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Inheritance Tax – the Pension Trap

Inheritance Tax – the Pension Trap
A recent Tax Tribunal decision (Fryer and others (personal representatives of Arnold (deceased)) v HM Revenue and Customs Commissioners) is a reminder of a little-known trap in the inheritance tax legislation, and has caused alarm among financial advisers.


When you die, inheritance tax (IHT) is charged on the value of your estate at the time of your death, and on any ’transfers of value‘ you have made in the previous seven years.

 

Most people think of a ’transfer of value‘ as a gift but there are other kinds, and the IHT legislation IHTA 1984, s 3(3)) includes an ’omission to exercise a right‘ by the deceased as a transfer of value if the result is to increase the value of someone else’s estate.


Letter of Wishes


The Arnold case concerned a Mrs Arnold, who had a fairly typical pension plan which allowed her to take her retirement benefits at any time between her 50th and 75th birthdays.  Were she to die during this period without having taken the benefits then the value would fall into a discretionary trust.  Mrs Arnold had written a ’letter of wishes‘ nominating her adult daughters and their families as her preferred beneficiaries.


HM Revenue & Customs (HMRC) contended that because she failed to take her pension benefits on her 60th birthday when the plan matured (in September 2002, when she had already been diagnosed with terminal cancer) she had made a ’transfer of value‘ for IHT purposes by failing to exercise her right to take the pension.


Judge Clark, who presided over the tribunal, found in favour of HMRC although he found that the transfer of value took place not when the policy matured but just before Mrs Arnold died in July 2003 – as this was the latest point at which she could have exercised her right to take a pension.  He also discounted the full value of the policy in an attempt to reflect its notional ’market value‘ immediately before Mrs Arnold’s death.


Proper Representation


It should be pointed out that instead of being represented by a barrister, the executors used the services of an ’independent financial advisor‘, who presented the case so badly that Judge Clark actually referred to this fact in the conclusion to his judgement.


The fact that his ’skeleton argument‘ (which is submitted to the Tribunal before the case is heard) began by saying it was “based mainly, but not exclusively, on the principle of fair play” made my heart sink as I read the report of the case. “Fair play” does not win arguments with HMRC, or impress Tax Tribunals.


Having said that, the case contained nothing new and was merely an example of HMRC following the policy they had announced in the February 1992 issue of their Tax Bulletin.  Mrs Arnold fell squarely into the list of pension arrangements that HMRC said they would “look closely at”.

 

I think the reason why the decision has caused so much excitement is that, as far as I can discover, it is the first case to be heard on this particular point referring to deferring pension benefits.  Whether this indicates that the appropriate circumstances do not occur very frequently, or that those challenged by HMRC capitulate on the basis that they do not believe they can win the case, I am unable to say.


Practical Tip


HMRC will presumably have the wind under their sails having won this case, and in any situation where someone is in very poor health and their pension plan is reaching its maturity date, they need to take professional advice on the possible additional liability to IHT – and what can be done to avoid it.


By James Bailey