Update | Estate planning: Finance Bill and problem wills

Many existing estate planning strategies are affected by new inheritance tax (IHT) provisions contained in schedule 34 of the Finance Bill, published in March 2013. The explanatory notes to the bill comment that the new rules are intended "to remove the tax advantage that is achieved by arrangements which exploit the current provisions" relating to the deduction of debts from the value of assets liable to IHT. The new legislation, which will apply to transfers or deaths occurring after Royal Assent, provides that a debt will not be deductible if it was incurred to acquire, maintain or enhance assets which qualify for IHT exemption as excluded property or for IHT relief as business property, agricultural property or woodland. Both existing and new borrowings will be affected.

In the current economic climate, this is a surprising attack by a Coalition government on the tax efficiency of financial arrangements, which may be crucial to the survival of family businesses and farms. Banks routinely prefer to lend on the security of residential property or quoted shares, not because they are conspiring to exploit the IHT rules, but simply because these assets are easy to value and easy to sell if the borrower defaults. A farmer or businessman who has mortgaged his house to the bank to fund his business can currently expect that on his death the amount owed to the bank will be deducted from the value of the house on which IHT is payable. Under the new legislation, when the farmer dies, the value of the mortgage on the house will be deducted from the value of the farmland on which no IHT is payable, as it qualifies for agricultural relief.

The Finance Bill also targets the deduction from a deceased person's estate of debts which are not repaid in money or money's worth. If the whole or part of a liability claimed as a deduction at death is not subsequently discharged, it will be allowed as a deduction from the estate only to the extent that there is a real commercial reason for it not being discharged. The liability will not be deductible if tax mitigation was one of the main purposes of the borrowing arrangements.

It seems this will apply to financial arrangements commonplace among families in which individuals and trusts provide long term liquidity for family assets and enterprises ultimately destined for future generations. Again, the usual driver for such arrangements is not tax avoidance but the difficulty of obtaining commercial financing on economically viable terms.

It has been pointed out that these provisions would in theory apply to a mortgage loan to joint proprietors one of whom dies and the other agrees with the bank to keep up the mortgage instalments, rather than paying off the loan. The loan would not be allowed as an IHT deductible debt of the estate of the joint owner who has died, unless the survivor's decision to go on paying the mortgage is a "real commercial reason" for it not being paid off.

There was no prior consultation on the draft legislation and changes may be expected before it reaches the statute book. Even so, many routine and long-established borrowing arrangements for individuals, partnerships and trusts are being urgently reviewed as tax targets under this new legislation.

The Finance Bill also contains the draft legislation proposed in the 2012 budget which allows a non-UK domiciled surviving spouse to opt to be treated as UK domiciled, as described in the previous estate planning update. One useful addition to the earlier draft is to allow the surviving spouse's UK domicile to be backdated up to seven years in order to cover failed potentially exempt transfers as well as transfers on death. The downside of the UK domicile election for the surviving spouse is that after making it, his or her own worldwide estate will be exposed to UK IHT. The election is irrevocable, and applies even to non-UK resident spouses until four years after he or she has ceased to be resident in the UK.

Problem wills

In the 19 March edition of Solicitors Journal, Emily Exton and Katherine Robinson considered the duties and responsibilities of the will draftsman following Hawes v Burgess [2013] EWCA Civ 94. At the other end of the testamentary process, when should a probate practitioner be worried about accepting a will at face value?

Turner v Phythian [2013] EWHC 499 (Ch) was a recent reminder that one should always be concerned about a will prepared by a beneficiary. Mrs Iris Wilson executed a will prepared by Mr Phythian under which he and his wife were the main beneficiaries. The Phythians were friendly with Mrs Wilson throughout much of her life, becoming increasingly involved with her affairs after her husband died. The will was successfully challenged on grounds of lack of proper execution, lack of mental capacity and lack of knowledge or approval of the contents.

The judge found that the will was properly executed and, on its face, rational. This raised the presumption of capacity. Nevertheless, because it was drafted by the main beneficiary, the court was required to "be vigilant and jealous in examining the evidence in support of the instrument" (Barry v Butlin (1838) 2 Moo PC 480) The evidence of photographs and emails painted a clear picture of the testatrix's mental frailty and her amicable relationship with her extended family. There was little independent evidence of her intentions, her instructions to the draftsman or even that she read the will which she signed.

Experience shows that practitioners should treat with caution all wills that treat children unequally, particular where earlier wills have provided for equal inheritances. Two recent cases concerned wills drafted by will-writing companies. In Schrader v Schrader [2013] EWHC 466 (Ch) the court found the will writer was "procedure-driven" and lacking the "experience of a seasoned solicitor". Importantly, she failed to make and keep an attendance note of the testatrix's instructions. The testatrix was aged 96, frail, vulnerable, and dependent on one of her sons, Nick, for her daily care. Nick arranged the will writer's visit to his mother. The new will favoured Nick at his brother's expense; the previous will had treated the brothers equally. Although the presumption of capacity applied because "the will is rational on its face - if there was no other evidence then capacity would be established", the surrounding circumstances raised suspicion, and the evidence satisfied the Court that there had been undue influence on the part of Nick, invalidating the will.

However, in Paynter v Hinch [2013] EWHC 13 (Ch) the involvement of a will writer did not raise suspicions; importantly, the testatrix herself chose whom to instruct. Her will giving her estate to the youngest child as sole beneficiary and disinheriting the two eldest was judged to be valid.

Lord Justice Mummery noted in Hawes v Burgess: "If a properly executed will has been professionally prepared on instructions and then explained by an independent solicitor it will be markedly more difficult to challenge its validity than in a case where those prudent procedures have not been followed." But that case demonstrated that solicitor-drafted wills are not bullet-proof. As in Schrader and Paynter, the new will benefited the deceased's children unequally whereas the previous will had given them equal shares; one beneficiary had arranged for her mother to consult the solicitor, remained present during their meeting and provided background information. The fact that the testatrix had no opportunity to read the will in draft also raised doubts that it embodied her wishes. The Court of Appeal confirmed that the judge was right to call for affirmative evidence that the testatrix knew and approved what she was signing.

So disappointed beneficiaries need not despair of challenging a will, even drafted by a professional, where there is strong evidence pointing to lack of capacity, lack of knowledge and approval or undue influence. But what if none of these occurred but the will still fails to give effect to the testator's intentions? In Kell v Jones [2013] All ER 153, this problem was insoluble. Again the will was drafted by an experienced solicitor who discussed it with the testatrix and understood his client's intentions. Clause 4 of the will contained cash legacies to various individuals and charities. Clause 6 gave the residue to "such of the beneficiaries named in clause 4 who survive me and if more than one in equal shares".

The testatrix intended only the individual legatees (not the charities) to inherit the residue. Both she and her solicitor thought that by specifying beneficiaries "who survive me" the gift of residue would automatically exclude the charities. This was not an inadvertent mistake; there were no clerical errors or omissions that would have justified rectification. The will was upheld. The disappointed beneficiaries will presumably bring a claim against the solicitor who failed to give effect to the testatrix's wishes.