Legacies “Free of tax” – Does this mean anything anymore?

 In Tax

Disclaimer: LawSkills provides training for the legal industry and does not provide legal advice to members of the public. For help or guidance please seek the services of a qualified practitioner.

wills childrenIn the recent past, it was commonplace to identify in wills if a legacy or devise was to be given “free of tax”, or “subject to tax”.  Some will drafters continue to include reference to “free of tax”.  Many drafters make no reference to tax on individual gifts, whilst others include both “free of tax” legacies and those where there is no reference to tax within the same instrument.  Does this have any continuing significance?

N.B.    Within this article, and unless otherwise stated, reference to “Legacies” includes all forms of legacy, including devises.

Background

For deaths before 1 January 1985, legacies of personalty under a will were given free of UK tax, unless otherwise stated.  However, the reverse applied to devises of realty, which were given subject to the payment of UK tax unless specifically exempted by the will.  To the extent that gifts of specific assets, whether, say, shares or property were “free of tax”, the tax element was deemed a general legacy which would abate with the cash legacies, etc. if the estate was insufficient to satisfy all testamentary gifts in full.

The LawSkills Monthly Digest

Subscribe to our comprehensive Monthly Digest for insightful feedback on Wills, Probate, Trusts, Tax and Elderly & Vulnerable client matters

Not complicated to read  |  Requires no internet searching |  Simply an informative pdf emailed to your inbox including practice points & tips

Subscribe now for monthly insightful feedback on key issues.

All for only £98 + VAT per year.

Lawskills Digest

This situation changed for deaths occurring on or after 1 January 1985, as a result of the coming into effect of s.211 Inheritance Tax Act 1984 (IHTA 1984) see box below.  In brief, s.211 provides that UK inheritance tax (IHT) on UK assets which vest in the deceased’s personal representative(s) is a testamentary expense (unless the will demonstrates a contrary intention).

So, what does this mean?

The effect of s.211 is that the liability for IHT is thrown onto the residuary beneficiaries.  This includes gifts of realty contained in pre 1985 wills where the testator dies on or after 1 January 1985 (or even tomorrow).  For the avoidance of doubt, this does not affect the rule that where realty is charged with a debt, the devisee takes the property subject to that charge (unless the will provides otherwise).

It should be noted that s.211 applies only to IHT on UK assets within the estate of the deceased.  It does not affect the liability for non-UK taxes or duties, or the allocation of IHT on other occasions, such as where legacies are payable on the termination of an interest in possession (discussed below).

Testamentary gifts: “free of tax”

In general, where a Legacy is “free of tax” the legatee/devisee receives the gift with no reduction attributable to the liability to IHT.

Where an estate is subject to non-UK taxes or duties, the legatee/devisee will normally be liable for such taxes/duties as they relate to the gift.

Should an abatement arise within the estate, the usual rules for marshalling of the assets apply, so that Legacies will only be reduced once residue has abated in full.

The meaning of any provision in a will is subject to it being construed on the basis of the entire will.  Accordingly, “free of tax” may also relieve a gift of the liability to any non-UK taxes or duties if they are specifically payable out of residue (or some other fund set aside for that purpose), or if the gift is designated to be “free of all taxes”.  It is a matter of construction and it may be necessary to see the original will instructions to ascertain the testator’s intentions.

Testamentary gifts: no specific reference to tax

In the absence of any direction, the provisions of s.221 apply, and the situation is much the same as for a gift specified to be “free of tax”.

As with gifts “free of tax”, where an estate is subject to non-UK taxes or duties, the legatee/devisee will normally be liable for such taxes/duties as they relate to the gift unless such taxes or duties are specifically payable out of residue (or some other fund set aside for that purpose).

Testamentary gifts: “subject to tax”

All such gifts are payable subject to bearing their proportionate share of any IHT payable by virtue of the testator’s death.  The apportionment is normally based upon the values as at the date of death of the taxable estate and the Legacy (e.g. Taxable estate of £1,000,000; gift of £100,000 – beneficiary liable to 10% of the IHT and interest thereon).

If the legacy is a cash legacy, the executors can deduct the IHT liability before payment.  However, if the gift is of specific assets, before satisfying it the executors should consider their own position.  If they distribute the assets and the beneficiary fails subsequently to put the executors in funds, the executors may have a personal liability to the estate for the tax monies not secured.  Accordingly, they might obtain sufficient funds from the beneficiary to cover the amount of IHT that could be attributable to the gift (plus interest on that IHT), mindful that the final IHT liability will not be known until the administration of the estate is completed – better to return a small overpayment than to try and obtain a top-up payment.

Where an estate is subject to non-UK taxes or duties, the legatee/devisee will normally also be liable for such taxes/duties as they relate to the gift.

Statutory legacies

Where the statutory legacy is payable to the surviving spouse or civil partner under intestacy, it will normally be exempt from IHT.  However, if the deceased was domiciled (or deemed domiciled) within the UK and the survivor is not UK domiciled, the exemption is limited and is reduced by all lifetime gifts made by the deceased to the survivor (s.18(2) IHTA). The statutory legacy may, therefore be subject to the same treatment as a legacy “free of tax”.  To the extent that the survivor is not entitled to any exemptions in relation to non-UK taxes or duties, these may also reduce the amount of the legacy they receive.

Legacies payable on the termination of a trust interest

It is axiomatic that s.211 IHTA does not apply where Legacies are payable out of a trust fund upon, say, the death of a life tenant.  Whilst it is rare for Legacies to be payable following the death of a life tenant under a testamentary trust, they do occur.  Although it is considered more unusual for such gifts to be made from an inter vivos settlement, with the use by some individuals of American style “living wills” this is an aspect that might become more frequent in the coming years.

Where an IHT charge arises when Legacies are payable out of a trust fund, unless the trust instrument directs otherwise those gifts are effectively “subject to tax”.  The IHT liability is then apportioned between the separate elements of the transfer of value that occurs.  As with testamentary gifts made “subject to tax”, the trustees should either deduct the tax (and interest thereon) from the Legacies before payment or, before transferring assets to them, secure funds from the beneficiaries to cover any potential IHT liability.

Clearly, if a gift is given out of the trust fund is made “free of tax” the IHT liability is thrown upon the rest of the trust fund.  It is only if the IHT charge exceeds the value of the rest of the trust fund that the “tax-free” gift will bear any of the tax liability.

Where gifts are payable out of a trust fund, say on the death of a life tenant, the trustees must also be mindful of the existence of any aggregable estate/titles.  Although the extent of the transfer of value within the trust fund might be readily ascertainable, any change in the value of aggregable funds will also reflect in the trustees’ IHT liability.  In such situations, trustees might consider obtaining clearance under s.239 IHTA from HMRC as early as possible, so that the maximum liability of the trust fund may be crystallised.

Fund designated for payment of taxes

Some wills and trust instruments provide for IHT arising, and sometimes for all similar taxes, to be paid out of a designated fund.  In such cases, whilst the fund is sufficient any Legacies payable will effectively be “free of tax”.  However, what if the designated fund is insufficient to satisfy the tax liability in full (including interest on the IHT)?

In a deceased estate, s.211 IHTA will kick-in and the IHT liability will fall on the residuary estate.

With a trust fund, the excess will be apportioned between the separate elements of the transfer of value that gives rise to the liability.

s.211 IHTA 1984: Burden of tax on death.

(1)       Where personal representatives are liable for tax on the value transferred by chargeable transfer made on death, the tax shall be treated as part of the general testamentary and administration expenses of the estate, but only so far as it is attributable to the value of property in the United Kingdom which—

(a)       vests in the deceased’s personal representatives, and

(b)       was not immediately before the death comprised in a settlement.

(2)       Subsection (1) above shall have effect subject to any contrary intention shown by the deceased in his will.

(3)       Where any amount of tax paid by personal representatives on the value transferred by a chargeable transfer made on death does not fall to be borne as part of the general testamentary and administration expenses of the estate, that amount shall, where occasion requires, be repaid to them by the person in whom the property to the value of which the tax is attributable is vested.

(4)       References in this section to tax include references to interest on tax.

 

 

 

FREE monthly newsletter

Wills | Probate | Trusts | Tax  | Elderly & Vulnerable Client

  • Relevant learning and development opportunities
  • News, articles and LawSkills’ services
  • Communications which help you find appropriate training in your area
Recommended Posts
Private use and liveries - pay the market reate and save IHT