Deed of Variation

Deed of variation

April King’s legal team can draft a Deed of Variation for you to vary the disposition of property under a Will or by intestacy, passing by the law of survivorship or by nomination.

A beneficiary or trustee may want to vary the way that property in the estate of a Deceased person has been disposed of.

Some reasons for making a Deed of Variation include:

  • The beneficiary wants to redirect the gift made to them, to some other member of the family because they have a greater need.
  • Varying the way the property was disposed of could save Inheritance Tax (for example, leaving the family home to a direct descendant would allow use of the Residence Nil Rate Band).
  • Increasing the amount that the Deceased left to charity would allow the estate to benefit from a reduced rate of Inheritance Tax.

Whilst there is more than one way to redirect an asset, the most common method is using a Deed of Variation. Where such a Deed complies with the statutory requirements and is made within two years of death, the redirection is ‘written back’ into the Will or intestacy law for Inheritance Tax and Capital Gains Tax purposes, as if the new provisions were actually what the Deceased had said all along. Inheritance Tax is recalculated on this basis, and of course Capital Gains tax does not apply as the ‘slate is wiped clean’ on death.

Contrast this with, for example, the beneficiary simply gifting the property that they have received to someone else. This is a ‘Potentially Exempt Transfer’ for Inheritance Tax purposes (i.e. Inheritance Tax may be chargeable if they die within a certain period of time) and a disposal for Capital Gains Tax purposes by the beneficiary (meaning CGT may be payable if the value of the property has increased since the Beneficiary inherited it). Further, if the beneficiary gifts the property to a trust, this will be a Lifetime Chargeable Transfer (unless the trust is for a disabled person) and Inheritance Tax may be immediately payable if the gift does not fall within their basic Inheritance Tax allowance; and for Capital Gains Tax purposes, it will be a disposal.

Another option for beneficiaries is to disclaim a gift. This means that the beneficiary rejects the gift and it then passes to the next person entitled under the Will or by law. Disclaimers are less common because they will only be of use if the next person entitled is who the beneficiary wants to inherit! Provided that the disclaimer complies with various statutory requirements, the asset will be treated as if it passed directly from the Deceased to the person next entitled for Inheritance Tax and Capital Gains tax purposes.

Clearly, a variation will be preferable in many cases. Note that if the Deed of Variation does not comply with the statutory formalities, it is viewed as a Potentially Exempt Transfer for Inheritance Tax and Capital Gains tax purposes. For this reason we would always recommend using a professional such as a solicitor to draw up your Deed, rather than attempting to draft a ‘Do It Yourself Deed of Variation’.

Glossary

These terms and acronyms are used below.

IHTInheritance Tax
CGTCapital Gains Tax
PETPotentially Exempt Transfer – a transfer made during someone’s lifetime that is potentially exempt from Inheritance Tax, if the person making it survives for seven years.
LCTLifetime Chargeable Transfer – a transfer made during someone’s lifetime that is immediately chargeable to Inheritance Tax if it exceeds the person making the transfer’s available Inheritance Tax Allowance – e.g. a transfer to a discretionary trust.
IHTA 1984Inheritance Tax Act 1984
TCGA 1992Taxation of Chargeable Gains Act 1992
Nil Rate BandA person’s basic Inheritance Tax Allowance (currently £325,000)
Residence Nil Rate Band or RNRBAn additional Inheritance Tax allowance of £150,000 (2019/20 tax year) or £175,000 (2020/21 tax year) where a person leaves a property which was once their residence to a ‘direct descendant’.

What variations can be made?

A Deed of Variation can be made in relation to “any of the dispositions (whether effected by will, under the law relating to intestacy or otherwise) of the property comprised in the estate immediately before his death” (s.142 Inheritance Tax Act 1984). This includes property passing by joint tenancy. In effect this means that the beneficiary receiving the joint property can vary as if the joint tenancy was severed prior to death and the Deceased’s Will left his/her share to the new beneficiary. In such circumstances it is necessary for the original beneficiary to convey the legal estate to themselves and the new beneficiary by a separate deed.

Can a discretionary trust be varied?

In theory you could vary a discretionary trust under Saunders v Vautier, if all beneficiaries were of full age and capacity and were between then entitled to the whole beneficial interest. However, discretionary trusts very often provide for minor or unascertained beneficiaries and in such cases, a variation is not possible.

In practice, this is not a problem – because trustees have the power to make appointments of the trust property (i.e. pay it out) under Section 144 IHTA 1984 and if done within 2 years of death, these will be written back into the Will as if the Deceased had made the appointment themselves.

What variations cannot be made?

Some property cannot be the subject of a Deed of Variation. Examples include:

  • Property in which the Deceased had an interest in possession prior to their death (i.e. a life interest in the property)
  • Property which the Deceased gave away but reserved a benefit in

In both of the above cases, Inheritance Tax is payable on the value of the asset, but a Deed of Variation cannot be made with a view to reducing IHT. The only exception is where the Deceased was given a life interest shortly before their death and did not take any benefit from it (s.93 IHTA 1984).

Statutory formalities

Inheritance tax

Under Section 142 of the Inheritance Tax Act 1984 (IHTA 1984) the beneficiary must enter into the variation, in writing, within two years of the deceased’s death.

The Deed must contain a statement by the persons making it that s142(1) IHTA 1984 is to apply to the variation.

Where the result of the variation will be that more Inheritance Tax is payable on the Deceased’s estate, the Deceased’s Personal Representatives must join in this statement. They may only refuse to do so if they do not hold sufficient assets to meet the additional tax liability.

Where the variation will result in a redirection of property to a charity, the charity must be notified. The effect of s.142 will only apply in relation to the charity exemption if HMRC has confirmation that this has been done.

The variation cannot be made for consideration in money or money’s worth, except consideration in the form of other variations or disclaimers of the same estate. In other words, the beneficiaries can make “cross-undertakings”, agreeing between them that they will receive different entitlements from the estate.

EXAMPLE:

Mark dies having exhausted his £325,000 nil rate band. He leaves quoted shares worth £150,000 to his son James, and his home worth £150,000 to his friend Barney. Inheritance tax is payable at 40% of £300,000 = £120,000.

James and Barney should vary the disposition so that James gets the property and Barney gets the shares. The Residence Nil Rate Band will be available to James in respect of the property because James is a ‘Direct Descendant’. The Inheritance Tax bill is reduced to £60,000.

Capital gains tax

The conditions for Capital Gains Tax purposes are similar to those for Inheritance Tax purposes. The variation has to be made in writing, within two years of the Deceased’s death, and it cannot be for consideration in money or money’s worth. The variation must contain a statement by the persons making it that Section 62(6) of the Taxation of Chargeable Gains Act 1992 is to apply.

As noted above, no Capital Gains Tax is payable on someone’s death – the slate is wiped clean – so the change of beneficiary does not matter for CGT purposes. However, the reason for electing for Section 62 to apply i.e. writing back, is that the beneficiary making the variation is not making a ‘disposal’ of the asset for Capital Gains tax purposes (otherwise, the Beneficiary would be liable for CGT on any gain in the asset value since death).

Must the variation be made by Deed?

Whilst IHTA 1984 and TCGA 1992 only require that the variation is made in writing, post-death variations are gratuitous promises to transfer property and should therefore be made by deed – otherwise they are not enforceable.

To write back, or not

The writing back effect is not automatic – it must be claimed (compare this to a disclaimer where the writing back effect is automatic). The original beneficiary of the asset has to decide whether to write back or not, (a) for Inheritance Tax and (b) for Capital Gains tax. They can choose the writing back effect for none, just one or both taxes. The decision whether to write back or not depends on the beneficiary’s tax position and that of the Deceased’s estate.

(1) Inheritance tax

If they don’t elect for s.142(1) IHTA to apply (i.e. they don’t elect to write back for Inheritance Tax purposes), the asset is treated as having passed to the beneficiary and he/she is treated as having made a Potentially Exempt Transfer. If he/she survives for seven years, it will be exempt from IHT. If he/she dies within seven years, it will become chargeable and will reduce the beneficiary’s nil rate band. If the Beneficiary redirects to a trust, he/she is treated as making a Lifetime Chargeable Transfer. No IHT is payable if it is within his/her nil rate band – after which 20% is payable. If they die within seven years of making an LCT, tax is recalculated at full death rates. Other gifts made during the beneficiary’s lifetime may also impact this.

If they do elect for s.142(1) IHTA to apply (i.e. they do elect to write back for Inheritance Tax purposes), there is no impact on the Beneficiary’s own inheritance tax position. The asset is treated as having passed from the Deceased to the new beneficiary directly. However, the Estate may then be liable for more Inheritance Tax, depending on whether there is anything left of the Deceased’s allowances and depending on the status of the new beneficiary. The new beneficiary may be a Direct Descendant (so taking advantage of the RNRB) or may be a spouse/civil partner (so taking advantage of the spouse/civil partner exemption).

If the consequence of the variation is that more Inheritance Tax will be payable, the detriment of this needs to be weighed up against the risk of the original beneficiary making a PET or LCT.

EXAMPLE A

Carl dies, leaving his entire £500,000 estate of stocks, shares and investments to his niece Charlie. Charlie is already financially stable and decides to gift this to her adult son.

If Charlie does not elect for s.142(1) to apply:

    • IHT on Carl’s death is £70,000 (£325,000 @ 0% and £175,000 @ 40%)
    • Charlie makes a PET. Provided that she survives for seven years, there will be no IHT to pay on the transfer and no reduction of her nil rate band.

If Charlie does elect for s.142(1) to apply:

    • IHT on Carl’s death is the same.
    • Charlie avoids making a PET.

Charlie should therefore include a statement that s.142(1) is to apply (i.e. write back).

EXAMPLE B

Sam dies, leaving his entire estate of stocks, shares and investments to his wife Chrissie, having previously used his nil rate band during his lifetime. However, Chrissie decides she is already provided for and wants to gift the estate to their son Matthew.

If Chrissie does not elect for s.142(1) to apply:

    • IHT on Sam’s death is £0 as the spousal exemption applies.
    • Chrissie makes a PET. Provided that she survives for seven years, there will be no IHT to pay on the transfer and no reduction of her nil rate band.

If Chrissie does elect for s.142(1) to apply:

    • IHT on Sam’s death is £200,000 (40% of £500,000 as he already used his nil rate band)
    • Chrissie avoids making a PET.

Note that Sam’s PRs would certainly have to join in the statement to elect for s.142(1) to apply, and could decline to do so if the estate had insufficient assets to pay the additional tax bill!

Clearly in this scenario, Chrissie should not elect for s.142(1) to apply – it is better for her to make a PET and take a chance that she will survive for 7 years. She could take out insurance to cover the eventuality that she might die sooner.

(2) Capital gains tax

If they don’t elect for s.62(6) TCGA 1992 to apply (i.e. they don’t elect to write back for Capital Gains tax purposes), the original beneficiary makes ‘a disposal’. This may mean they made a gain or a loss for CGT purposes, depending on whether the asset has increased or decreased in value from the date of death. The new beneficiary is treated as having acquired the asset at market value at the date of disposal. If the gain is small, this may be covered by the original beneficiary’s annual Capital Gains tax allowance (for the 2019/20 tax year this is £12,000 for an individual). Alternatively if the original beneficiary has made losses on the disposal of other assets during the same tax year, these can be used to offset the gain. Either way, no CGT is due.

If they do elect for s.62(6) TCGA 1992 to apply (i.e. they do elect to write back for Capital Gains purposes), the asset is treated as having passed directly to the new beneficiary from the Deceased and there is no disposal. No CGT is due. However, note that the new beneficiary is treated as having acquired the asset at its market value at the date of death. If the asset has since increased in value, the original beneficiary should consider not electing if they can absorb that increase through their annual CGT allowance.

EXAMPLE A:

Oliver dies, leaving quoted shares to Holly which have increased in value by £12,000 since death. Holly decides she does not need the gift and wants to vary it so it goes directly to her sister Courtney. Holly has not made any other disposals for CGT purposes this tax year.

If Holly does not elect for s.62(6) TCGA 1992 to apply:

    • CGT payable on Oliver’s death is still zero
    • Holly has made a disposal with a chargeable gain of £12,000. However, this is covered by her annual exemption so she pays no CGT.
    • Courtney acquires the shares at their higher current value. Consequently when she comes to sell the shares there will be less of a gain and less CGT payable.

If Holly does elect for s.62(6) TCGA 1992 to apply:

    • CGT payable on Oliver’s death is still zero
    • Holly has not made a disposal so there is no CGT payable.
    • Courtney acquires the shares at their value on death (because it is as if the Deceased left them to her directly). When she comes to sell them, she will pay CGT on the gain made between the death and her acquiring them (£12,000) plus any gain made up to the point of sale. It is therefore possible that a lot more CGT will be payable.

EXAMPLE B: 

Oliver dies, leaving quoted shares to Holly which have increased in value by £20,000 since death. Holly decides she does not need the gift and wants to vary it so it goes directly to her sister Courtney. Holly has already made several disposals for CGT purposes this tax year and has no CGT allowance left.

If Holly does not elect for s.62(6) TCGA 1992 to apply:

    • CGT payable on Oliver’s death is still zero
    • Holly has made a disposal with a chargeable gain of £20,000. She has no annual exemption so CGT will be due on this.
    • Courtney acquires the shares at their higher current value. Consequently when she comes to sell the shares there will be less of a gain and less CGT payable.

If Holly does elect for s.62(6) TCGA 1992 to apply:

    • CGT payable on Oliver’s death is still zero
    • Holly has not made a disposal so there is no CGT payable.
    • Courtney acquires the shares at their value on death (because it is as if the Deceased left them to her directly).

Whilst it is true that in this scenario, electing will result in a bigger CGT bill for Courtney, the original beneficiary Holly should still elect as Courtney benefits from the asset of the shares. Holly should not be out of pocket by her gift!

What if the original beneficiary reserves a benefit in the asset?

What would happen if the original beneficiary makes a variation but continues to enjoy the asset? For example, they inherit a house, they vary the disposition so it goes to one of their children, but they continue to live in the house?

To answer this question, we need to look at what IHTA 1984 actually says. A variation takes effect:

“as if the variation had been effected by the deceased or, as the case may be, the disclaimed benefit had never been conferred.” (IHTA 1984 s.142)

So in this example, the gift of the house to the new beneficiary is treated as if it has been made by the Deceased. The original beneficiary is written out of the picture. Consequently, any reservation of benefit is irrelevant for these purposes – it does not impact the original beneficiary’s estate, it falls into the new beneficiary’s estate for IHT purposes. However, don’t conclude from this that giving away a property you inherit is always a good idea – what happens if the new beneficiary falls into financial difficulty, gets divorced or simply falls out with you?

Note also that, where property is directed into a trust, the original beneficiary is treated as the Settlor (the person making the trust) rather than the Deceased. Consequently, if the original beneficiary makes themselves a beneficiary of that trust, there may be income tax consequences as there are no equivalent writing back provisions for income tax purposes.

Can more than one variation be made?

More than one variation in relation to the estate can be made, provided that each one deals with a different part of the estate. Different components or shares of the residuary estate can be varied.

You cannot make a variation in relation to property that has already been varied previously.

When consent of the court is necessary

If the variation involves beneficiaries that are minors or who do not have mental capacity, consent of the court must be sought and can be granted under the Variation of Trusts Act 1958. If course, the court will only exercise these powers if the proposed arrangements are made for the benefit of the beneficiaries.

In conclusion

You can use a Deed of Variation to redirect property that you have acquired as a result of death. If you comply with the statutory formalities, you can do this without tax implications – but you need to consider carefully whether to elect to write back for Inheritance and Capital Gains tax purposes.

Some benefits that can be gained from ‘writing back’ include:

  • The original beneficiary does not make a PET/LCT for IHT purposes or a disposal for CGT purposes.
  • The original beneficiary can in theory give away the property and continue to use it – however, be aware of the risks here; and
  • The variation may allow the estate to benefit from the reduced 36% IHT rate.

If you are interested in making a Deed of Variation, please contact Jen Wiss-Carline : jen@aprilking.co.uk