How to Make a ‘Disclaimer’ - and its Inheritance Tax Effect

How to Make a ‘Disclaimer’ - and its Inheritance Tax Effect
Inheritance tax (IHT) is levied at 40% on an individual’s estate on death. A basic tenet of English law is freedom for an individual to dispose of his property, owned at the date of death, by will in any way whatsoever and to whomever he pleases. So what is the problem?

A beneficiary under a will is under no obligation to accept the gift which the testator has left to him/her under his will. The beneficiary may therefore choose to ‘disclaim’, i.e. not accept, the gift.

There may be a number of reasons for an individual to effect a disclaimer. The beneficiary may simply not believe in inherited wealth; he may feel that his inheritance is too large or excessive; he may feel that there are other more deserving beneficiaries (e.g. charities); he may have fallen out with the testator and wants, as a point of principle, to not accept anything from him, etc.

If the beneficiary chooses to disclaim the inheritance it is important that he has not accepted the gift, as it is not then possible to disclaim it, and a beneficiary is unable to disclaim only part of a gift (i.e. he either accepts the whole inheritance or none of it).

Inheritance Tax and Disclaimers

Unfortunately, should a beneficiary disclaim his inheritance, for IHT purposes he is treated as having made a transfer of value (in essence he is treated as if he has himself made a gift of his inheritance) which may precipitate an IHT charge; this is the position even though from a practical perspective the beneficiary in fact received nothing. However, despite the possible IHT charge, there are no capital gains tax (CGT) consequences.

Inevitably, the risk of a possible IHT charge may deter a beneficiary from effecting a disclaimer. Fortunately, provision is made within the IHT legislation to permit a disclaimer to be made without any risk of an IHT charge albeit subject to the following conditions:

• The disclaimer must be executed by an instrument in writing (although a deed is not strictly necessary; a simple letter suffices);

• The disclaimer must be executed within two years of the testator’s death; and

• The disclaimer must not be made for any consideration in money or money’s worth (i.e. cannot sell his inheritance).

Where the conditions are satisfied, the disclaimed gift is regarded as having never been conferred on the beneficiary, ab initio, and hence no IHT charge if he disclaims; it’s as if he was never a beneficiary under the will. A failure to observe these conditions may result in an IHT liability.

Can it Be Passed On to Someone of Your Choice?

It may be that a beneficiary may only want to make a disclaimer if he is able to redirect his inheritance to someone who he would like to inherit instead. This is not possible. Once a gift is disclaimed, it is the testator’s will which then determines who inherits.

As a will on death becomes a public document, any beneficiary thinking of disclaiming a gift is able to ascertain who will then inherit the gift and, accordingly, may take an informed decision. The will may either provide for another named person to inherit or, by default, the gift may simply fall into residue (i.e. what is left of the deceased’s estate after all debts have been discharged and specific gifts have been made) for the residuary beneficiary.

Nevertheless, the beneficiary is powerless on disclaiming the gift to specifically redirect it.

Deed of Variation or Disclaimer

Where the person who inherits if the gift is disclaimed is unacceptable to the disclaiming beneficiary, his other option is to effect a so-called ‘deed of variation’ (DoV).

Under a DoV the beneficiary is able to redirect his gift to whoever he chooses (including persons who are not beneficiaries under the will) and, in principle, there are no IHT or CGT consequences; thus a DoV tends to be more popular than the disclaimer.

Nevertheless, if the beneficiary doesn’t care what happens once he has refused the gift, a disclaimer is the answer.

Practical Tip

Make sure that whether a disclaimer or a DoV is executed that the relevant formalities are followed otherwise adverse IHT (and CGT charges) may arise.

 By Malcolm Finney