Estate planning update

The Court of Appeal’s decision in Buzzoni v Commissioners for HM Revenue & Customs [2013] EWCA Civ 1684 was a gift practitioners received with some enthusiasm.

The court overturned the decision of the First Tier Tax Tribunal and the Upper Tribunal in favour of the Revenue, and found for the taxpayers, the executors of the late Mrs Kamhi.

The case involved Mrs Kamhi’s acquisition of a leasehold flat in London. She entered into the usual covenants with the head landlord to pay rent and service charges, keep the property in repair and decorated and contribute to the maintenance of the common parts.

In 1997, Mrs Kamhi created an underlease of the flat for a term beginning in 2007 and running until 2094. She retained her superior leasehold interest. On the same day, she made a gift of the underleasehold interest to the trustees of a new settlement of which she was not a beneficiary. She died in 2008.

The Revenue accepted that Mrs Kamhi’s gift took effect when made (in 1997) and not when the underlease began (in 2007) but contended that “the property (was) not enjoyed to the entire exclusion, or virtually to the entire exclusion, of the donor”, because the underlease was subject to covenants in favour of Mrs Kamhi as lessor, which mirrored the covenants contained in her own lease. According to the Revenue, this was a gift with reservation of benefit and thus on Mrs Kamhi’s death inheritance tax was payable on the subject matter of the gift under section 102(1)(b) of the Finance Act 1986.

The Court of Appeal accepted that the benefit of the underlessee’s covenants was derived from the subject matter of the gift, but held that this benefit did not affect the exclusivity of the donee’s enjoyment of the gifted property. The court reached this conclusion because, to obtain the head landlord’s consent to the grant of the underlease, the donee had entered into direct covenants with the head landlord, which were identical to those given to the donor in the underlease. The donee’s obligations to the donor made no difference whatever to its enjoyment of the property. It was bound to comply with the covenants it had entered into with the head landlord.

The principle underlying the Court of Appeal’s judgment is that for IHT purposes the crucial test is the donee’s enjoyment, not the donor’s actual or possible benefit.

This is helpful when considering estate planning via the carving out of sub-leasehold interests, where the commercial requirement for an effective chain of covenants is easy to demonstrate. Potentially the principle is capable of wider application to gifts of other assets where it is not practicable for the donor to be excluded from all conceivable benefit or where, inadvertently, the wording of the gift does not amount to an express exclusion of the donor.

Rectification applications

The Chancery Division’s helpful attitude in rectification applications was demonstrated in The Hampel Discretionary Trust 1999 [2012] EWHC 2395, a judgment which appeared some weeks before the Buzzoni decision.

The donors made a gift on trusts of which they were the trustees. The trust deed excluded “the trustees” from all future benefit. It later dawned on them that if the donors ceased to be trustees, the exclusion clause would no longer apply to them, and they could become beneficiaries. Furthermore, no other family members would be willing to be a trustee, because the clause could exclude them from benefitting.

The court ordered rectification of the Hampel trust deed to exclude the donors as settlors from all benefit and removing the exclusion of future trustees from benefit. The judgment makes it clear that it is unnecessary for the court to reach any definite conclusion on the correct interpretation of the trust deed, or the tax consequences of it. It was sufficient that the evidence shows there is real doubt that the wording fails to give effect to the gift that the donors intended to make.

HMRC compliance checks

The Revenue’s December 2013 Trusts & Estates section update (www.hmrc.gov.uk/cto/newsletter-181213.pdf) outlined improvements that have been made to its inheritance tax compliance processes.

For cases the Revenue consider high-risk and requiring a compliance check, they will send the adviser an initial letter within 8-10 weeks of receiving the relevant account. This will simply confirm that the case has been selected for review.

An ominously titled “investigator” will then be assigned to the case, and will make contact (usually by phone) to discuss matters further. The investigator will be the main contact point for all further communication. The Revenue anticipates making contact within 4-6 weeks of the initial letter, so 12-16 weeks from submission of the account, with the aim to “reach early agreement” and resolve matters quickly and if possible by phone.

However, the Revenue acknowledges that a case will likely be resolved by phone only if the risk was small, although this appears to contradict the Revenue’s statement that only high-risk cases will be reviewed.

A time lag of three months between the submission of an account and contact with the investigator does not seem particularly quick. The Revenue’s initial letter gives the HMRC helpline number but neither a contact name nor an email address, making it virtually impossible to chase up.

Practitioners have generally noticed a slowing down in response times from the Revenue, particularly where IHT applies to the deceased’s trust interests as well as his free estate. The Revenue’s lack of engagement obstructs post-death planning measures which are subject to inflexible time limits, such as the two-year limit for varying a will, and is frustrating for executors, beneficiaries and practitioners.

Limited solutions are available. Purchasing a certificate of tax deposit will prevent interest accruing on the amount of the tax certified, although the adviser has no idea whether the Revenue is likely to accept the valuations and tax computations put forward. Submitting an old-style application for an IHT clearance certificate, in duplicate, at least allows one to report to the client that one has done everything possible.

IHT charges on trusts

In December, the Revenue issued a summary of responses to its consultation published in May 2013. The practitioner’s eye is irresistibly drawn to this sentence in the Revenue’s response: “We believe that the tax system should be neutral in its treatment of trusts, neither penalising nor encouraging their use, i.e. wherever possible to provide equality of treatment between direct transfers to individuals and indirect transfers to individuals via trusts.”

The Revenue acknowledges that there is a danger that making changes to the existing regime would lead to increased complexity and retrospective tax charges on trusts. On the other hand, it is not willing to entertain a system enabling settlors to set up multiple trusts each with its own nil-rate band, or recycling a trust’s nil-rate band every seven years, because of the loss of tax revenue this would produce.

On the vexed question of whether income not distributed by trustees should be considered after a certain period to have been accumulated and added to capital, which may then come within the scope of an IHT charge, the Revenue clearly intends to proceed with legislation on this. Happily, the Revenue has accepted STEP’s recommendation that capitalised accumulations should be subject to the IHT periodic charge (on ten-year anniversaries) only.

There will be no exit charges on the distribution of previously accumulated income (which represent income in the hands of the beneficiary). The Revenue now proposes that income received five years or more before a ten year anniversary and remaining undistributed at the anniversary date will be subject to IHT as part of the trust capital.

To avoid the need for complicated record-keeping on the dates of income receipts, all such income will be taxed at the full rate as if it had been relevant property for the whole of the ten years prior to the anniversary date.

Legislation is also in prospect to bring forward the due date for trust IHT returns to coincide with the date on which the IHT liability is due: six months after the end of the month in which the taxable event occurs.

Wills and probate

Changes are in the air which will affect time-honoured will-drafting practices. Same-sex marriages will be available from 29 March 2014 and will affect not only the wills of the individuals concerned, but also those of their relatives.

The Inheritance and Trustees’ Powers Bill, currently on its journey onto the statute book, will update the time-honoured definition of personal chattels in section 55(1)(x) of the Administration of Estates Act 1925. Out goes a picturesque list that includes “carriages, horses, stable furniture and effects” and in comes the simpler formulation of “tangible movable property”.

Another welcome change in the Bill is increased provision for the surviving spouse of an intestate. If the deceased has no surviving descendants the spouse will receive the entire residue. If there are children or grandchildren, the spouse will take half the residue outright, not just for life.

Because the residential property boom is taking many estates over the limit of the £250,000 statutory spousal legacy, the present rules creating a compulsory life interest trust for the spouse, often of a small amount, complicate the probate and administration process and present an obstacle to sensible post-death planning. These changes are eagerly awaited.