A Deed of Variation can be used by the beneficiaries to change entitlements under a Will.
The main reasons why beneficiaries may wish to vary or redirect inheritances are:
To save inheritance tax.
To alter the interests under a Will.
To provide for someone who has been omitted from a Will or who has not been given adequate financial provision.
To resolve any uncertainty or amend a defect in a Will.
A recent case, Vaughan-Jones v Vaughan-Jones, illustrates how not to plan for inheritance tax.
The deceased had prepared a Will which divided the residue of his estate into four equal shares between his widow and three sons. After the death the beneficiaries ‘became aware’ that these circumstances gave rise to an inheritance tax liability. A few days before the second anniversary of his death, a deed of variation was executed by the family redirecting the residue to the widow absolutely. Evidence suggested that by entering into the deed of variation the family had all intended that the inheritance tax be eliminated in that the widow would benefit from spouse exemption on the entire element of the estate passing to her.
Unfortunately, the variation as drafted did not include a statement that the parties were claiming retrospective tax treatment for inheritance tax purposes and such a statement is a pre-condition of changing the tax status of the original bequest. The legal effect of the deed of variation was therefore to give the residue to the widow … but still incur inheritance tax.
The family applied to rectify matters so as to insert the missing statement into the Deed on the basis that it had been omitted by mistake … the evidence suggested that the Deed had been prepared using an out of date precedent. The Judge accepted that there was just sufficient evidence to satisfy the high burden of proof required in a rectification claim of a mistake on the part of all the relevant parties to the Deed in question.
The Judge ruled that the Deed should be rectified to include the missing declaration that the parties claimed retrospective tax treatment.
Unfortunately, in demonstrating there had been a mistake, the evidence also revealed an intention on the part of the family that the inheritance tax free funds received by virtue of the rectified Deed would be transferred back by the widow to her sons.
Oh dear !
The judgment records that HM Revenue & Customs had already given notice that it considered the Deed was entered into as part of a wider arrangement and so was ineffective for tax purposes. How so ?
Inheritance Tax Act 1984 section 142(3) denies retrospective tax treatment where a deed is entered into “ for any consideration in money or money’s worth other than consideration consisting of the making, in respect of another of the dispositions, of a variation or disclaimer to which that subsection applies.” Unfortunately, the variation was therefore doomed from the start as far as inheritance tax efficiency was concerned.
How much simpler this would have been had the testator obtained tax advice at the same time as the Will was drafted.
The use of Deeds of Variation to save inheritance tax is currently under review. The ‘smart money’ says that nothing will change on the grounds that this has been the conclusion of all previous reviews.
The contrarian view is that times change and that the review may recommend that the situation which arose under ‘Error 1’ ( i.e. that the legal effect of a deed of variation in the above circumstances would be to give the residue to the widow but still incur inheritance tax ) should always be the default position. In other words, a Deed would be effective for all purposes other than for those of taxation. After all, should not a testator accept responsibility for balancing his or her wishes regarding devolution of the estate against the accompanying tax implications during their lifetime and certainly at the same time as drafting his or her Will ?
Whether the existing legislation will stand or whether it is amended along ‘contrarian’ lines, it is clearly far more effective planning to consider ones exposure to inheritance tax well before you die rather than have the tax cost of an ineffective Will or planning sprung upon a family at a difficult time. My guess is that the review may, and only may I stress, seek to move responsibility back to the testator.
Every family currently has ‘two bites at the cherry’ with respect to inheritance tax mitigation – once during the testators life and once again in a more restricted sense for the family within two years of death. If the review only leaves ‘one bite’ then the real beneficiary of testators failing to take tax seriously will be the Treasury.