Inheritance Tax (IHT) planning post-death will generally involve the individual signing a Deed of Variation (previously called a Deed of Family Arrangement). A Deed of Variation is a document signed by a beneficiary of an estate (whether that is from a Will, an intestacy or otherwise) in which the destination of the beneficiary’s inheritance is changed. If the Deed of Variation is signed by the individual within two years of the date of death of the person who has died, and the appropriate tax election is made, the amended gift is deemed to have been made by the person who has died for IHT and Capital Gains Tax (CGT) purposes.
For IHT, a Deed of Variation therefore means that the gift is outside of the individual’s taxable estate immediately rather than after seven years, and the individual can still benefit from the varied gift without the Gift with Reservation of Benefit (GROB) rules applying. The GROB rules state that if the individual enjoyed a significant benefit in or enjoyment of the asset given away then it will remain part of the taxable estate on death regardless of how long ago the gift was made, which will not apply with a Deed of Variation.
For CGT, a Deed of Variation means that the new beneficiary is treated as owning the asset from the date of death instead of the date of the variation, and the variation itself is not a disposal. However, if the variation sets up a trust, it is still the individual – not the deceased – who has made the variation and who is treated as the settlor of any continuing trusts. This means that where the individual making the variation is also a beneficiary of the trust, future trust gains are taxable on the individual as settlor not on the trustees. The CGT election is only effective to provide that the assets are treated as being acquired at market value at date of death.
Whilst a Deed of Variation results in the amended gift being deemed to have been made by the person who has died for IHT and CGT purposes, it is not so backdated for income tax, and so only applies to this tax from the date of the Deed of Variation.
Whilst a Deed of Variation has tax advantages, it is still a gift by the individual for all other purposes. As such, an individual who varies a gift in an estate in order to claim or retain means-tested benefits, or avoid assets passing to their Trustee in Bankruptcy, will be treated as if they had intentionally deprived themselves of capital as with any other lifetime gift.
A Deed of Variation must be in writing. The personal representatives in the estate being varied only need to sign the Deed of Variation if it results in additional IHT being payable in the estate. To obtain the tax advantages there must be no “consideration” paid for the individual to enter into the Deed of Variation, and so the individual must pay the legal costs of the Deed of Variation. Further, there must not be any agreement or understanding that the new beneficiary of the gift will give the asset back to the individual at a later date.
Whilst there can be any number of variations in the same estate, each variation must deal with a separate asset since it is not possible to execute more than one Deed of Variation over the same asset.
If any interests of a minor child or mentally incapable person are to be altered then the variation needs the approval of the Court.
A Deed of Variation can only apply to assets comprised in a person’s estate immediately before his death, and so any asset subject to the GROB rules cannot be varied given that it only forms part of the taxable estate of the person who has died, and not their actual estate. A deceased Joint Tenant's interest in a property passing by survivorship can be redirected by Deed of Variation.
Whilst a discretionary trust set up in the Will cannot be varied (given that it is highly unlikely that all potential beneficiaries can be a party to the Deed), the trustees can, within two years of the date of death, distribute the assets from the trust to any one or more of the beneficiaries and this is treated for tax purposes as being made by the deceased.
Variations are often used to pass assets (and possibly the nil rate band of the person who has died) to a discretionary trust, whether an existing trust or a trust set out in the Deed of Variation itself. This brings with it some of the benefits of IHT planning through Wills, such as securing Business Property Relief (BPR) and / or Agricultural Property Relief (APR), dealing with highly appreciating assets, guarding against beneficiaries becoming bankrupt or divorcing (other than the individual signing the Deed of Variation), further IHT planning opportunities, and avoiding the political and administrative issues with relying on the transferable nil rate band. In addition, a Deed of Variation can be of benefit in the following specific circumstances:
- Using spouse exemption
Where assets in an estate which are in excess of the nil rate band pass to a taxable beneficiary such as an adult child, the taxable beneficiary could vary the Will in favour of an exempt beneficiary such as the surviving spouse.
- Generation skipping
An adult child who inherits from a parent can sign a Deed of Variation in favour of his own children (that is, the deceased’s grandchildren). There is no IHT saving in the deceased parent's estate, but the varied assets have been immediately taken out of the taxable estate of the adult child.
- Using charity exemption
Whilst signing a Deed of Variation to make a donation to charity will result in that part of the estate being free of IHT, this will not increase the amount that passes to the taxable beneficiaries free of IHT. However, it may be possible to sign a Deed of Variation to increase an existing donation in a Will to charity so that the gift passes the 10% test, meaning that the remainder of the estate qualifies to pay IHT at the reduced rate of 36%.
- Double death variations
It is possible to vary the distribution of an estate even if the original beneficiary subsequently dies, so long as the variation occurs within two years of the date of death of the estate to be varied. This is often referred to as a double death variation.
If, for example, a surviving spouse has an estate which is equal to the IHT threshold (taking account of the availability of the transferable nil rate band) then no IHT is payable.
If, however, that surviving spouse was awaiting an inheritance from a deceased uncle’s estate, but had not taken any action to minimise the potential IHT consequences of this during their lifetime, then IHT would be payable in the surviving spouse’s estate on that inheritance. So, a Deed of Variation could be signed in the estate of the deceased uncle, by the personal representatives in the estate of the surviving spouse, so as to pass the inheritance from the deceased uncle’s estate to the beneficiaries in the estate of the surviving spouse.
In a Deed of Variation, the individual redirects the gift to an alternative beneficiary. A disclaimer, on the other hand, is simply a refusal to receive the gift in the first place. The disclaimer therefore gives the individual no control over the ultimate destination of the gift. The Will of the person who has died or the Rules of Intestacy, where there was no Will, then dictates who receives the asset instead. Any act of acceptance or receipt of benefit will prevent a disclaimer, and the whole interest has to be disclaimed.
One advantage of a disclaimer over a Deed of Variation is in relation to income tax. The effect of the disclaimer is to make the gift void from the date of death and there is no taxation of the pre-disclaimer income on the individual disclaiming the gift. This is particularly useful if, as a result of the disclaimer, the individual’s minor children benefit.
It is always preferable that the deceased should have a well drafted Will rather than relying on the ability of any beneficiary to make variations or disclaimers. The law may have changed, the tax consequences are unlikely to be as beneficial and the beneficiary may not be able or willing to make the Deed of Variation or disclaimer.