There has been a bit of a furore on the Solicitors for the Elderly discussion forum recently following press articles about Deeds of Variation and particularly the Daily Mail’s reference to it as a ‘controversial tax loophole’. Although a deed of variation can save tax in certain situations, it is basically a device for a beneficiary to record the gift of some or all of his or her interest in a deceased’s estate in favour of another individual or a charity or a trust. It will be used where the situation after someone’s death is not covered by the terms of the deceased’s will or intestacy and for all sorts of reasons, not necessarily related to tax, it is desirable to change the terms of the deceased’s will.
The deed of variation sets out how the beneficiary is rearranging or redirecting his or her interest in the estate. It can be preferable to the beneficiary’s other option of ‘disclaiming’ the gift (where they simply refuse to accept it) as it means that the original beneficiary can choose who (or what) receives it.
A deed of variation can be helpful where the first to die of an unmarried couple has failed to make a will and the cohabitee would otherwise lose everything to the beneficiaries who were entitled under the intestacy rules. In these circumstances, the beneficiaries of the intestacy would each have to come to the decision to ‘do the right thing’ as they cannot be made to gift their interest (the deed of variation has to be voluntarily) and the alternative is likely to be a difficult and probably expensive claim against the estate under the 1975 Inheritance Act for the family and dependants.
It can also be helpful to make sense of the current inheritance tax regime where couples now have a transferable nil rate band. Prior to the Finance Act of 2006 it was necessary for married couples and civil partners with an estate over the value of one nil rate band to pass some of it to a discretionary trust (if the survivor was likely to need it) or outright to their children or relatives (if the survivor did not) on the first death. This was an artificial arrangement to avoid a higher inheritance tax bill when the survivor of them died and thankfully it is no longer needed. However, where a couple have not updated their wills a deed of variation can be useful to pass the estate on to the survivor of them as the couple would have wished if only the tax regime had allowed them to.
The variation is essentially a gift by the original beneficiary under the will or intestacy. If it is completed within 2 years of the deceased’s death, provisions in the Inheritance Tax Act 1984 and Taxation of Chargeable Gains Act 1992 mean that although the beneficiary is making a gift of his or her interest, that beneficiary will not be responsible for any tax payable as a result of the gift and instead the terms are ‘read back’ into the will.
In relation to inheritance tax, the reading back provisions mean that the gift is considered as part of the distribution of the deceased’s estate overall. So, if the total amount transferred to chargeable beneficiaries exceeds the deceased’s nil rate band then tax will be payable, but otherwise it will not.
It would be rather unusual for a variation to trigger an inheritance tax charge, but it depends on the reasons for doing the variation in the first place. In cases where the original beneficiary is re-organising the estate to make provision for dependants and relatives, inheritance tax considerations may be secondary to the needs of these individuals.
I should add, for completeness, that it is only capital gains and inheritance tax that is covered by these reading back provisions. For income tax purposes, the variation is only effective from the date the deed itself is executed. Generally, the original beneficiary is assessed on any income produced up to the date of the variation and the new beneficiary after that.
Hopefully, most people will not require a deed of variation as they will have an up to date will in place that reflects the current situation and includes everyone or everything that should be included. It is obviously very important to keep checking the terms of your wills (or if you haven’t got one, to make one) to ensure it is up to date. The deed of variation can be extremely useful and it will always be possible to make one, but whether or not the favourable rules for capital gains and inheritance tax will apply to the variation remains to be seen. A change in the tax law could remove the advantages of the reading back provisions, so that although an estate can always be varied (or a beneficiary’s interest disclaimed) the ‘tax loophole’ is removed.
For further information on any aspect of this article please contact Rebecca Lauder, a Partner in our Lancaster office on 01524 386500 or firstname.lastname@example.org