The key trust and estate issues from 2019 – Part III

We will continue to look at the latest on the Trust Registration Service (TRS), and then we will consider a few important topics selected from the author’s inbox.

 

As promised in January, (having been interrupted by some topical developments in February), this month we will conclude our review of some interesting topics from 2019.

PETs and Absolute Trusts

We highlighted the issue of premiums paid to absolute trusts of life policies in January and promised to cover the issue in more detail later. When a policy is subject to an absolute/bare trust, what is the inheritance tax treatment of premiums paid? With a regular premium policy, you would expect that, in most cases, the premiums paid by the settlor/donor would be covered by the normal expenditure out of income exemption. If not, there is the annual (£3,000) exemption. But what if the premiums exceed or are not covered by any of the exemptions?

Typically, a short answer when considering gifts to an absolute trust is that any gift to it will be a potentially exempt transfer (PET). However, in fact this is not necessarily the case, and for an explanation, you need to look to the statutory definition of a PET in section 3A of the IHT Act 1984.  This provides that a gift can be made to an individual and so be a PET

• ‘to the extent that the value transferred is attributable to property which, by virtue of the transfer, becomes comprised in the estate of that other individual, IHT Act 1984/S3A (2)(a) or
• so far as that value is not attributable to property which becomes comprised in the estate of another person, to the extent that, by virtue of the transfer, the estate of that other individual is increased, IHT Act 1984/S3A (2)(b)’.

If the policy in question is a pure protection policy, say a term assurance that will never acquire a surrender value, the payment of premiums will not increase the value of the estate of the other individual; and if the payment is made directly to the life office it will never become comprised in the estate of that other individual either.

HMRC’s IHT Manual IHTM 20332 confirms that the PET treatment is available to the extent that the value of the transferee’s estate is increased. Value in this context means the open market value and is a matter for HMRC’s Actuarial Team to consider.

If the amount of the premium paid direct to the insurance company is more than the increase in the value of the policy, the excess will be an immediately chargeable lifetime transfer (CLT) (subject to any other available exemptions).

This means that if a protection policy has no value (as in most cases), the PET treatment will not apply if premiums are paid directly to the life office.

To avoid the premiums being treated as CLTs the donor should make payment to the trustees (which will then increase the value of the trust fund and so the value of the beneficiary’s estate) for the trustees to pay the premiums.

While for the vast majority of absolute trusts premiums will be covered by one exemption or another, it is important to remember the above conditions. Of course, even if the premiums exceed the exemptions and do not qualify as PETs, there will be no immediate IHT liability on any CLT if the settlor’s nil rate band is still available. On those rare occasions where an immediate IHT liability may result, it will be important to remind the settlor/donor that the payment should first be made to the trustees and this will require them to open a bank account from which the premiums will be payable to the insurance company.

There have been a couple more questions raised in relation to PETs. In one case, a grandparent wanted to pay school fees for his grandchild. Whilst the desire was to make absolute gifts for the benefit of the grandchild, it was important to structure the gifts in such a way as to fall within section 3A. Payment of the fees directly to the school (to discharge the parent’s liability for the fees)  would not be covered, whereas a cash gift made to the son ( the grandchild’s parent) to fund the fees would be a PET.

Another point to remember in relation to PETs is that, while gifts to lifetime flexible interest in possession trusts made after 21 March 2006 will not  qualify as PETs, where premiums continue to be paid to a pre-2006 flexible trust of a life policy that has not been changed since  6 October 2008, these continue to be treated as PETs.

Setting aside trust transactions on the grounds of a mistake

It is not unusual for individuals or trustees to carry out a transaction in a mistaken belief that they are saving tax or that there will be no adverse tax consequences, when the opposite turns out to be the case. Sometimes this happens even after taking advice from a solicitor or tax adviser. Can anything be done to remedy such a situation? Well, short of suing the adviser, an application to the Court will be required and it will be up to the Court to grant relief.

Where trustees act in error, with the result that they incur more tax than anticipated, the trustees may seek to overturn their actions through the Court by invoking the principle in Hastings-Bass (see below).

Following the Supreme Court’s judgment in Futter v HMRC and Pitt v HMRC [2013] UKSC 26,  (from the Court of Appeal’s combined judgement in Pitt v Holt and Futter v Futter, [2011] EWCA Civ 197) which concerned the principle  known as the rule in Hastings-Bass (following the case of Re Hastings-Bass [1974] EWCA Civ 13), as well as the question of mistake, it is now clear that the scope of Hastings-Bass is far narrower than previously thought.  However, genuine mistakes can definitely be remedied by the Court.

In accordance with the principles set out in Lord Walker’s judgment the conditions which must be met for the Court to rescind a voluntary disposition are as follows:

1. there must be a mistake (which is to be distinguished from mere ignorance or inadvertence);

2. there must be a mistake either as to the legal character or nature of a transaction, or as to some matter of fact or law which is basic to the transaction; and

3. the mistake must be sufficiently serious as to render it unjust on the part of the donee to retain the property given to him.

It does not matter if the mistake in question is due to carelessness by the person making the voluntary disposition, unless the circumstances are such as to show that they deliberately ran the risk, or must be taken to have run the risk, of being wrong.

In 2019 we had two interesting cases which illustrate the application of the above principles.

Payne and another v Tyler and another [2019] EWHC 2347 (Ch)

In this case, the trustees of a discretionary settlement sought to set aside a deed of appointment.

Mr Mallett died in 2010 and, in his will, left half of his estate to Mrs Alston. Upon advice from her solicitor, Mrs Alston executed a deed of variation of the relevant provisions of Mr Mallett’s will so that, instead of inheriting her share of the estate outright, it was held on the terms of a discretionary trust. The aim of this was to ensure that the funds did not form part of her estate for IHT purposes on her death.

A short time later, Mrs Alston required additional income, so the trustees decided to exercise their power of appointment, granting her an irrevocable life interest (immediate right to the trust income) under the trust. The trustees sought advice on this proposal from a tax specialist, who incorrectly advised that the appointment (within two years of Mr Mallett’s death) would not affect the IHT treatment of the trust. Based on that advice, the trustees executed the deed of appointment.

Following Mrs Alston’s death in 2016, it became apparent that the tax advice had been wrong. The trust fund in which Mrs Alston had a life interest (created by the deed of appointment within two years of Mr Mallett’s death) did in fact form part of her estate for IHT purposes, giving rise to a tax liability of over £100,000.  This is because appointments made within two years of death are read back into the original will and so are treated as made by the deceased (section 144 IHT Act 1984). Remember that section 144 applies automatically, unlike section 142 IHT Act (Deeds of variation) which applies only if the deed contains a statement that it should apply. The deed of appointment effectively created an immediate post-death interest ( IPDI) arising  on the death of  Mr Mallet.

Given that the result of the appointment was opposite to what Mrs Alston wanted to  achieve the trustees  applied to the Court to set aside the deed of appointment on the grounds of mistake.

The High Court concluded that all three conditions from Pitt v Holt were met so agreed to set aside the appointment.

In particular, the Court acknowledged that the discretionary trust existed solely to ensure that the funds inherited by Mrs Alston from Mr Mallett fell outside her estate for IHT purposes. Had the correct tax advice been given, the trustees would not have made the appointment within two years of Mr Mallett’s death. The Court also accepted that this mistake was sufficiently serious due to the level of tax payable as a result of the mistake and the fact that the effect of the mistake was to completely negate the purpose of the original variation of Mr Mallett’s will.

Hartogs v Sequent (Schweiz) AG and others [2019] EWHC 1915 (Ch)

Here, Mr Hartogs applied to set aside transfers he had made to two offshore discretionary trusts.

Acting on professional advice, Mr Hartogs had made several transfers of funds to offshore trusts between 2009 and 2014. However, although Mr Hartogs was non-UK domiciled, he had become “deemed domiciled” in the UK for IHT purposes prior to 2009, something which his advisers had failed to identify.

As a result of his “deemed domicile” status, the transfers into trust gave rise to an immediate IHT liability of nearly £3m, and the trust fund would also have been subject to 10-yearly charges and exit charges on distributions from the trust. Had he known about these tax consequences; Mr Hartogs would not have made the transfers. He therefore sought to set aside the transfers on the ground of mistake.

In this case the Court also agreed to set aside the transfers. It was clear that the transfers into the trusts were entirely tax-driven and entered into on the basis of the mistaken belief that they would not give rise to the IHT charges in question. Had Mr Hartogs been advised of the tax consequences, he would not have made the transfers into trust.

It was acknowledged that Mr Hartogs’ lack of knowledge of the tax consequences could be argued to be mere ignorance or inadvertence, rather than being categorised as a mistake within the Pitt v Holt conditions. However, the Court accepted that this lack of knowledge led Mr Hartogs to a false belief or assumption and that this was sufficient to constitute a “mistake”. Given that the tax arising on the transfers into trust approached £3m and that Mr Hartogs would not have made the transfers had he known of the potential tax charges, such mistake was sufficiently serious to make it unconscionable for it to stay uncorrected.

Comment

While the taxpayers in the above cases  managed to avoid their unintended tax liabilities, it is interesting to note that  the judge emphasised that the Pitt v Holt  principles “should not be viewed as an available ‘get-out-of-jail-free’ card”, which may be invoked whenever a taxpayer finds himself facing a charge to tax which has not been anticipated, and that relief will only be given where the strict conditions set out in Pitt v Holt are met.

It should also be noted that both the above cases involved fairly common tax mitigation arrangements. In the SC judgement referred to above  Lord Walker suggested that “in some cases of artificial tax avoidance the court might think it right to refuse relief, either on the ground that such claimants, acting on supposedly expert advice, must be taken to have accepted the risk that the scheme would prove ineffective, or on the ground that discretionary relief should be refused on grounds of public policy.” Next month, subject to any dramatic changes resulting from the 11 March Budget, we will look at some of the more complex IHT avoidance schemes.