The key trust and estate issues from 2020 - Part IV

 

Over the last three months we have considered some aspects of important issues from 2020: the new rules on will execution; the extension to the Trust Registration Service (TRS); electronic execution of trusts; the online Lasting Power of Attorney (LPA) tool and the online processes for probate and for land registration. This month, in the final part of this review of 2020, we will consider some significant Court decisions relevant to financial services. This article is based on English law.

2020 case law in estate planning

As mentioned last month, in 2020 we had numerous interesting cases relating to trusts, wills and post-death estate disputes.

We have also had a number of interesting tax avoidance cases, the most pertinent to financial advisers being the case on the “home loan” inheritance tax (IHT) avoidance scheme which we consider below.

 

The “Double trust” home loan scheme - the Shelford case 

This scheme was in fact one of the main reasons for the introduction of the pre-owned assets tax (POAT) rules in Sch 15 Finance Act 2004 on the grounds that it appeared to avoid the gifts with reservation of benefit (GWR) provisions while allowing the settlor to make an effective gift of their residence while continue to occupy it. Under such a scheme, typically, an individual settlor established two interest in possession (IIP) trusts, the first under which the settlor had a life interest, and the second (with the IIP granted to, say, the settlor’s children) under which the settlor was excluded from benefit. The settlor would then sell their home to the trustees of the first trust for the full market value, but the purchase price would be left outstanding in the form of an IOU which would be repayable only after the settlor's death. As a next step, the settlor would gift the IOU to the trustees of the second trust. Under the pre-22 March 2006 rules this would be a potentially exempt transfer (PET) which would fall out of account after seven years. 

The settlor would continue to reside in the house rent-free without a GWR arising by virtue of their interest in possession in the first trust which owned the house. The only gift made by the settlor was that of the IOU, to the second trust from which the settlor received no benefit. This gift would drop out of the charge to IHT on the settlor’s survival by seven years. The home would form part of the settlor’s estate on death (by virtue of their IIP), but, for IHT purposes, the value of the debt (IOU) was deducted from the value of the home.

HMRC has long been of the view that none of the variants of the home loan or double trust scheme succeed in circumventing the GWR rules. If this is correct, then a reservation of benefit will exist in the property that was sold to the trust in which the taxpayer retained a life interest and the POAT charge will not apply by virtue of paragraph 11(5)(a) Schedule 15 FA 2004.

While awaiting a case on the correct treatment of the above schemes (please see below re the decision in Shelford), HMRC’s initial approach was that those paying the POAT charge should continue to do so, in the knowledge that a full POAT repayment would be made should the Court find in favour of HMRC. However, due to the length of time, and the uncertainty of litigation, HMRC later agreed proposals for unwinding schemes to bring the property back into the taxpayer’s estate and HMRC has taken the unusual step of publishing guidance on the consequences of unwinding a scheme.

HMRC guidance was published in September 2017 and essentially states that where the home loan or double trust scheme is unwound during the taxpayer’s lifetime (either by the loan being assigned back to the taxpayer or written off), then the property is no longer subject to a reservation of benefit, and the whole house (or other property comprised in the qualifying IIP trust) is part of the taxpayer’s chargeable estate without a deduction for the loan. The GWR provisions provide that when a property ceases to be subject to a reservation of benefit the taxpayer is deemed to have made a PET at that time. However, there is no loss to the taxpayer’s estate when the reservation ceases as a result of unwinding, so long as the property becomes comprised in the taxpayer’s estate, so there is no PET to take into account on death within seven years.

Where the scheme has not been unwound by the date of death, HMRC is prepared to settle cases on the basis that a GWR arises in the house (or other property comprised in the settlement in which the settlor had a qualifying life interest) to the extent that the house (or other property) is subject to the loan. The value of such property would then be included as a GWR in the estate of the deceased person on death.

In these cases, the IHT due on the property can be paid by instalments but the right to pay by instalments will cease on the sale of the qualifying property.

Since the introduction of the POAT very few of these schemes have been established, but many pre-existing schemes remain.

At last, in 2020, we finally had a decision (Shelford v HMRC, 2020 UKFTT 0053 TC). The First-tier Tax Tribunal (FTT) ruled that a 'home loan' scheme entered into in 2002 by a Mr Herbert had not achieved the desired objective of removing the main residence from the estate of the homeowner – instead, the scheme could cause the property to be subject to two separate IHT charges – once in the homeowner’s estate; and again by virtue of his IIP in the settlement to which it was ‘sold’.

The scheme was entered into by John Herbert in 2002, and, with effect from 2004/05, a POAT charge had been paid by him in respect of the scheme. Following Mr Herbert’s death in 2013, a dispute arose in relation to the IHT due on his estate as a result of the scheme. Mr Herbert’s executors disagreed with HMRC’s IHT determinations and appealed to the FTT. Following a detailed analysis of the steps and documentation that formed the arrangement, the FTT found that the sale agreement between Mr Herbert and the trustees of the life interest trust was void (because the documentation did not comply with the requirements of section 2 Law of Property (Miscellaneous Provisions) Act 1989 and so the house formed part of Mr Herbert’s estate on his death. When Mr Herbert died, the house was worth £2.95 million.

Additionally, if Mr Herbert did not dispose of the house, he would not have had any liability to the POAT and the Judge left it to the parties to agree on the terms of the variations to HMRC’s IHT determinations (including any entitlement that Mr Herbert's estate may have had to a refund of prior payments of the POAT).

Because the FTT Judge expected the case to be appealed, he also considered what the IHT analysis would be in the event that it was decided on appeal that there was in fact a valid sale of the house to the trustees. In this alternative analysis, the Judge concluded that:

• the house would form part of Mr Herbert’s death estate as his ability to dispose of it freely was restricted by the agreement to sell it to the trustees; but,
• it also formed part of the settled property which was also treated as forming part of his taxable estate due to the life interest. The trust had a liability of £1.4m (i.e. the sale price of the house at the time the arrangement was implemented) which the executors were entitled to deduct in calculating the total value of the settled property within Mr Herbert’s estate.

While this would mean that the property value at death would be double-counted, the Judge commented: “this serves as a warning that the implementation of tax avoidance schemes can sometimes have the consequence of the participants paying more tax than if they had done nothing: if you play with fire, do not be surprised if your fingers are burnt.”

As it happened, the taxpayers in Shelford have not appealed. There are other similar cases, but where the documents were executed correctly – apparently a new test case is being taken in this category, although  given the Judge’s IHT analysis mentioned above, it is unlikely that there would be a different IHT outcome from another case.

It is not clear what the implications are for anyone who may be in the middle of settlement negotiations with HMRC. However, those who have paid the POAT charge in order to avoid IHT may find themselves with an IHT charge anyway.

 

The Staveley case

The second case of significant interest to financial advisers was the Supreme Court decision in the Staveley case concerning the deceased’s omission to draw lifetime benefits under her personal pension - HMRC v Parry (2020) UKSC 35.

A Mrs Staveley, who was in serious ill health, transferred her section 32 pension plan into a personal pension to avoid her husband having any entitlement on her death. She died shortly after the transfer and without having drawn any lifetime pension benefit.

HMRC’s view is that during a transfer process, the right to decide who receives death benefits comes back into the estate and that is what is being given away. In good health, the death benefits have no value, so there is nothing to give away in terms of value for IHT purposes. However, in serious ill health, there could be a transfer of value for IHT purposes.

Between the FTT (Tax Chamber), the Upper Tribunal, the Court of Appeal and the Supreme Court, arguments went on (i) whether Mrs Staveley made a chargeable transfer when she made the pension transfer (subject to IHT) or whether an exemption in section 10 IHT Act 1984 (no intention to confer gratuitous benefit) applied, and (ii) whether there was an omission to exercise a right (to draw benefits from a pension plan) and so IHT was due under section 3(1) IHTA 1984. There were lengthy technical arguments between HMRC and the estate of Mrs Staveley as the Courts disagreed with one another. What is important to remember is that the Supreme Court decided on the facts of the case that the transfer did not give rise to IHT, but the omission did. The decision on the omission is now largely academic, because, since 2011, the legislation has been changed so that section 3(3) cannot apply to such omissions that occur under registered pension schemes (section 12 (2ZA) IHT Act 1984). However, care still needs to be taken in relation to pension transfers (and other situations where pensions can be subject to IHT, such as contributions) made by those in ill health (and who are likely to die within two years). This is however a complex topic, deserving of a separate article.

 

Other cases

During the 2020 series of articles, we considered, in some detail, a case on the interpretation of a will where beneficiaries were not sufficiently clearly defined (Wales v Dixon & Ors [2020] EWHC 1979 (Ch). Nov 20; also, a case on the interpretation of the settlor’s letter of wishes (In the Matter of the R Trust [2019] SC (Bda) 36 Civ Oct; a case on the removal of a misbehaving executor (Frejek V Frejek [2020] EWHC 1181 (Ch); as well as the case of a possible breach of trust by making payments to the settlor – (Sofer v Swissindependent trustees,  [2020 ]EWCA Civ 699).

There were a number of other cases of interest, especially those concerning home ownership and execution of trust documents, which we will cover when discussing the relevant topic in the future. To close this review though, here are a couple of decisions related to the rules on the execution of wills, and in particular the so called “golden rule”, which everybody who advises on making a will needs to be familiar with.

In a rather extraordinary turn of events the “golden rule” came to be tested in the Court last year in relation to the will of the very Judge, who, as the then Law Lord, set it down, namely the late Lord Templeman. This “golden rule” for drafting wills is that “in the case of an aged testator or testator who has suffered a serious illness … the making of a will … ought to be witnessed or approved by a medical practitioner who satisfies himself of the capacity and understanding of the testator, and records and preserves his examination and finding”.

 

Lord Templeman’s will - Goss-Custard v Templeman [2020] EWHC 632 Ch

As it happened, Lord Templeman made his last will in 2008 with the assistance of an experienced solicitor, but in his case the “golden rule” was not followed. This gave rise to a challenge of the will by Lord Templeman’s son and his wife on grounds of lack of testamentary capacity when the instructions for the will were given and when it was executed. If the will was not valid, there was an earlier will from 2001, which had different provisions in respect of the family home.

However, the Judge held that there was “no cogent evidence to suggest that Lord Templeman’s mental functioning was impaired in 2008 to any significant degree”. He noted that “Given Lord Templeman’s reputation, his evident intellectual resources even at that age and the perfectly rational terms of the new will on the face of it, he did not find it surprising (the golden rule notwithstanding) that [his solicitor] decided not to enquire further or suggest that Lord Templeman be medically assessed, though of course, this litigation demonstrates he should have done”. This was despite the fact that it was admitted that Lord Templeman had started to experience problems with his short term memory some time before and the condition had gradually deteriorated, which may well have been an early onset dementia, but this was never diagnosed or indeed treated.

Clearly, given who the testator was, the case was exceptional and should not be relied on for us ordinary mortals. Also, it has to be added that just because the “golden rule” is followed, it does not make a will automatically valid, and, conversely, as illustrated here, if the rule is not followed it will not be automatically invalid. Equally, even if someone has been diagnosed with dementia, it does not automatically mean they have no capacity to make a will.

What matters is that a testator: (i) understands the nature of the will and its effect; (ii) understands the extent of the property of which he is disposing; (iii) is able to understand and appreciate the claims to which he ought to give effect; and, (iv) is not affected by any disorder of the mind that influences his will in disposing of his property.

All then depends on the facts of the case. However, we did have another decision in 2020 where the will was declared invalid because the rule was not followed.

 

Clitheroe v Bond [2020] EWHC 1185 Ch and Clitheroe v Bond [2021] EWHC 1102 Ch

In this case, which was referred to by the Judge as a “bitter probate dispute”, the Court was asked to determine whether the late Mrs Jean Mary Clitheroe had testamentary capacity to make each of her wills (one made in 2010 and the other in 2013) and in addition, or in the alternative, whether either of the wills resulted from fraudulent calumny. The dispute was between one surviving daughter, who challenged the wills, and the son of Mrs Clitheroe.

The daughter was said to have been excluded from any inheritance on the basis that she was “a shopaholic and would just fritter it away”. The son was the executor and trustee of both wills and benefited from the residuary estate. He had been involved in the preparation and execution of both wills and the “golden rule” had not been followed. The burden of proof in relation to capacity lay with him.

In the first instance the Deputy Master refused to admit either of the wills to probate, having concluded that the deceased’s son had failed on the balance of probabilities to demonstrate that his mother was not suffering from an affective disorder of the mind and was not suffering from delusions that affected her testamentary capacity when she made either the first or the second will. There was also insufficient evidence to support the allegation of fraud (in relation to which the burden of proof lay with the daughter).

The decision was appealed, but the appeal was in most parts rejected by Mrs Justice Falk (in May 2021) who also proclaimed that the original test for capacity had not been overridden by the provisions of the Mental Capacity Act 2005, despite this having been one of the stated reasons for the Deputy Master’s decision. A part of the appeal has been adjourned to give the parties an opportunity to reflect and come to an agreement without further costs.

 

Comment

With the expansion of the Disclosure of Tax Avoidance Schemes (DOTAS) rules to IHT, frankly, there has not been much in the news about any new IHT planning schemes. For those with existing schemes, especially any involving private residences, it may be appropriate to review their effectiveness if that has not been done for a while (or at all).

On the subject of wills, clearly the “golden rule” is still with us and so any adviser involved in helping clients with the preparation and execution of their wills needs to be aware of the importance of establishing mental capacity.

 

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