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My PFS - Technical news - 16/02/16

Personal Finance Society news update from 3rd February to 16th February 2016 on taxation, retirement planning, and investments.

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Taxation and Trusts

Retirement planning


Dividends and life companies

(R02, AF4, CF2, FA7)

We have commented earlier that following the publication of the draft clauses for the Finance Bill 2016 we were still no nearer an answer on the tax treatment of dividends within the policyholders' funds of UK life companies. We made enquiries of HMRC and we have now received a reply from HMRC that states '…it is not the intention for the proposed changes to affect the taxation of UK Life Companies. Where those companies receive income that is affected by section 102(3) Finance Act 2012, that income is taxable at the Basic Rate (currently 20%), not at the dividend ordinary rate. The abolition of the dividend tax credit and the amendment of the dividend ordinary rate should have no effect on that income. Where the company receives dividend income not affected by section 102(3), it will continue to be taxed on that income as any other company (i.e. the income will be exempt) and so the abolition of the dividend tax credit should have no effect.'

The net result in terms of effective tax rates is summarised by us in the table below: 

Investor tax rate











Within dividend allowance







Above dividend allowance











  • For basic rate taxpayersDividends within UK investment bonds will be taxed in the same way as dividends within the dividend allowance, but will be more favourably taxed within a bond once the allowance is exhausted as a basic rate taxpayer will have no tax to pay on a chargeable event gain (assuming the top-sliced gain keeps him/her within basic rate tax). Above the dividend allowance a basic rate taxpayer suffers 7.5% on directly received dividends.
  • For higher and additional rate taxpayersAll dividends within UK investment bonds will ultimately be taxed at 20% (higher rate) or 25% (additional rate) because of the treatment of chargeable event gains on encashment. The bond is thus less attractive where the dividend allowance is available, but beneficial if the allowance is exhausted by other dividend income the investor receives.  The bond wrapper also offers tax deferral on the underlying dividend income.

This "no change" approach is inconsistent with the planned treatment of interest in the context of the Personal Savings Allowance, but nonetheless welcome for that.

Long-term care - The deprivation of assets rules and gifts of property

(AF1, AF2, RO3, JO3)

There is anecdotal evidence that local authorities are paying closer attention to lifetime gifts of property where a subsequent application for assistance with care is made. Here we review the rules regarding the so-called "asset deprivation".

A recent case involved a widow who went into residential care. Three years earlier her husband died and because their home was owned jointly as tenants in common, it was possible for the husband's half of it to be transferred into a trust for their children under his Will. The family decided at that time  to transfer the mother's half of the property into a trust as well "to make things easier" knowing that it may or may not be assessed for the mother's care needs.

Upon assessment they received a letter from the council's legal department stating that because the mother was receiving home care at the time of the transfer to the trust she had a reasonable expectation that she would need care and support in the future and, as a result, they would class the gift to the trust as deprivation. 

It is well known that when carrying out the financial assessment for care home funding the council will ask a question similar to: "Do you or have you ever owned a property?" If the answer is "Yes" and you have given it away they would then make enquiries as to the reasons why you gifted the asset. 

The key point is that if the gift is treated as deliberate deprivation, the local authority will treat it as "notional capital" which will affect the eligibility for local authority funding.

So how does the local authority decide whether there was a deliberate deprivation? 

There may be more than one reason for disposing of a capital asset, only one of which is to avoid a charge for care. Avoiding the charge need not be the main motive, but it must be a significant one.

When deciding if deprivation was 'deliberate' the local authority might look at the following: 

  • Motive/intention: when disposing of assets, was the main reason to avoid care charges?
  • Timing: there is no set time limit, although local authorities are unlikely to investigate too far back. Most importantly, they will look at the time between the person realising that they needed care and the disposal of the assets.
  • Amount: was the gift a significant amount that would make a difference to a relative's capital limit? The asset would have to be worth a significant amount for the local authority to pursue this action. Giving away a £300,000 property, for example, would significantly affect the individual's total capital whereas smaller 'gifts' - such as giving a £300 ring to a granddaughter - are unlikely to prompt further investigation.

It all boils down to intention. When the person made the gift, could they have reasonably known that they might need care? For example, if the individual was already ill when they signed their property over to a relative that would look suspiciously like 'deliberate deprivation'.

Guidance on applying the principles of notional capital are included in the Care and Support Statutory Guidance 2014 (which supplements the Care and Support (Charging and Assessment of Resources) Regulations 2014 and which has superseded the Charging for Residential Accommodation Guide (CRAG)). The guidance incorporates the notion of reasonableness. For example, paragraph 12 of Annex E states that 'it would be unreasonable to decide that a person had disposed of an asset in order to reduce the level of charges for their care and support needs if at the time the disposal took place they were fit and healthy and could not have foreseen the need for care and support.'

It is important to bear in mind the rule that if a transfer is made within 6 months of going into care, it is treated as made for the purpose of deliberate deprivation.

Although the transfer of the property into the trust in the circumstances described above was made for a number of reasons (and a desire to hold the entire property in a trust rather than having the ownership split between the trust and the mother may well have made perfect practical sense), since the lady in question was already in receipt of some social security benefits at the time of the transfer to the trust, it is probably unsurprising that the council decided there had been a deliberate deprivation. Indeed, in this case, there was probably no need for the mother to make the transfer of her part to the children because her half, being a tenancy in common in half of the property with the other half owned by others, would have had only a small open market value.  Cleary, the timing is important. Some individuals have used the so-called "asset protection trusts", normally set up well in advance of needing any assistance.  Unfortunately, these have had rather bad press recently following the conviction and jailing of eight people last year for mis-selling such arrangements. We will come back to this topic in another bulletin. 

Domicile - Income tax and capital gains tax

(AF1, AF2, RO3, JO3)

At Summer Budget 2015 the Chancellor announced the government's intention to reform the taxation of UK resident individuals who are non-domiciliaries (non-doms).

Broadly, it was announced that a deemed domicile rule for long-term residents would be amended to 15 out of 20 (from 17 out of 20) tax years for inheritance tax purposes from 6 April 2017.  This rule would then also apply for income tax and capital gains tax purposes.

Following this announcement, draft legislation has now been published for consultation regarding the position of those who would otherwise be non-domiciled in the UK as a matter of general law and, who it is proposed, should be treated as being deemed domiciled in the UK for the purposes of income tax and capital gains tax as well as IHT. Comments are invited by 2 March 2016.

The two deeming provisions are given by Conditions A and B of the draft legislation. Condition A applies to anyone born in the UK with a UK domicile of origin and whilst they are UK resident; and Condition B applies to anyone who has been resident in the UK for at least 15 out of the previous 20 tax years.

Currently, the main UK tax advantage of being a "non-dom" is that, despite being resident in the UK, such an individual can arrange to pay tax on income and gains earned outside the UK only when these are remitted to the UK by electing the remittance basis of taxation.  This requires the payment of a Remittance Basis Charge (RBC) which is set at £30,000, £60,000 or £90,000 per annum depending on the length of UK residence. However, the new provisions will restrict access to the remittance basis so that anyone deemed UK domiciled by virtue of either Condition A or B above will not be able to elect for the remittance basis.

In addition, these provisions amend other aspects of income tax and capital gains tax law that offer advantages to non-doms but which do not directly rely on part of the remittance basis to be amended.

Please see here for more details.

National Savings - Interest received on the 65+ Guaranteed Bonds

(R02, AF4, CF2, FA7)

The National Savings & Investments' one-year and three-year Guaranteed Bonds were first launched in early 2015 and were open to everyone aged 65 and over. The interest rates were set at 2.8% for the one-year Bond and 4% for the three-year Bond.  With the three-year Bonds, interest is added yearly and taxed yearly but is only paid out at maturity.

Currently, and up until 6 April 2016, savers will pay tax on interest that the Bonds pay at their usual tax rate. However, those whose Bond matures after 5 April 2016 could receive their interest tax free provided they remain within the new personal savings allowance (PSA) which will be £1,000 for basic rate taxpayers and £500 for higher rate taxpayers.

Essentially, a saver who put £10,000 (the maximum) in a one-year Bond would earn £280 (i.e at 2.8%) in interest which would be taxable if the Bond matures before 6 April 2016. If, on the other hand, a one-year Bond matures after 5 April 2016 this interest is likely to be tax free provided the investor has no other interest to cause them to exceed their PSA.

The position could be even more favourable for a saver who put £10,000 (the maximum) in a three-year Bond. They would earn £1,249 (£400 in year one, £416 in year two and £433 in year three) total interest. The interest on the three-year Bond is added to the account annually which means that, even with the maximum amount deposited, a basic rate taxpayer who receives the interest after 5 April 2016 could receive that interest tax free provided they have no other interest to cause them to exceed their PSA.

The introduction of the PSA is, however, still subject to consultation so there are still some questions which remain unanswered. Despite this, it appears that the tax position on interest can vary significantly for two individuals who took out their Bonds on different days where maturity is for one before 6 April 2016 and after 5 April 2016 for the other.

Over £2bn collected from accelerated payment notices

(AF1, RO3)

Over £2 billion has been collected from users of tax avoidance schemes as a result of government measures to collect disputed tax up-front via accelerated payment notices. 

In September 2015 this figure stood at £1 billion - so a dramatic increase in the last 4 months.

Jennie Granger, Director General for Enforcement and Compliance, HMRC, said:

"Accelerated Payments continue to turn the tables on individuals looking to avoid paying their fair share of tax. Those who take part in tax avoidance now have to pay up-front and dispute later. It really is time to get out of avoidance - HMRC wins the vast majority of cases that people litigate, with many more settling before litigation.

HMRC is now issuing over 3,000 Accelerated Payment Notices a month, and has issued over 41,000 notices since Accelerated Payments were introduced. By the end of 2016, HMRC expects to have completed issuing notices, bringing forward over £5 billion in payments for the Exchequer by March 2020."

Dividend tax change opportunities

(AF2, AF4, JO3, CF2, FA7)

With all of the (understandable) concentration on pension change it's not surprising that the massive change to dividend taxation taking effect from 6 April 2016 has gone a little under the radar, by which we mean it probably would have got a little more attention had it been happening at a different time.

You know about:

  • The abolition of the dividend tax credit…and the consequent end to the need to gross up the net dividend received to work out the tax on it, then to deduct the tax credit to work out the actual tax payable on the dividend
  • The first £5,000 of dividends being (unconditionally) tax free
  • The 7.5% increase in the effective rate once you've exceeded the £5,000 allowance (and by the "effective rate" we mean the rate of tax found by expressing the tax actually payable by the investor as a proportion of the net dividend received eg 25% for higher rate taxpayers) 

But what does all of it mean?  Well, it depends on the circumstances, but HMRC believes that 85% of dividend-receiving taxpayers will be better off under the new rules.  But the tax change is estimated to generate £2bn of extra tax.  So where's it coming from? Well, a good guess would be SME owners paying themselves by dividends (that exceed £5,000 for basic rate taxpayers and around £20,000 for higher rate taxpayers) instead of salaries.

What does it mean for advisers?  Well, in the face of such a fundamental change, advisers have the responsibility (yes, we think, responsibility) to engage with:

  • All their SME-owning clients
  • All investor clients with investments beyond pension and ISA wraps

The engagement should be focused on determining:

  1. For SME owners - how to most tax efficiently extract funds from the company.  By the way, dividends are still likely to be the most tax/NIC effective way to remove funds from a company …just not quite as attractive as it is under the current rules.
  2. For investors there will be an interesting need to re-assess the "beyond pension and ISA" wrapper choices.  Should investments be held "unwrapped", as collectives, or "wrapped" in a UK/offshore bond to secure the optimum tax outcome?  There's no easy answer.  It depends on the facts.  But the adviser needs to model the likely future to ascertain the course most likely to deliver the optimum outcome.  And previous devices may need to be reviewed.

And, fundamentally, no-one can really know whether the "wrapped/unwrapped" decision made for a portfolio will turn out to be the right one by delivering the optimum after-tax outcome. 

Because the future is essentially uncertain a process of "wrapper allocation" based on a range of reasonable probabilities has to be worth considering. To do this you would simply model (ideally using an appropriate tool) a range of reasonable "futures" for the investor factoring in a range of different tax, investment and timing variables that could be reasonably relevant to the investor. If you get a consistent "wrapped or unwrapped" outcome for each modelling exercise then go with that. If you get different outcomes then simply make a "% probability" assessment for each of the modelled futures and split the portfolio appropriately. There are other ways but this way could operate to reasonably defend against the risk of "all eggs in one basket". You might see it as complementary to the better known process of asset allocation.

The Disclosure Of Tax Avoidance Schemes Hallmark Regulations

(AF1, RO3)

In July 2015 the government published, for consultation, draft changes to the hallmark regulations describing standardised tax products, loss schemes and IHT. The draft regulations also brought arrangements involving IHT into the scope of the existing confidentiality and premium fee hallmarks and introduced a new hallmark describing certain financial products.

The consultation ran until September 2015 and, while responses were generally supportive, many of those who responded voiced concerns that the changes could inadvertently result in the disclosure of ordinary tax planning. This was a particular concern in relation to IHT where the hallmark was so widely drafted it could be construed to catch loan trust arrangements where there was no initial gift as well as bare trust versions of loan trusts and discounted gift trusts on the basis that there was no 'settlement'.

Having considered the responses, the government has made a number of amendments to the regulations for the standardised tax products and financial products hallmarks, and has laid updated regulations which will have effect from 23 February 2016. Alongside this, the government has published a response document to the technical consultation which summarises the amended regulations and announces the government's intention to develop a revised draft IHT hallmark for further consultation in 2016. 

The changes can be summarised as follows:

Standardised tax products- This hallmark is intended to catch marketed avoidance schemes. The changes proposed remove the grandfathering provisions (which essentially exempt from disclosure any scheme the same or substantially the same as anything made available before the hallmark was introduced).  They also alter the emphasis of the test so that for a standardised tax product to be disclosable it must be reasonable to expect an informed observer (having regard to all relevant circumstances) to conclude that the main purpose of the standardised arrangement(s) is to enable a person to obtain a tax advantage or that the arrangement(s) would be unlikely to be entered into but for the expectation of obtaining a tax advantage. 

Following consultation, the government has amended the draft regulations to ensure that products excluded from the financial products hallmark by virtue of the exemption relating to the Code of Practice on Taxation for Banks are also exempted from the standardised tax product hallmark. 

While Social Investment Tax Relief and Seed Enterprise Investment Schemes should not usually be notifiable if entered into for ordinary, genuinely commercial or investment reasons, they will remain within the scope of the hallmark to guard against the possibility of wider arrangements being put in place to avoid tax or obtain more relief than would otherwise be due. 

Losses hallmark- This hallmark targets schemes designed to create tax losses for individuals to set against other personal income or gains. The changes widen the existing 'main benefit' test to 'one of the main benefits' to prevent promoters from arguing that the main benefit of a scheme is potential future profits rather than short-term tax losses. The government is satisfied that the fact that the changes in the hallmark allow an informed observer to "have regard to all the relevant circumstances" when considering the main motivation for the scheme, means that genuine business start-up losses remain outside the scope of this hallmark.

Financial products- This is a new hallmark aimed at schemes using financial products that include terms unlikely to have been entered into were it not for the tax advantage, and schemes using financial products which include contrived or abnormal steps without which the tax advantage could not be obtained. Concerns that the new hallmark, as drafted, had the potential to catch 'ordinary tax planning' has led the government to amend the drafting to exclude certain arrangements - including (but not limited to) the sale of a business in exchange for financial products which allow deferral (roll-over) of a gain until later disposal.

Further clarity will be provided in revised DOTAS guidance on areas where it was considered unnecessary to provide a legislative exclusion on the basis that the arrangements will not be caught unless used as part of wider arrangements the main purpose of which is the generation of a tax advantage. These areas include:

  • entering into a loan of less than 12 months which is 'short' for income tax purposes where there is no requirement to deduct tax from interest distributions;
  • investing under the EIS (or SEIS);
  • choosing debt rather than equity to fund a particular activity/transaction;
  • investing in a Self-Invested Pension Plan;
  • setting up and operating a tax-advantaged employee share scheme;
  • using discounted bonds;
  • setting up an Employee Ownership Trust;
  • joining the Real Estate Investment Trust regime

Inheritance Tax- The IHT hallmark was introduced with effect from 6 April 2011 and has historically applied only to arrangements that seek to avoid IHT charges during a person's lifetime by typically making gifts to relevant property trusts. The draft changes made to the regulations in the summer expanded the existing hallmark to ensure that all types of IHT avoidance have to be disclosed, (i.e. schemes seeking to avoid IHT charges following death as well as during a person's lifetime) and removed the existing "grandfathering" provision which exempts schemes from disclosure if the same or a substantially similar scheme was made available by any person before the hallmark was introduced. The draft hallmark also introduced the concept of a person obtaining a "tax advantage" and the testing of this to be linked to this being considered by the concept of refining "an informed observer, having regard to all the relevant circumstances."

The wide drafting of the amended regulations meant that ordinary tax planning - including the ordinary settlement of property into trust - could conceivably be caught. The government has confirmed, in the response document, that its interpretation of the provisions as published is that lifetime gifts, the ordinary settlement of property into trust and use of the normal out of income exemption would not be notifiable and has committed to review the hallmark to clarify and amend as required. 

The original draft regulations included specific exemptions for loan trusts and discounted gift trusts but a number of issues arose as regards precisely which types of scheme were covered.  The response document clarifies that the exemption will apply to loan trusts where there is no initial gift on the basis that a 'disposition' for the purposes of the hallmark will include a loan. Bare trust versions of loan trusts and discounted gift trusts are equally covered by the exemption and so not within the scope of the hallmark where the arrangement is based on an insurance product and the hallmark will be revised to ensure this is so.  The government will also consider whether clarification of the position in guidance or amendment of the hallmark is required in relation to various other arrangements, including those based on capital redemption policies, flexible reversion trusts, split or retained interest trusts and schemes that allow the settlor's interests to be defeated.

Confidentiality and premium fee hallmarks- These hallmarks currently apply only to schemes involving income tax, capital gains tax, corporation tax and National Insurance contributions. Following consultation, the government has decided to retain the proposed wording and bring IHT within the scope of this hallmark as planned.

HMRC intends to contact stakeholders in due course with draft guidance covering all the changes made before incorporating changes into final guidance.

The news that the government has recognised that the revised IHT hallmark as originally drafted was open to misinterpretation, and that further changes will now be made to ensure that non-abusive arrangements will not need to be disclosed, will be welcomed throughout the industry. The government is intending to publish a further draft of this hallmark for a 12 week technical consultation early in 2016.

The latest technical document from HMRC provides further reassurance that genuine trust arrangements using life assurance policies will remain outside the DOTAS reporting regime. Regulations making changes to the other hallmarks is expected to come into force by the end of February and will be supplemented by updated HMRC guidance. 

EU to require central register of bank clients

(AF1, RO3)

The EU Fourth Anti-Money Laundering Directive is to be further amended this year. This time it will require Member States to set up centralised national bank and payments registers - and to make all information on holders of bank and payment accounts available to governments.

The European Commission has stated that the reason for this addition comes as a result of the terrorist attacks in Paris as this change will enhance the ability to identify sources of terrorist funds and block their movement. 

By June 2016, it is intended that the Directive will incorporate the following:

  • 'Harmonised and enhanced' due diligence measures for high-risk third countries, which will be identified on a new blacklist of jurisdictions with 'strategic deficiencies' in their anti-money laundering laws. This blacklist will be adopted early this year.
  • Tighter restrictions on the use of virtual currencies, such as Bitcoin, and pre-paid instruments such as cards used for low-value purchases. The anonymity provided by virtual currencies will be ended by bringing them within the Directive's scope so that financial institutions that exchange virtual for real currencies will have to apply customer due diligence controls. Lower thresholds for identification will apply to anonymous pre-paid cards.
  • Centralised bank and payment account registers or electronic data retrieval systems for all EU Member States. Full access for EU States' Financial Intelligence Units to information on the holders of all bank and payment accounts.
  • An extension to the scope of the existing restrictions on cash transactions to allow authorities to act upon lower amounts of cash where there are suspicions of illicit activity, and also to include cases of cash shipped by freight or post.
  • International cooperation on the implementation of restrictive measures, such as UN sanctions. The European Commission is also considering a specific EU regime for the freezing of terrorist assets, under which there would be mutual recognition by EU Member States of asset freezes and confiscations.
  • A comprehensive common definition of money laundering offences and sanctions across the EU.

It will be interesting to see what the outcome will be in this regard. In the meantime, the European Commission is calling on Member States to commit to do this by the end of 2016. The current deadline for transposition into Member States' national laws is 26 June 2017.

An increase in the number of families paying IHT

(AF1, RO3)

According to the Office for Budget Responsibility (OBR) the number of UK families paying IHT on death has reached a 35 year high.  The main driver of this is the surge in UK house prices. 

Almost three times as many families as six years ago are expected to face the tax.  The OBR estimates that just over 40,000 families will face IHT in the current tax year but that this will rise to over 45,000 in 2016/17.  The new residence nil rate band (RNRB), when it is introduced (gradually) from 2017/18, will have an initial "reducing" effect but it is thought this reduction will be gradually countered by predicted increasing house prices.  In 2009/10 only 2.6% of deaths generated an IHT liability.  This has risen to 7.1% in 2015/16.  The OBR has predicted that IHT will affect 8% of estates in 2016/17. 

Another contributor to the increasing number of estates being affected by IHT (in addition to house prices) is, of course, the frozen nil rate band - it has been at £325,000 since 2009 after all. 

The Treasury expects IHT to yield around £4.4bn in 2015/16.  So while IHT is not exactly the government's main contributor it's creeping up. 

Back to the residence nil rate band.  As indicated above, the OBR reckons that once this is in force the number of deaths subject to IHT will fall by a third to 30,000 (around 5.4% of total deaths).  But this number will then start to rise again, according to the OBR, to around 6% in 2020/21.  Despite cutting the number of estates subject to tax, the RNRB is not estimated to cut the overall tax yield which is expected to grow gradually to £5.6bn by 2020/21. 

In closing this summary, the % of the overall IHT yield paid by estates worth more than £1m rose from 4% in 2006/7 to 7% in 2012/13.

IHT continues to be an economically and emotionally important tax.  The major part of the overall IHT yield is paid by estates valued at over £1m and the majority of these are more likely to be individuals who are or could be the clients of advisers. 

Effective IHT planning with residential property is notoriously difficult though.  The GWR and POAT rules make sure of that.  And for estates worth more than £2m the RNRB will be reduced (by £1 for every £2 of value over £2m) and completely extinguished at £2.35m.  Remember, too, that in querying whether your estate is over £2m you ignore business property relief and agricultural property relief.  

For those minded to do something about IHT but where the main asset giving rise to the IHT liability is residential property then (assuming neither paying a full market rent or sharing occupation of the property with the donee is acceptable) it might be worth looking at protecting the liability with insurance where this is commercially viable.  For a couple the product to use should be a last survivor plan held in an appropriate trust.  Premiums would usually be exempt and the sum assured tax free.

If the taxpayer(s) couldn't or didn't want to pay any or all of the premiums the donees might be prepared to pay or contribute.  After all the policy would provide a sum assured that would benefit them.


The IHT treatment of pension scheme transfers

(AF3, CF4, JO5, FA2, R04, RO8)

For many years, a potential trap has existed in cases where a member of a pension scheme who is in serious ill health and knows of that ill health, transfers his pension rights to another pension scheme and dies within 2 years.  In such circumstances, HMRC can take the view that the person has made a transfer of value for IHT purposes under section 3(1) IHT Act 1984.  This is on the basis that when making the transfer the scheme member has the choice to transfer the pension rights to a scheme under which his estate will be entitled on death.  By choosing a scheme under which the death benefits are held subject to a discretionary trust, the member has, in effect, brought the death benefits back into his estate and then given them away again to the new chosen scheme.  This will be a chargeable lifetime transfer of the value of the pension plan benefits payable on death less the value of any retained benefits eg. tax free cash and guaranteed pension benefits. 

Clearly, in most cases, a member makes a transfer in order to secure better pension benefits for him/herself and so a transfer of value will not arise because of the exemption in section 10 IHT Act 1984. This provides that there will be no transfer of value in cases where there is no intention to confer a gratuitous benefit (see below).  However, HMRC takes the view that people will not be entitled to this exemption in cases where the reason for their decision to transfer is their ill health and their intention to benefit others - thus the 2 year rule.  Of course, the section 10 exemption will be available in cases where the action is clearly for the member's benefit ie. because benefits are transferred on to flexi-access drawdown and then immediately fully vested. We will be issuing a bulletin giving further clarification on this issue shortly. 

A number of people have not been convinced about the legal basis of HMRC's 2 year rule.  Whilst HMRC have always said that they have legal opinion to support their approach, it has to be said that it is difficult to comprehend how a transfer of value can arise in a case where a pension plan is subject to a discretionary trust of death benefits which exclude the member and his/her estate as a beneficiary and it is transferred to another similar pension plan where there is a similar discretionary trust of death benefits.  The before and after situation look remarkably similar so where does the transfer come from?

Well now we have a legal case to challenge this.  In a case between the late Rachel Staveley and HMRC, the Lower Tax Tribunal were asked to consider the validity of a section 3(1) assessment in such a case. The LTT Tribunal held in favour of the estate on the section 3(1) point and HMRC have appealed the decision. (Parry and Others (Mrs R F Staveley's Personal Representatives) v HMRC (2014) UKFTT 419 TC 03548).

The case also looked at a section 3(3) assessment on the basis that there had been an omission to exercise a right under section 3(3) IHT Act 1984 but because of the introduction of section 12(2ZA) IHT Act 1984 by Finance Act 2011, such assessments are no longer likely. In this article we therefore confine our considerations to section 3(1). 

The Facts 

Mrs Staveley was, with her husband, a member of an Executive Pension Plan established many years ago by a company owned by her husband.  She was divorced from her husband in 2000.  As part of the divorce settlement, Mrs Staveley gave up her shares in the company and her share of the pension scheme was transferred to her. In order to segregate it from the pension scheme, it was placed in a section 32 (buy-out) plan in her name. 

The divorce was acrimonious and left her with bitter feelings towards her ex-husband and concern about her long-term financial security. 

Mrs Staveley did not want her ex-husband or his company to benefit from any part of her pension fund. There was a risk of this happening on her death because the pension plan was overfunded and under the terms of the section 32 any overfunded benefits could be returned to the employer company.  One way of minimising this risk was to transfer her pension fund out of the section 32 plan into a personal pension plan (PPP).  However, because of the legislation that then applied, she would need to wait 10 years before doing this. 

Between 2003 and 2006, there was various correspondence between Mrs S and her advisers as to her options as regards the pension plan.

A letter from Mrs Staveley to her advisers in 2003 shows she was weighing up the possibility of drawing her pension at 57 (to maximise the overall benefit from the pension) or waiting another four years when the plan would have existed for 10 years anniversary and she could transfer the fund to a PPP.

In 2004, the advisers wrote to Mrs Staveley to advise her of a forthcoming legal change expected for April 2006 which would make it possible for her to transfer her pension fund to a PPP from that date and not wait until the 10 year anniversary. 

There was nothing in this letter about the PPP having any IHT benefits compared to the existing s 32 policy.

In 2006, the legislation changed so that such a 10 year wait was no longer necessary and Mrs Staveley was informed of this.  She duly transferred the s32 plan to an AXA personal pension plan on 9 November 2006.

In the meantime, Mrs Staveley had suffered from ovarian cancer in 2004.  In 2005 she was advised that she was in remission but the symptoms returned in 2006 and eventually she was offered only palliative care.  She died on 18 December 2006, aged 56 having transferred the section 32 plan to the AXA personal pension plan about 5 weeks earlier. 

HMRC took the view that this transfer of pension rights gave rise to a transfer of value of £405,694 under section 3(1) because it was made at a time when Mrs Staveley knew she was in serious ill health and the transfer was motivated by inheritance tax planning.

The Legal Argument

To be caught by section 3(1) IHT Act 1984, the transfer needed to amount to a disposition which resulted in the reduction of a person's estate.

The estate agreed that the transfer of the policy to the PPP was a "disposition" but they did not agree that it was a transfer of value because it was covered by the exemption in section 10 IHT Act 1984.

To satisfy the exemption in section 10 two conditions need to be satisfied, as follows:-

(i) it must be shown that the disposition was not intended and was not made in a transaction intended to confer any gratuitous benefit on any person and 

(ii) either:

  • it was made in a transaction at arm's length between persons not connected with each other or 
  •  it was made on terms that might be expected to be made in a transaction at arm's length between persons not connected with each other

The Tribunal looked at the two conditions in turn.

(a) Intention to confer a gratuitous benefit 

The first question to consider was whether the transfer of the s32 policy to the PPP was intended to confer any gratuitous benefit on any person? 

In this respect the estate argued that Mrs Staveley's sole intention on transferring her pension funds from the s 32 policy to the PPP was to remove any possibility of risk that any part of the pension fund might be returned to the former employer. 

In considering the HMRC arguments, the Tribunal found as follows:- 

  • HMRC's view was that the changes in law in April 2006 were such that it should have been obvious that while the fund remained well below the then lifetime allowance of £1.5million (it was about half that), there was no risk of any part of the pension fund being returned to Morayford Ltd and then back to her ex-husband.  Even if Mrs Staveley did not know this, she had at least a dual motive in transferring the funds and that second motive was to ensure that the death benefits passed to her sons free of IHT. Whilst the Tribunal accepted that as a matter of law a person could have dual motivation, they did not find it was made out as a matter of fact in this case.  In particular they found no evidence that Mrs Staveley's second intention was to ensure the death benefits passed to her sons free of IHT.  They found no evidence of that.  Whilst she did seek advice on IHT, it was clear that the only subject matter on which she sought advice in October 2006 was keeping the benefit of her pension fund away from Morayford.  She did not discuss IHT with her family.  She entered into no other form of IHT planning. While her adviser took IHT into account in the advice which he gave to her, the Tribunal considered it more likely than not that Mrs Staveley took what was said in the October 2006 letter at face value and was under the (mistaken) impression that the transfer would not affect the amount of IHT payable in the event of her death.  IHT planning did not, therefore, form part of her motivation.
  • HMRC argued that, even ignoring the IHT, Mrs Staveley clearly had an intent that the death benefits would pass to her sons, and this was an intent to confer a gratuitous benefit. She signed the statement of wishes.  However, the Tribunal did not see how this could be properly described as an intention toconfera gratuitousbenefit.  Her sons were her beneficiaries named in her will and therefore the persons who had stood to benefit from the death benefits of the s 32 policy (which after April 2006 would have been the whole fund).  They were the persons named in her expression of wishes for the PPP.  Either way they were the intended beneficiaries so that the transfer did not confer a benefit that was new to them and cannot therefore have been part of the motivation for Mrs Staveley.
  • HMRC argued that Mrs Staveley understood that the sons were the beneficiaries under the PPP.  Therefore, irrespective of the fact that had been the beneficiaries under the old policy, she knew a benefit would be conferred on them by the PPP. The Tribunal did not agree.  The entire premise of section 10 is that benefit is conferred.  It presupposes that the benefit did not exist before and is newly conferred.  If HMRC were right, a transfer from one PPP to another PPP for commercial reasons (perhaps to get a better rate of return), without any change in beneficiaries, would be caught.  The Tribunal did not think that this was intended by Parliament. The only difference to the sons in being named in the statement of wishes in respect of the PPP rather than as her residuary legatees for the death benefits from the s 32 policy, was that the death benefits could be paid to them directly by the pension administrator and not come to them under their mother's estate:  the effect was that the death benefits could avoid IHT whereas before the transfer they would have been subject to it. Therefore, whilst this was a very real benefit, this IHT advantage was not a benefit which Mrs Staveleyintendedto confer, even though that was the effect of what she did. 

In conclusion, the Tribunal accepted that the transfer of the funds from the s 32 pension to the PPP was not intended to confer any gratuitous benefit on any person.  But that alone did not decide the case in the appellants' favour.  In addition, to obtain the protection of section 10, the estate needed to satisfy the Tribunal that the transfer was not part of atransactionor series of transactions intended to confer gratuitous benefit and that it was at arm's length.

(b) Transfer not part of a transaction or series of transactions intended to confer gratuitous benefit

HMRC's case was that the transfer, combined with the expression of wishes was not at arm's length because the combined effect of both was a disposition in favour of the sons of the death benefits.  

With regard to this the Tribunal concluded that the omission to take the pension benefits could not be described as a transaction and therefore the two events (the transfer and omission) cannot properly be described as a series of transactions. 

Moreover, they also rejected HMRC's argument that the omission to take a pension was an 'associated operation' with the transfer of the fund to the PPP.  

Therefore whilst the transfer from one pension fund to another was a disposition, the expression of wishes effected no disposition because it conferred neither an obligation on the Scheme Administrator nor rights on the sons.

(c) Transaction at arm's length

To qualify for the section 10 exemption, the Estate still had to demonstrate that the transfer was either a transactions at arm's length between persons not connected with each other or on terms that would be expected in such a case.

The transaction in question was the transfer of Mrs Staveley's funds from the AXA policy to the AXA PPP.  The only parties to that transaction were Mrs Staveley and AXA.  This transaction was clearly between unconnected parties and at arms length.

HMRC, on the other hand considered that the transfer must be seen as including the expression of wishes. It was indeed part of the application form.  In effect they considered that the transaction in question involved three parties: Mrs Staveley, AXA and her two sons.

In this respect the Tribunal found that the expression of wishes (whether viewed as part of the transfer of the pension fund or as an associated operation with it) was between Mrs Staveley and the AXA Scheme Administrator. It informed the Scheme Administrator of Mrs Staveley's wishes with respect to her death benefits but did not confer any obligation on the Scheme Administrator. While the sons were the object of the expression of wishes, they were neither parties to it nor given any rights or property by it. 

If an expression of wishes is not by itself a transaction (as no consideration is given) it is nevertheless the sort of thing that would happen in an arms length transfer into a pension policy and therefore satisfies section 10(1)(b). 

HMRC lost their argument that the transfer of the pension plan resulted in a transfer of value for IHT purposes under section 3(1) IHT Act because those acting for the estate were able to sustain the section 10 exemption on the basis that that there was no intention to confer a gratuitous benefit and the disposition was made between persons not connected to each other (or on terms that would be expected between people not connected with each other). 

Given that HMRC have challenged numerous cases on this basis in the past where a transfer has been made by someone in serious ill health and died within 2 years, this is clearly of some considerable importance. The following quote from the Tribunal is particularly relevant:

If HMRC were right, a transfer from one PPP to another PPP for commercial reasons (perhaps to get a better rate of return), without any change in beneficiaries, would be caught.  We do not think that this was intended by Parliament.

On the basis that we believe that most transfers are made for commercial reasons eg. to enable the pension holder to access better investment choices, pay lower charges, undertake consolidation or access flexi-access pensions, such a transaction would not involve the conferral of a benefit on anybody other than the pension scheme member.  If the Upper Tribunal uphold this decision, some of the current "IHT problems" on pension transfers may be alleviated. 

The Appeal is due to be heard on Monday 15 February.  We await the outcome with considerable interest.

Tax relief: Past and present

(AF3, CF4, JO5, FA2, R04, RO8) 

Last July, alongside the second Budget of the year, the Treasury issued "Strengthening the incentive to save: a consultation on pensions tax relief". As consultation documents go, it was curiously thin (23 pages) and short on questions (8, all of a general nature rather than about any specific proposals). In fact, there were hardly any significant ideas for change - the nearest was reference to a suggestion of "a fundamental reform of the system so that pension contributions are taxed upfront (a "Taxed-Exempt-Exempt" system like ISAs), and then topped up by the government".

One chapter of the document was devoted to the current cost of pension tax relief, with a chart showing thegrosscost of tax relief oscillating around £50bn between 2010/11 and 2013/14 (when the annual allowance was £50,000 and lifetime allowance £1.5m). The 2013 Budget estimated that the April 2014 cuts to the lifetime and annual allowances would save just over £1bn in the coming tax year. Similarly, the combined effects of April's further lifetime allowance reduction and annual allowance tapering are forecast to save the Exchequer £1.77bn by 2019/20. 

Newer HMRC historic data covering 2014/15 should emerge this month. In the interim it is worth looking at how that near-£50bn cost referred to in the consultation was derived and comparing it with the last year before the simplified (sic) regime arrived:


Income tax relief on





Occupational Scheme Contributions:



   By employees



   By employers



Personal Pension Scheme Contributions:



   By employees



   By employers



Contribution to PPs and RACs by self employed



Investment income of pension funds



Total tax relief*



National Insurance relief on employer contributions



Total tax and NIC relief



*Numbers may not total due to rounding 

Inflation over the eight-year period (Oct 2005 - October 2013) was 26.0% (CPI) or 30.3% (RPI). On the RPI measure the gross cost of tax relief thus just outpaced prices. In their tables, HMRC arrive at a net figure for the tax cost of pension by deducting tax received on non-state pension payments. This was £9.3bn in 2005/6, resulting in a net figure of £27.4bn. In 2013/14 pensions in payment produced £13.1bn of tax, bringing the net tax cost down to £35.2bn - again an increase roughly in line with RPI inflation.

As a measure of true cost, starting with current relief and then deducting tax paid on pensions funded possible many years is somewhat bizarre. Even the consultation paper said:

"… this [method] may misrepresent the actual cost to the government each year. First, the income received by the government from pensions in payment will in all likelihood come from pensions which received tax relief many years ago.  Therefore subtracting it from the gross cost of relief provided on pensions today may not provide an appropriate estimate of the net cost. Second, tax rates of individuals may change over their lifetime and therefore the rate of relief they receive may not correspond to the amount of tax they ultimately pay on their pension. 

One important factor that emerges from this number crunching is that the consultation paper's concern that "the government forwent nearly £50 billion in 2013-14" and use of gross costings is, at best, a creative use of data. If the net cost is compared with gross tax receipts, then in 2005/06 pensions cost 7.2% of total tax receipts. By 2013/14 that proportion had risen to 7.7%, largely because the financial crisis meant that the denominator (total HMRC receipts) had grown by only 19.5% - much less than inflation. Based upon actual 2014/15 tax receipts and an assumption that the pension net cost does not move from the £35.2bn of the previous year, the proportion falls to about 7.4%.

For all the bluster about uncontrollable costs, the cost of pensions has not changed that much once the bare numbers are scrutinised in more detail. However, automatic enrolment will add to future outlays, as the November move to push out the final date for 8% contributions made clear. The complaint that, to quote the consultation paper, "Over two thirds of pensions tax relief currently goes to higher and additional rate taxpayers" is equally mischievous, because at least part of the blame can be placed on successive governments that have chosen to allow higher rate taxpayer numbers to increase rapidly.

Tax relief: Future

(AF3, CF4, JO5, FA2, R04, RO8)

"The distribution of pensions tax relief across the population has also evolved over time. Over two thirds of pensions tax relief currently goes to higher and additional rate taxpayers. However, the introduction and gradual reduction of the lifetime and annual allowances have significantly reduced the share of pensions tax relief that goes to additional rate taxpayers since 2009, a trend that is likely to continue when the tapered annual allowance is introduced in April 2016 for those with an income over £150,000. Increases in the Personal Allowance in recent years have also led to a decrease in the share of pensions tax relief which goes to those with an income below £19,999. 

… pensions tax relief is designed to provide an incentive for individuals to defer their income until their retirement. However, the gross cost of pensions tax relief is significant. Including relief on both income tax and National Insurance contributions, the government forwent nearly £50 billion in 2013-14."

So said the consultation paper on tax and pensions issued last year. As our earlier bulletin explained, the actual gross cost of tax relief in nominal terms has been flat in recent years. The net cost, using the questionable method adopted by HMRC, dropped by 8.6% in nominal terms between 2010/11 and 2013/14. Nevertheless, the thrust of the paper and all the surrounding comment has been on reducing the cost to the Exchequer. The reason is clear enough from the latest government borrowing numbers and the gloomy forecasts in the Green Budget from the Institute for Fiscal Studies (IFS). Pension tax relief has often been described as "low hanging fruit" for Chancellors, not least because public understanding is poor.

The two main ideas being floated are:

Flat Rate Relief 

The idea of having a single rate of tax relief was regularly mooted in the last parliament and heavily advocated by Steve Webb. The original driving force was the bias towards higher and additional rate taxpayers, who account for only about half of all contributions. Any move towards a flat rate would increase the total amount of tax relief offered up front to those on middle or lower incomes, but reduce the amount offered to those on higher incomes. 

In 2013, the Pensions Policy Institute (PPI) published an estimate that a flat rate of tax relief of around 30% might be roughly revenue neutral, at least in the short term. However, as the IFS notes in its Green Budget, "…there is uncertainty around this estimate for a number of reasons. First, it is based on estimates of the distribution of up-front tax relief on contributions made directly by individuals in recent years, whereas the majority of pension contributions have been made on individuals' behalf by their employers. Second, the cost and distribution of this up-front relief will have been changed by the recent reductions to the annual limit and lifetime allowance. Third, any changes in pension saving behaviour in response to the reforms would also affect the impact on revenues."

The current figure being floated in the press is a flat rate of 25%, ie a contribution of £75 net would buy £100 of benefits. 25% is well below the PPI break-even estimate and is reckoned to be worth a £6bn a year saving to the Exchequer (although note the IFS doubts, especially long term). One way to look at the effect of a 25% rate is to consider the immediate value of what £1,000 gross earnings would produce if it were taxed (ignoring NIC), paid as a pension contribution with either the current tax relief or a flat 25% applying and then immediately with drawn as a UFPLS taxed at the individual's marginal rate. 

Marginal Rate

Net earnings

Gross Contribution


Effective tax rate

































As the table makes clear, on this basis, higher and additional rate taxpayers would be better - at least in terms of personal contributions - just taking the pay and not contributing.  However, that ignores gross roll up (if there were no immediate UFPLS), changed marginal rates between work and retirement and other pension advantages such as the death benefit treatment. 

The flat rate approach would also create a new administrative burden in terms of: 

  • Defined benefit schemes (mostly now in the public sector), where there would need to be something akin to a pension input period calculation each year to determine the total contribution and thus the relief due.
  • For defined contribution schemes no such issue arises, but employers' contribution would still attract tax for higher and additional rate taxpayers that would have to be collected.

If there were a flat rate, it seems probable that the government will adopt the same approach that it has for buy-to-let mortgage relief, ie bring all of the contribution into the tax calculation (thereby increasing total income for tax calculation purposes) and then set relief against tax payable.

ISA Style Taxation 

At present the income tax treatment of pensions is broadly that contributions to are made from pre-tax income, returns on pension fund investments are tax-free, and the pension income is taxed on receipt. In the economist's jargon this is referred to as an EET (exempt-exempt-taxed) regime.

The July consultation paper did comment that one suggestion that had been made was switching to a TEE (taxed-exempt-exempt) regime, where contributions were made from net income and then investment returnsandbenefits are free of tax. ISAs are a current example of TEE in practice. This explains the press references to ISA pensions, although this is slightly misleading because even the July consultation paper envisaged that there would be some (unspecified) government up-front top-up to the contribution.

The IFS comments that "Moving to a system in which contributions are taxed up front rather than on receipt would dramatically boost tax revenues in the near term. But levying this income tax up front would come at the expense of a reduction in revenues in the future, as the government will no longer collect income tax on these pensions in payment." To the extent that there was a top-up the boost to the Exchequer would be reduced, but the real question mark is over the longer term. 

Mr Osborne would effectively be bringing forward tax from the future and leaving his successors to deal with the eventual outcome (untaxed benefits) - a familiar strategy for chancellors. Would the public trust future inhabitants of 11 Downing Street not to recast the system as Tet - with a little slice of tax (t) on benefits? Those with long memories will recall that the investment period suffered just such a 't' hit when in 1997 Gordon Brown abolished 20% dividend tax credit reclaims for pension funds. 

Going to TEE would also raise the same issues as flat rate relief in terms of assessing DB contribution and taxing employer's contributions. Right now it seems to be the less favoured option.

As the IFS remarks, "…there would likely be complicated responses in the very short term before the policy is implemented. Both of the major reforms being considered would lead to higher-income individuals expecting to receive less generous tax treatment of pension contributions in future. Therefore, they might plausibly respond by bringing forwards their future pension contributions in order to qualify for more generous tax treatment while they still can. This would have the effect of depressing income tax receipts prior to the reform coming into effect and then increasing them significantly for a while thereafter."

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