In defence of deeds of variation

In accordance with inheritance tax legislation, a legal agreement within two years of the death to vary the destination of an inheritance, (including a distribution out of a discretionary trust set up under a will) can be backdated to the date of death for inheritance tax purposes. The legal agreement is generally known as a 'deed of variation'.

This rule has applied for the last 40 years, having first been included when the Capital Transfer Tax Act 1984 was introduced by Labour in 1975. It was made in order to allow beneficiaries who, through no fault of their own, would be treated harshly by what is now inheritance tax. It created the opportunity to have the same treatment as those whose inheritance, through better advice and planning, would be taxed more favourably.

Whether the budget announcement of a review into the use of deeds of variation for 'tax avoidance' was serious, and not just an attempt to embarrass Ed Miliband, remains to be seen. But it risks losing an essential opportunity to repair poor or non-existent estate and tax planning, whose consequences often emerge only after the death.

Often wills are made decades before the death and based on an entirely different tax regime or tax reliefs and allowances prevailing at the time. House price inflation has brought many more estates into inheritance tax and created unexpected problems for the surviving family.

If there is no will, the inheritance on intestacy and its tax consequences is dictated by statute, and takes no account of tax planning. Unfortunately there is still a common belief that husbands and wives and civil partners automatically inherit everything, and a will is unnecessary. This is completely wrong. If there is no will and children are involved, in reality they have only a limited inheritance fixed by law.

The long-established opportunity to back-date a variation of the inheritance under both wills and intestacies affords an opportunity to avoid the consequences of poor, or non-existent planning, typically of being forced out of the family home or other unlooked for outcomes, if it can be agreed between all the main beneficiaries, possibly helped along by a reduction in the IHT bill if that applies.

Inheritance under a will perhaps made decades ago, or under the misunderstood intestacy rules, is a different matter to filling in an annual tax return based on up-to-date knowledge. Provided action is taken properly and promptly, it shouldn't be considered 'tax avoidance' to allow the family to put right the failure of the deceased to make full provision for their wife or husband, or take advantage of the available tax allowances, or to adjust to an unpredictable change in tax rules since the will was prepared.

If it affords an opportunity to pass on an inheritance tax free to the next generation, it encourages wealth redistribution, which is something promoted by all political parties.

In the early 1970s, Mr Philips made a will which, as he was unmarried, left everything to his elder brother. He never married, but died aged 90 without updating his will. His brother, who by this time was 91, had no need of money and wanted to gift his younger brother's estate, worth £625,000, to his own grandchildren.

There was no prospect of saving IHT on his younger brother's estate, but if the will stood as it was and the elder brother inherited £405,000 (after IHT of £220,000) and then gave the inheritance to his grandchildren, at his age the chances were that he would not survive another 7 years to make the gift tax free. The gift would then be caught for IHT again on his own death, and the overall IHT liability before the grandchildren inherited increased by up to an additional £162,000.

By signing a deed of variation which changed his brother's will to leave the entire estate to the grandchildren, Mr Philips saved an unnecessary double charge to IHT, and potentially £162,000 of tax on their inheritance.

Had Mr Philips' brother taken the right estate and tax planning advice, he would have made a new will which had exactly the same effect as the deed of variation. It would be obvious that he would have wanted the grandchildren to benefit, but like so many, had never thought to update his will made so long ago.

Is it unreasonable to conclude that the variation saves tax on the inheritance, but does not 'avoid' it when it only allows the grandchildren a last chance to do what their great uncle could, and would have done anyway?

Roger Peters is senior partner at Gordon Dadds

He specialises in private tax, trusts, wills, estate planning and charity law.

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