Pension Death Benefits & IHT – a useful reminder
The recent case of Fryer v HMRC  UK FTT 87 is a reminder that cases brought before the new First Tier Tax Tribunal are limited to matters within their statutory authority – namely, they are to consider the statutory provisions as they are and not as the parties to the proceedings might want them to be on the basis of fairness. It follows that where a person is found to fall within a statutory provision, it must be applied.
In this case, the provisions in question were s.3 IHTA 1984 (relating to what is a transfer of value) and s.10 IHTA 1984 (providing for dispositions not intended to confer a gratuitous benefit).
Mrs Arnold had taken out a personal pension policy in 1995 and wrote a trust on discretionary terms for the benefits which might become payable under it. Her beneficiaries under the trust included her children. She also provided a Letter of Wishes to the trustees indicating that the full value of the arrangement was to go to her daughters Tracey and Jayne in equal shares.
The pension arrangements permitted her to draw down a pension and lump sum at any time between the ages of 50 and 75 and that ‘normal pension age’ under the policy was 60 (which would have been 8 September 2002). Mrs Arnold was in fact 53 at the time the policy was taken out and was diagnosed with ovarian cancer on or around 15 April 2002. She died on 30 July 2003 without having taken the retirement benefits available to her under the plan. This would result in the fund’s value enhancing the discretionary trust for the benefit of her daughters. She had no need for the income should she have requested a drawn down of her pension.
Although the person representing the executors tried to make a case for no IHT due on the purported transfer of value the omission to exercise her rights caused on the basis of fair play the law was clear and in HMRC’s favour.
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Did Mrs Arnold make a transfer of value for the purposes of s.3(3) IHTA 1984 by failing to draw down her retirement benefits before her death?
S.3(3) envisages the concept of passive dispositions i.e. omissions, which result in the enhancement of another person’s estate or of settled property (as here) in which no interest in possession subsists, not just ‘active’ transfers.
There are 3 elements to a disposition under s.3(3):
- Deliberate omission to exercise a right – Mrs Arnold deliberately failed to exercise her right to take the retirement benefits available to her under the policy.
- With a resultant diminution in the value of the disponer’s estate – the effect of Mrs Arnold’s deliberate omission to exercise her right was that her estate was diminished by the value of the retirement benefits.
- The omission led to the value of another person’s estate or settled property becoming increased in value – Mrs Arnold’s failure to exercise her right resulted in the discretionary trust increasing in value by the value of the retirement benefits.
Could s.3(3) be displaced by s.1IHTA 1984?
The Executors could displace the position of s.3(3) if they could bring themselves within s.10 IHTA 1984 i.e. by establishing that Mrs Arnold’s omission to exercise her right was not intended to confer a gratuitous benefit. It is in two parts:
(i) Was it intended to confer a gratuitous benefit on any person? There was no evidence brought on this point save that the emphasis throughout on behalf of the Executors was that Mrs Arnold did not need the income which was why she did not draw down her pension as the income would only have increased her income tax bill. This was not sufficient to address whether or not she intended to confer a gratuitous benefit on any person as quite simply she must have intended to by creating the trust to receive the benefits under the pension policy and by not exercising her option to take her retirement benefits at any time during her life.
(ii) If so, can you show that the disposition was not made in a transaction intended to confer any gratuitous benefit on any person? The transaction was the creation of the discretionary trust and it was clearly intended to confer a gratuitous benefit in that it was designed to benefit the discretionary trust beneficiaries and, by the letter of wishes, Mrs Arnold’s daughters in particular.
S.10(1)(a) & (b) require it to be shown that either that disposition (i.e. the omission) was made in a transaction at arm’s length between persons not connected with each other, or that it was such as might be expected to be made in a transaction at arm’s length between persons not connected with each other.
An omission to act will not usually be an arm’s length transaction and it wasn’t here; equally Mrs Arnold was a trustee of the settlement she made and as such she was connected to herself as settlor and remained connected when she appointed her daughters as trustees.
Therefore, Mrs Arnold’s omission to exercise her rights under her pension policy at any time during her life was taxable under s.3(3) IHTA 1984 and was not exempted by s.10 IHTA 1984.
The HMRC Tax Bulletin of February 1992 entitled “ Inheritance Tax: Retirement Benefits under Private Pension Contracts – s.3(3) IHTA 1984” sets out a concessionary treatment which applies in the majority of pension arrangements and explains that HMRC would only take the view taken in this case where there is evidence that the policy holder’s intention in failing to take up retirement benefits was to increase the beneficiaries of the death benefits rather than themselves where the policyholder became aware that he or she was suffering from a terminal illness or was in such poor health that his or her life was uninsurable and at or after that time took one of a series of actions including deferring the date for the taking of retirement benefits.
- Despite the fact that the purposive approach is supposed to apply to the interpretation of tax statutes it pays to appreciate the letter of the law and how it will affect your particular client.
- When someone has been diagnosed as terminally ill it is unlikely that any action which has the effect of reducing their estate on death will be ignored as not being a transfer of value which will become taxable on death
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