Tax consequences of court applications

 In Gill's Blog, Probate, Tax

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I was preparing a webinar on proprietary estoppel and the judgment in Guest v Guest [2022] UKSC 27 brought to my attention a weakness in court decisions and those seeking judgements involving the transfer of assets – the lack of evidence on the tax consequences of what is sought.

The problem

When making a claim under the Inheritance (Provision for Family & Dependants) Act 1975 (IPFD 1975) the applicant is seeking an order for reasonable financial provision because the deceased did not adequately provide for them. In the case of the spouse or civil partner, this can include transfers of capital and assets rather like on divorce but unlike divorce there is no requirement to present tax evidence to the court to inform it adjudication process.

Similarly, when making claims for resulting and constructive trusts, proprietary estoppel and other equitable remedies. The outcome of which may mean assets are transferred between people or an estate on death and the applicant.

In some cases, the order will involve the sale of chargeable assets which will potentially give rise to a charge to Capital Gains Tax (CGT) in other cases there may be a transfer to a trust creating an opportunity to use holdover relief for CGT but at the same time introducing an entry charge for Inheritance Tax (IHT).

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IPFD claims

The tax treatment of the outcomes of a claim differs depending on whether a potential claim is settled without proceedings or with an order. If a claim is settled without proceedings but within the Deed of Variation rules, it must meet the relevant conditions i.e. be made within two years; all the parties are over 18 and competent to agree to the variation; the IHT & CGT elections are contained in it.

If it is not possible to meet those conditions e.g. the settlement is reached more than 2 years from death or the beneficiaries include minor children; then an order will be needed even if reached by consent – to gain the tax read back contained in s.19 IPFD 75 & under s.146 IHTA 1984. There are no equivalent provisions to s.146 IHTA 1984 in the CGT or Income Tax legislation. It therefore follows that for those taxes it is essential to gain the reading back that s.19 IPFD 1975 affords, so any order must comply with s.2 IPFD 1975.

For example, the Deceased’s estate was valued at £450,000 and left to his second wife. The Court ordered that £185,000 be treated as bequeathed to trustees of the Will to pay income to his second wife until death or 1/3/1996, whichever is the earlier event. The second wife survived. Her interest in possession was terminated on 1/3/1996 and the capital passed to the deceased’s son from his first marriage. That part of the property covered by spouse exemption has now passed to a chargeable beneficiary but there is no charge to IHT, provided the termination proves to be more than seven years before second wife’s death as it is a Potentially Exempt Transfer by the second wife.

There are some nasty traps when dealing with IPFD claims, in particular s.29A IHTA 1984. This section removes exemption from a transfer of value if in settlement of the whole or any part of a claim against the deceased’s estate it effects a disposition of property not derived from the transfer i.e. it is from the transferee’s own money outside the estate.

Proprietary estoppel

The increase in claims for proprietary estoppel in connection with high value farms is a classic example of the potential for a pyrrhic victory. In other words, succeeding in a claim only to have the benefits adversely affected by tax.

In Guest the suggestion that the claimant should wait until the death of their parents who had reneged on their promise to him was in principle sensible. This would avoid a CGT charge which would otherwise arise on selling the farm, when on death there would be a CGT uplift and Agricultural Property Relief (APR) too. However, what does ‘wait until death’ actually mean? A claimant who has fallen out with the defendants over a breach of promise is unlikely to accept another promise that they will leave the farm or a part of it to them on death, is he?

The obvious solution of making a trust so that the defendants undertake a self-settlement on themselves for life, remainder on death for the claimant obviously provides certainty for the claimant but introduces a potential entry charge for IHT on the creation of a lifetime trust if the farm is sold and the capital is transferred into trust, as well as a CGT charge on the sale.

Transferring an interest in agricultural property may work, if that is possible, enabling 100% APR on the transfer into trust and providing CGT holdover relief on the disposal as an option.

Another option might be giving the claimant the benefit of a loan secured against the farm which can be called in by the claimant either on the defendants’ death or on a sale by them to a third party. The only problem on death is debts can only be deducted from the valuation of a deceased’s estate to the extent they are imposed by law or are incurred for a consideration in money or money’s worth – s.5(5) IHTA 1984. A debt effecting the financing of certain relievable property (s.162B IHTA 1984) or which is not discharged after death for non-commercial reasons (s.175A IHTA 1984) will limit the deductibility of the debt in the defendants’ estates.

Conclusion

Specialist tax advice should be obtained at an early stage in proceedings and shared with the court as part of the evidence in support of an applicant’s claim or a defendant’s defence. A Judge hearing the case may not have a tax background and should be made aware of the tax consequences of any order that s/he may make.

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