Acase occasionally comes along which generates a great deal of interest among all those concerned with giving inheritance tax planning advice to clients. One such case was that of Dr Phizackerley, which considered whether loans taken from a trust would constitute debts against the estate of a deceased person for IHT purposes.
The facts of the case were quite unusual. Dr Phizackerley was a consultant biochemist who lived in tied accommodation until his retirement in 1992, when he and his wife bought a £150,000 house which was put in their names as joint tenants. It was agreed by both parties that as Mrs Phizackerley did not work during her marriage, all the funds must have been provided by Dr Phizackerley.
In 1996, Dr Phizackerley severed the joint tenancy so that he and Mrs Phizackerley held the property as tenants in common. The same week, Mrs Phizackerley made a will which left the nil-rate sum to a discretionary trust and the residue of the estate to her husband absolutely.
Mrs Phizackerley died in 2000. Under the will, her half-share in the house was transferred to Dr Phizackerley, who promised to pay £150,000 index-linked to the trustees of the discretionary trust. On his death two years later, his estate, ignoring the promise of payment to the trustees, was value at just under £530,000.
The case was referred to the special commissioner to decide whether the debt owed to the trustees, which had meanwhile increased to £153,222.99, was deductible from the estate of Dr Phizackerley or whether deduction was prevented by section 103 of the Finance Act 1986. This prevents the deduction of a debt where, and to the extent that, the consideration given for the debt or encumbrance consists of “property derived from the deceased”.
The special commissioner said that, on the face of it, the half-share in the house was indeed derived from the deceased, Dr Phizackerley. It was the subject matter of a disposition made by the deceased, so the debt incurred by the deceased in favour of the trustees of the nil-rate-band discretionary trust was not deductible. The tax planning therefore failed.
What implications will this decision have for advisers recommending the use of discounted gift schemes, loan trusts and discretionary will trusts for clients? For the Phizackerley decision to apply, three things must be present.
– There must have been a gift by, for example, a husband to his wife, on or after March 18, 1986.
– The wife must then have created a trust, either during her lifetime or on death.
– The trustees must subsequently have made a loan or loans back to the husband with the intention of creating a debt against his estate and thereby reducing the future IHT payable on his death.
If all these things apply, then the value of the original gift will be deducted from the loan or loans and only any balance will be deductible from the husband’s estate.
This is clearly not the normal position where clients are considering effecting lump-sum IHT mitigation schemes such as discounted gift schemes and loan trusts. So, in most cases, the Phizackerley decision will not be relevant.
In any event, detailed enquiries into the source of the funds only need to be made by advisers once any trust is created and it is desired to make loans back to a beneficiary to create a debt against his or her estate. This may be more common where a discretionary will trust is created on the first death, there had been some equalisation of assets earlier to enable both nil-rate bands to be used and the surviving spouse is granted a loan or loans by the trustees.
The order of death is also vitally important. If Dr Phizackerley had predeceased his wife, then any loans granted to her by the trustees of his discretionary will trust would have been fully deductible on her death.
It is true that advisers should always be aware of the source of funds to be used in any IHT planning exercise but in the case of normal planning using discounted gift schemes or loan trusts, there will be very few circumstances where the decision in Phizackerley will be relevant.
Brian Murphy is financial planning manager at Axa Sun Life.