Malcolm Finney looks at deeds of variation and their potential effect for inheritance tax purposes.
To many, the deed of variation concept is a strange animal. It permits a beneficiary under a will following the death of the testator to re-direct their inheritance to someone else, whether that someone else is, or is not, a beneficiary under the will, effectively overriding the wishes of the testator.
Re-directing an inheritance
The particular attraction of the deed of variation (DoV) is that subject to the satisfying of a number of conditions (IHTA 1984, s 142), the redirection may be made in an inheritance tax (IHT) efficient manner.
Example 1: Gift under a will re-directed
Tom left his favourite painting in his will to his only son, Tim.
Tim never liked the painting, but his mother loved it. She had hoped to receive it.
Tim executed a DoV re-directing the painting to his mother.
In the example above, the IHT charge on Tom’s estate on death will be reduced, as the charge which would have applied due to the painting being left to his son is removed, and Tim’s gift is treated as if it had been a gift from Tom to his wife. The gift from husband to wife constitutes an IHT-free inter-spouse gift.
Now consider the following, not unusual, scenario.
Example 2: Re-direction to a deceased beneficiary
Harry, who is married to Mary, made a will leaving his estate to his two children in equal shares. On his death, IHT is paid on his estate (valued at £600,000).
Mary died eighteen months later. Under her will, her estate (valued at £50,000) passes to the two children in equal shares. Her estate fell within the nil rate band (£325,000), so no IHT charge arose on her estate.
The two children have been advised that if Harry’s estate had been left to Mary, no IHT charge would have arisen on his estate and on her death her aggregate estate of £650,000 could be left to the two children with no IHT charge arising, as Mary would be entitled to her own £325,000 plus Harry’s £325,000 (i.e. an IHT allowance of £650,000). Can this be achieved?
In this example, the desired outcome could be achieved if the two children were able to execute a DoV with respect to their inheritance under their father’s will re-directing it to their mother; but, at the date of executing the DoV, their mother is no longer alive. The question thus arises whether a gift can be made to a person who has died.
Logically this would seem to be impossible. However, it could be argued that the gift (i.e. the re-direction under a DoV) from the two children of their inheritance from their father is not, as such, re-directed to their now deceased mother but to her executors forming part of her estate, to then be administered as part of her estate. The conditions which need to be satisfied when executing the DoV would, of course, need to be satisfied, in particular, requiring execution by the two children within two years of their father’s death.
DoV by executors
A not too dissimilar issue arises where, for example, X dies leaving their estate to Y who dies within two years of X. The issue is whether it is possible for a DoV to be executed with respect to Y’s inheritance from X given Y has died.
This is possible because as the executors of Y’s estate benefit from the inheritance from X they can execute the DoV (albeit they may require the agreement of Y’s beneficiaries).
If inheritance tax on the deceased’s estate is increased due to execution of a DoV the executors of the estate must also be parties to the DoV in addition to the individuals who are making the DoV.