Blind ambition

Many people believe that inheritance is set in stone. Some may know that they can make a claim against an estate if they feel they have been unfairly neglected by the distribution, but less well known are the options for beneficiaries making post-death rearrangements and avoiding litigation. While rewriting a will or the intestacy rules is not possible, their effect can be altered in many cases.

Efficient tax planning is one reason for wanting to change the distribution of an estate. Beneficiaries can maximise the value of the net estate, for example by fully using the deceased's nil rate band, making better use of inheritance tax (IHT) reliefs, such as business property relief or reaping the benefit of the new 36 per cent rate of IHT where a sufficient proportion passes to charity.

But rearranging the dispositions could have nothing to do with tax. For example, an original beneficiary may wish to provide for others with greater need of funds than themselves or to benefit an organisation or person who gave particular help or support to the deceased.

The original beneficiary can personally gift outright some or all of their inheritance to someone else. However, such a gift to an individual would be a potentially exempt transfer (PET) and, should the donor die within seven years of making the gift, it would be caught in their own estate for IHT purposes.

It may also be a disposal for capital gains tax (CGT) purposes. If the beneficiary transfers the property to trustees, it will usually (unless it is a trust for disabled persons) be a lifetime chargeable transfer (LCT) for IHT and will always be a disposal for CGT.

So what are the alternatives? One option, provided the beneficiary has not already accepted any benefit from the gift, is to refuse their interest in it completely (a disclaimer). However, the disclaiming beneficiary cannot redirect the gift to a person of their choice, and instead the property passes automatically to those next in line under the will or intestacy rules. Furthermore, the beneficiary must disclaim the whole interest they were to receive, not just part of it, unless the instrument governing the distribution of the estate (usually the will) specifically allows for partial disclaimers.

Deed of variation

A more common method of rearranging an estate is using a deed of variation (sometimes called a deed of family arrangement). It is more flexible than a disclaimer because the original beneficiary can redirect the property to a recipient of their choice. This allows new beneficiaries to benefit and limitations and contingencies to be imposed. However, a variation cannot be made without the agreement of all beneficiaries potentially affected. To consent, they must all be 18 or over and have mental capacity.

Where the appropriate formalities are observed, the effect of disclaimers and variations is to write the provisions of the rearrangement back into the terms of the deceased's will or intestacy for IHT purposes, that is the varied dispositions are treated as having been made by the deceased. Thus, the estate is taxed on the basis of the amended distribution and the original beneficiary is not considered to have made a PET or LCT. Similarly, the beneficiary is not treated as having made a disposal for CGT purposes (although where the variation creates a settlement, the beneficiary is still regarded as the settlor of that settlement).

To achieve this writing-back effect, the disclaimer/variation must be in writing and made within two years of the deceased's death, for no consideration in money or money's worth. Particular property may only be redirected once, so a second variation of the same property will not be effective for tax purposes. The written instruments must include a statement that the appropriate legislative provisions that allow the writing back, specifically section 142(1) Inheritance Tax Act 1984 and/or section 62(6) Taxation of Chargeable Gains Act 1992, are to apply.

The beneficiary making the change must decide whether IHT and/or CGT should apply, taking into account their personal tax position and that of the estate. There is no provision to allow writing back for income tax purposes, hence income received before the variation or disclaimer from the property affected will be taxed as the original beneficiary's own income, as it can be afterwards if an original beneficiary redirects income-producing property to their minor child (although not if the minor child inherits via a parental disclaimer).

But be warned. While rearrangements allow an opportunity to benefit from hindsight, none of us has foresight. Such arrangements and their current tax treatment might not always be available.

Ailsa Moorhouse is a solicitor at Penningtons