Construction – is it or is it not a Disabled Person’s Interest?

 In Trusts

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Preparing trusts in Wills providing for the testator’s disabled child is a balancing act between generating a flexible vehicle for both the disabled person’s lifetime and beyond their death and deciding whether the trust needs to be a Disabled Person’s Interest for IHT or whether it would be better to be a Discretionary trust subject to the relevant property regime. The recent case of Barclays Bank Trust Company Ltd as Trustees of the Poppleston Will Trust v HMRC [2011] EWCA 810 examines the construction of such a Will to determine its correct tax treatment on the death of the disabled beneficiary.

The Inheritance Tax (IHT) treatment of a Disabled Person’s Interest (DPI) is distinct from the IHT treatment of discretionary trusts.

If a trust is a DPI then during the lifetime of the disabled beneficiary there is deemed to be an interest in possession even if there is no actual interest in possession provided for in the trust deed. This ensures that the trust will be outside the relevant property regime and therefore the trust fund will not be subject to periodic charges every 10 years, thereby preserving the capital of the fund whilst the disabled beneficiary is alive.

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If the trust does not qualify for DPI treatment and is not otherwise an interest in possession then it will be within the relevant property regime. However, the advantage of being subject to the periodic charge system is that the value of the trust fund will not be aggregated with the disabled beneficiary’s own estate on death and will not then be subject to IHT at 40% on the whole value of the combined funds over any available Nil Rate Band or other reliefs.

Instead, it will be subject to an exit or proportionate charge on any capital appointed out of the trust at the lower rate of the relevant property regime, which is calculated by formula, and currently cannot exceed 6% of the trust fund’s value.

To qualify as a DPI it is necessary to comply with s.89 IHTA 1984 which, so far as is relevant to the current case, provides as follows:

s.89(1) This section applies to settled property transferred into settlement after 9 March 1981 and held on trusts –

(a) Under which, during the life of a disabled person, no interest in possession in the settled property subsists, and

(b) Which secure that not less than half of the settled property which is applied during his life is applied for his benefit.

(2) For the purposes of this Act the person mentioned in subsection (1) above shall be treated as beneficially entitled to an interest in possession in the settled property.

The facts

Constance and William Poppleston had one child, Edwin, who was born in 1948. In about 1963 the retina in each of his eyes became detached and from then on he was a disabled person within the meaning of the definition in s.89(4) IHTA 1984.

The Popplestons each made Wills in which Barclays Bank Trust Company Limited was appointed to be the sole executor and trustee. After certain bequests the residuary estate in each case was left to the surviving spouse for life and then on the terms of clause 7 (iii), which had clauses (a) to (e) paraphrased as follows:

(a) Provided for the whole or any part of the trust income and/or capital to or for the benefit of Edwin during his life with power to pay such income or capital to any person, hospital or organisation having the care of Edwin without seeing to the application thereof

(b) Surplus income shall be accumulated and but during the period of 21 years from commencement such accumulations could be applied as income of the current year

(c) After the expiration of 21 years and during the remainder of Edwin’s life the trustee shall pay or apply any income not paid or applied for his benefit to the persons who benefit if Edwin had died

(d) After the death of Edwin the trustee holds the trust fund and the future income and all accumulations if any for all or any child or children of Edwin who shall then be living and attain 21 and if more than one equally between them

(e) If Edwin had no children or none who survived to 21 then the trust fund was to be held for the nephews and nieces on attaining 25 in equal shares.

Clause 8 of the Wills contained some supplemental provisions:

8(v) made the usual amendments to ss 31 and 32 Trustee Act 1925 so that there was no restriction on the advancement of the whole of the trust fund.

8(viii) stopped the exercise of any power or provision preventing a person with an interest in possession from having such an interest and preventing s.71 IHTA 1984 from applying.

The Popplestons died in 1990 and 1992 and at the time of their Wills and respective deaths they had six nephews and nieces and seven great nephews and great nieces. Edwin died on 23 July 2005 without having married or leaving any issue.

At the time of Edwin’s death HMRC determined that the fund was subject to IHT on the basis of s.89 since he had to be treated as having an interest in possession. This gave rise to an IHT charge of £158,963. It was agreed between the parties that Edwin did not have an interest in possession as defined in ss. 5 and 49 IHTA 1984 because of the wording of clause 7 (iii) (a) of the Wills.

The first instance decision

The Bank appealed against the determination on the basis that the condition imposed by s.89(1)(b) that the trusts on which the residuary estates were held should secure that not less than half of the settled property applied during the life of Edwin should be applied for his benefit were not satisfied because:

  • Clause 7 (iii) (a) permitted the payment of income or capital to any person, hospital or organisation having his care
  • Clause 7 (iii) (b) permitted income arising during Edwin’s lifetime to be accumulated and then paid to his children or the nephews and nieces after the 21 year accumulation period had expired; and
  • Clause 8 (v) (b) permitted the whole of the trust capital to be advanced to any child of Edwin or if none the nephews and nieces.

The appeal was dismissed on the basis that clause 7 (iii) (a) required payments had to be made for Edwin’s benefit. Clause 7 (iii) (b) only permitted payment of accumulations to Edwin and clause 8 (viii))a) prevented the exercise of the power of advancement so as to exclude the application of s.89.

The appeal

The Bank appealed against the decision of Mr Justice Vos and in addition sought leave to appeal on an additional point namely that as Edwin had been free in his lifetime to assign his interest to another it could not be said that the trusts ‘secured’ that at least half of the settled property which was applied in his lifetime was applied for Edwin’s benefit.

Sir Andrew Morritt, the Chancellor of the High Court, gave the lead judgement which the other law lords followed.

Clause 7 (iii)(a) – he did not agree with the Bank’s submission that as this clause exonerates the Bank from any obligation to see to the property application of any payments made to any person, hospital or organisation that there was nothing to stop the Bank paying the money to such a person or institution which then used the money for research or to purchase equipment completed unconnected to Edwin’s care.

He concluded that the power to pay income or capital was an additional means of applying the trust property for Edwin’s benefit and that the trust for Edwin coloured the purpose of the power so that in this context the power can only be exercised for Edwin’s ‘benefit’ which has the same meaning as ‘benefit’ in s.89(1)(b).

Clause 7 (iii) (b) – The clause provides for the application of the accumulated income of the accumulation period. HMRC argued that the power to apply this accumulated income after the expiration of the 21 year period could only be exercised in favour of Edwin under clause 7 (iii) (a) whereas the Bank argued that it could be paid to his children or the nephews and nieces.

Mr Justice Vos discounted the Bank’s argument on the basis that it required a purposive construction to give effect to the intention of the Will trusts which was primarily for the benefit of Edwin. The Bank argued on appeal that there was no scope for such interpretation of the Wills and no evidence as to what the draftsman or the testator or testatrix had intended.

Although, Sir Andrew did agree that caution was required in construing Wills nevertheless clause 8 (viii) shows that the draftsman and the testator was concerned about IHT and the application therefore of s.89 IHTA 1984.

He found that clause 7 (iii) (b) is self-contained and is limited to the accumulation period only so that the ability to pay accumulated income out as income of the current year only related to that 21 year period and not the period beyond. The any accumulated income would thereafter be capital of the trust fund. As such it could be paid to Edwin if alive under clause 7(iii)(a) or if dead to his children or nephews and nieces under clause 7 (iii) (d) or (e).

Clause 8 (v) (b) – this was the provision which removed the restriction on advancement under s.32 Trustee Act 1925. The effect of the modification is that s.89(1)(b) cannot be satisfied because if that power were exercised in full during the lifetime of Edwin no capital of the settled property could be applied for the benefit of Edwin. That possibility means that the trusts on which the Bank holds the property do not ‘secure’ that not less than half the capital is applied for Edwin during his lifetime.

HMRC argued that this problem is overcome by clause 8 (viii)(a) which precludes any such exercise of the power to prevent Edwin otherwise having an interest in possession under s.89(2). The Bank argued that it did not apply to the extended power of advancement but the Judge at first instance commented that it that was true it would destroy the clear purposes of the Will trusts, namely the care of Edwin during his lifetime.

Although the Bank argued on appeal that Edwin did not have an interest in possession the Chancellor said that the clause could be interpreted to mean the deemed interest in possession which a person is treated as having under s.89(2). He felt it was clear from the wording of clause 8 (viii) as a whole that the draftsman was concerned about the IHT consequences and of the different IHT treatments where there is an interest in possession and those where there is not and the draftsman should be attributed with having knowledge of the terms of s.89 in that regard.

Assignment – the Chancellor did not agree with the suggestion that s.89 could not apply to the trusts because unlike a conventional protective trust there is no provision restricting Edwin from disposing of such interest as he had and that if he did so no income could be applied for his benefit.

The Chancellor commented that the time at which s.89’s conditions had to be satisfied was when the property was transferred into the settlement. At that time the trusts did secure that not less than half the settled property applied during Edwin’s lifetime had to be applied for his benefit. The fact that at some later time Edwin disposed of his interest so that the property could not then be applied for his benefit is irrelevant.

Practice points

The drafting of Wills for the parents of disabled beneficiaries requires full understanding of the different IHT treatment of s.89 IHTA 1984 compliant trusts and those which do not qualify as DPIs.

In some cases a DPI will be the best approach but in other cases there may be other children of the testator who may benefit from a relevant property regime treatment and avoid the large or potentially large IHT bill which would arise on the death of the disabled beneficiary if the relevant property regime applied instead.

Practitioners need to take careful instructions and consider the various generations which the testator is trying to benefit before giving advice on the different IHT treatment.

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