Deeds of Variation in wills are important for this part of estate/succession planning, but they are potentially at risk. This article explores their value.

Roger Peters, senior partner at Gordon Dadds, a London-based law firm, talks about a recent development in the world of wills in the UK, raising important and potentially troubling questions about succession planning. This publication invites readers to respond by email to tom.burroughes@wealthbriefing.com

Whether George Osborne, UK finance minister, was serious when he made his annual Budget announcement of a review into the use of Deeds of Variation for “tax avoidance” remains to be seen, but it has raised serious concerns amongst experienced private client advisors who are worried that an attempt by the Chancellor to tease [official opposition leader] Ed Miliband could lead to the misconceived closure of an essential opportunity to rectify poor or non-existent estate and tax planning, whose consequences usually emerge only after death. The suggestion that it allows “tax avoidance”, rather than tax saving, is politically based and mischievous.
 
It appears that Miliband’s family had used the arrangement entirely legitimately to minimise the inheritance tax payable on his father’s death. They took advantage of the rule in inheritance tax legislation that a variation within two years of the death of the destination of an inheritance, (including a distribution out of a discretionary trust set up under a will), can be backdated to the date of death for inheritance tax purposes.

The rule has applied for the last 40 years, having first been included when capital transfer tax legislation was introduced by a Labour Government in 1975 to allow beneficiaries who for no fault of their own would be treated harshly for what is now inheritance tax, an opportunity to have the same treatment as those whose inheritance, through better advice and planning, would be taxed more favourably. 
 
Often wills are made decades before death, and based on an entirely different tax regime or tax reliefs and allowances prevailing at the time. House price inflation has brought many more estates into inheritance tax, and created unexpected problems for the family.  If there is no will, the inheritance and its tax consequences on intestacy is dictated by statute, and takes no account of tax planning. Unfortunately there is still a mistaken urban myth that husbands and wives and civil partners automatically inherit everything, so a will is unnecessary. In reality they have only a limited inheritance fixed by law if there is no will.
 
The long-established opportunity to back-date a variation of the inheritance under both wills and an intestacies affords an opportunity to avoid the consequences of poor or non-existent planning, typically of being forced out of the family home or other unlooked for outcomes, if it can be agreed between all the main beneficiaries, possibly helped along by a reduction in the IHT bill if that applies.
 
There seems to be no significant political challenge to the concept that inheritance between spouses and civil partners should be tax-free. Provided action is taken properly and promptly, it isn’t “tax avoidance” to allow the family to put right the failure by the person who has died to take full advantage of that basic entitlement, or to adjust to an unpredictable change in tax rules since the will was prepared. If it affords an opportunity to pass on an inheritance tax free to the next generation, it encourages wealth redistribution, which is something promoted by all political parties.
 
Two case studies illustrate the point. The family home which he lived in with his wife and grown up children was bought by Mr Jones in 1995 for £180,000. Mr Jones thought it was unnecessary to go to the expense of making a will, as he firmly – but wrongly - believed that when he died everything he had would pass automatically to Mrs Jones. In fact the intestacy rules would allow Mrs Jones only a statutory legacy of £250,000 and half the rest of his estate. The house, which had increased in value to £1 million, was the only asset of Mr Jones’s estate when he died.  
 

Out of the estate, Mrs Jones gets only £635,000, IHT-free as she was married to Mr Jones; her two children receive £325,000 between them, after IHT of £20,000. The children’s share and tax on it might only be found by selling the house in which their mother was expecting to live for the rest of her life.  
 
Under the rules as they are, she and her children retrieved the situation by agreeing to complete a Deed of Variation, altering the intestacy distribution to direct the entire estate to Mrs Jones, and so allowing her to remain in her home as her husband had mistakenly believed she would be able to do.
 
In the early 1970s, Mr Philips made a will which, as he was unmarried, left everything to his elder brother. He never married, but died aged 90 without updating his will. His brother, who by this time was 91, had no need of money and wanted to gift his younger brother’s estate, worth £625,000, to his own grandchildren. There was no prospect of saving IHT on his brother’s estate, but if the will stood as it was and the elder brother inherited £405,000 (after IHT of £220,000) and then gave the inheritance to his grandchildren, at his age the chances were that he would not survive another seven years to make the gift tax-free. The gift would then be caught for IHT again on his own death, and the overall IHT liability before the grandchildren inherited increased by up to an additional £162,000.
 
By signing a Deed of Variation which changed his brother’s will to leave the entire estate to the grandchildren, Mr Philips saved an unnecessary double charge to IHT, and up to £162,000 of tax on their inheritance.
 
Had both Mr Jones and Mr Philips taken the right estate and tax planning advice, they would each have made a will with exactly the same effect as the Deed of Variation. The true intention of the Jones Deed of Variation was to avoid his widow having to leave her home, not to “avoid” tax; and, as in many cases of this kind, it is likely that the tax saved then would have to be paid when Mrs Jones died and her own estate, including the house, became liable to inheritance tax.

In Mr Philips’ case, it would be reasonable to assume that his brother would have wanted the grandchildren to benefit, but like so many, had never thought to update his will made so long ago. It is much to be hoped that the consultation, if it takes place, will sensibly conclude that when it comes to inheritance, there is nothing legally or morally unfair in allowing the beneficiaries a last chance to do what should have been done.