exceeds £100 gross in a tax year, all income from the settlement thus created will be treated as that of the settlor under section 629 ITTOIA 2005, whether paid to or for the benefit of the child, or accumulated (post-8 March 1999 settlements). For pre-9 March 1999 settlements, assessment on the settlor only applies to the extent income is paid to or for the benefit of the child. This is where the disadvantage of rearrangements after death by deed of variation, as opposed to an appointment being made under a discretionary will trust, becomes apparent.
For CGT purposes it is only the original redirection (i.e. the gift by the original will beneficiary) that will be treated as having been made by the deceased. For future purposes, any subsequent CGT will be applied in accordance with the normal rules. This means, if the redirection is to a discretionary trust, future gains will be taxed on the trustees. This rule was of more significance before April 2008, where the settlor would have been taxed on the gains of a settlor-interested trust. This would have been the case where the original beneficiary created a discretionary trust under which they remained a beneficiary. As these provisions no longer apply, this is of less relevance.
It used to be thought the above-mentioned provisions in respect of income tax could provide an additional advantage where redirection was in favour of a charity. Here, the gift to charity made under a deed of variation would, for IHT purposes, be treated as made by the deceased, thereby providing full exemption from IHT, while for income tax purposes it would be the original beneficiary under the will who would be treated as making the gift. The argument was the original beneficiary was entitled to income tax relief under the provisions in respect of gift aid (allowing for tax relief in respect of certain gifts to charities). However, in the case of Harris v HMRC (2010) such relief was denied.
When stamp duty applied to documents, which was until 1 December 2003, both a deed of variation and a disclaimer by a deed used to be exempt from stamp duty provided such a deed was certified to the effect the instrument fell within category M in the Schedule to the Stamp Duty (Exempt Instruments) Regulations 1987.
Currently, a variation must contain a stamp duty certificate only if the instrument of variation alters the destination of stocks, shares or marketable securities. The relevant category for deeds of variation remains as above.
When a variation deals with assets subject to stamp duty land tax such a transaction is exempt from the tax.
Tony Wickenden is joint managing director of Technical Connection