The correct use of deeds of variation
18 June 2019
23 September 2019
Barbara Gardener, Senior Consultant Tax and Trusts, Technical Connection Ltd
For whatever reason, at Technical Connection we have recently had a surprisingly large number of enquiries concerning two particular issues, both related to a situation where matters were not as they should have been after the death of a person.
The first issue relates to assets owned jointly, as joint tenants. The second concerns the so-called loan trusts or gift and loan trusts, where after the death of the lender there is a loan due to the estate but to repay it would require a surrender of a bond held by the trustees of the said loan trust and this would result in a chargeable event gain which was not desirable.
Surprisingly, some suggested solutions, even those offered by some solicitors dealing with the estates in question, showed a worrying lack of understanding. So this month we will review the basics of deeds of variation and next month we will deal with some specific methods of post-death planning, especially in the two areas mentioned above.
Most advisers will have some understanding of the concept of a deed of variation, ie. a device which, it is often said, allows you to rewrite a will after someone has died, perhaps to improve the inheritance tax position after death or to “skip a generation”. Although the Government carried out a review of deeds of variation in 2015, and initially announced that they were planning to introduce changes to this area of law, in the end they decided to leave things as they were.
What is a deed of variation?
The first point to make is that a deed of variation refers to a change in the destination of an inheritance after a death, whether the deceased has left a will or not. If it is done within a certain time limit and in a prescribed form (as explained in more detail below), it will have the effect as if the deceased himself or herself did it - but only for certain purposes, not for all.
The law which gives effect to deeds of variation is contained in section 142 of the Inheritance Tax Act 1984. It is actually useful to repeat the words used there, as it seems that most of the misunderstandings concerning deeds of variation stem from the fact that no reference to the actual statutory provisions has been made.
The key part of section 142 provides as follows:
- - (1) Where within the period of two years after a person's death -
- any of the dispositions (whether effected by will, under the law relating to intestacy or otherwise) of the property comprised in his estate immediately before his death are varied, or
- the benefit conferred by any of those dispositions is disclaimed,
by an instrument in writing made by the persons or any of the persons who benefit or would benefit under the dispositions, this Act shall apply as if the variation had been effected by the deceased or, as the case may be, the disclaimed benefit had never been conferred.
Requirements for a valid deed of variation
The requirements are that:
- The variation must be executed within two years of the person’s death.
- All beneficiaries losing out as a result of the variation must agree and be party to it.
- It must be in writing.
- If the redirection increases the amount of tax due on death the personal representatives must join in.
- It must not be made for any consideration in money or money’s worth.
- It must include a statement of intent for tax purposes.
We will look at the above requirements in more detail in the remainder of this article.
“Real world” drafting or “make believe” drafting
There are, in principle, two methods of making a variation. The simplest variation would be for an individual to state that they are effectively redirecting their legacy. For example, the preferred words may be “by way of variation of my inheritance from John Smith who died on [date], I direct the executors to pay £X out of my entitlement to my daughter Jane”.
The above wording is very clear and reflects the reality, ie. that the person making the variation has received an inheritance and is effectively redirecting it to a third party.
On the other hand, many draftsmen adopt the “make believe” drafting which, in effect, will state that the estate is to be administered as if the will of the deceased contained the clauses specified in the deed of variation. Sometimes there is a “schedule” added to the deed which would include what would appear to be a “draft will” including various supplementary provisions such as the choice of executors etc. However, such supplementary clauses will be of no effect and are presumably a result of the mistaken belief that a deed of variation can in effect “rewrite” a will. As stated above, all that a deed of variation can do is redirect a legacy.
The agreement of the beneficiaries
The variation must be signed by all the people who would lose out because of the variation. If these include children or unborn beneficiaries, then the approval of the Court will be needed - the parent’s signature on behalf of a child is not sufficient. It would also follow that if the legacy under the will is to a discretionary trust then, unless all the beneficiaries of the trust are over 18 and ascertained, no variation will be possible without the Court’s approval. The trustees of the trust have no power to effect a variation.
For a variation to be effective for IHT purposes it must contain a statement that those signing the variation intend that it should take effect for IHT purposes, ie. that the provisions of section 142 IHT Act 1984 should apply. This way, for IHT purposes the variation would mean that the new legacy is treated as having been made by the deceased. This is, of course, of fundamental importance if the original legacy was to an individual and this is subsequently redirected to a discretionary trust under which the said individual is also a beneficiary as this would not amount to a gift with reservation of benefit.
Capital gains tax
As for IHT, if the variation is to be effective for CGT purposes it must contain a statement of intent for that purpose. Here the appropriate words would be that section 62(6) Taxation of Chargeable Gains Act 1992 shall apply. If there is no such statement of intent, then the variation itself will be treated as a disposal by the original beneficiary.
It should be noted that for CGT purposes it is only the original redirection (ie. the gift by the original will beneficiary) that will be treated as having been made by the deceased. For future purposes, any subsequent CGT will be applied in accordance with the normal rules. This means that if the redirection is to a discretionary trust, future gains will be taxed on the trustees.
There are no equivalent provisions in the income tax legislation as far as deeds of variation are concerned. Therefore, for income tax purposes, the original beneficiary is treated as the settlor and if redirection is into a discretionary trust under which the settlor is one of the beneficiaries, it will be a settlor-interested trust with the usual income tax consequences. If the original beneficiary is not one of the beneficiaries of the trust but his or her minor unmarried children are, again, the parental settlor anti-avoidance provisions will apply.
Varying provisions on intestacy
It is possible to make a variation of an intestacy in the same way as a variation of a will. Of course, different words would be needed in the instrument of variation but, again, it is important to remember that all that can be done by a deed of variation under section 142 IHT Act 1984 is to “vary” a disposition. It is not possible to appoint executors or make any other provisions. However, if a trust is being declared under a deed of variation of an intestacy, it is perfectly possible to include the relevant administrative trust provisions.
Variation of the disposition
It is important to remember that for a deed of variation to be valid, there must actually be a variation of the disposition. Potential problems may arise with a variation of intestacy provisions where the “make believe” drafting is adopted, ie. a deed of variation purports to incorporate an entire will, rather than simply a redirection of legacies. To the extent that such provisions merely restate or repeat the intestacy provisions, for example leaving a legacy to the widow etc, this will not in fact amount to a variation. While this may make no difference for inheritance tax, or even capital gains tax purposes, it may affect the income tax position. As stated above, if a disposition is under a deed of variation, the settlor for income tax purposes is the original beneficiary of the will/intestacy. If there is no variation then, for income tax purposes, one would need to look to the original will/intestacy provisions.
Deeds of variation and joint ownership
Although it is not possible to sever a joint tenancy via a will, it is possible to effect a deed of variation in respect of an asset which was jointly owned (ie. on a joint tenancy basis) and therefore would have automatically passed to the survivor under the joint tenancy. There may be potential practical problems when an asset in question is a life assurance policy or a joint shareholding and it is desired that one half of the asset passes to someone other than the other joint owner. We will deal with this point next month.
Variations and the pre-owned assets tax (POAT)
Although variations are not effective for income tax purposes, which means they could potentially be caught by the POAT provisions (the POAT being a form of income tax), there is a specific exemption in the legislation for trusts created under a deed of variation where the original beneficiary remains one of the beneficiaries under the trust.
Variations after the assets have been distributed
Deeds of variation can be made whether or not the administration of the estate has been completed and the property concerned has been distributed or not. Of course, if the assets have been distributed, the property will have to be recovered and physically redirected. If the property included assets that have produced income since the distribution, the deed of variation should include a specific provision as to what should happen to that income.
The destination of the same assets or entitlement passing under a will or intestacy may not be varied more than once. However, what is possible is, for example, if a husband dies and leaves all his assets to his wife and then she dies, then it is possible to make in effect more than one variation in respect of the same assets by varying both wills, provided it is done within two years of the first death. (This would mean that the second spouse must also die within that period). Historically, such variations would have been appropriate where the first spouse did not utilise his or her full nil rate band on death but this is less important now that we have the transferable nil rate band.
Now that we have covered the basics, next month we will consider some specific scenarios of deeds of variation in practice.
This document is believed to be accurate but is not intended as a basis of knowledge upon which advice can be given. Neither the author (personal or corporate), the CII group, local institute or Society, or any of the officers or employees of those organisations accept any responsibility for any loss occasioned to any person acting or refraining from action as a result of the data or opinions included in this material. Opinions expressed are those of the author or authors and not necessarily those of the CII group, local institutes, or Societies.