A Happy Ending

  • Author : Carolyn Bagley
  • Date : August 2011
ABOUT THE AUTHOR: Carolyn Bagley TEP is a Partner at Hewitsons

It isn’t often enough that one gets to report a happy ending, least of all one volunteered by HMRC. This one will help pension policyholders, and those with SIPPs, who receive a terminal diagnosis. It also helps relatives of those who die both before their time, and before taking their pension rights.

Background

Fryer and others v HMRC [2010] UKFTT 87 (TC) concerned Mrs Arnold, whose death before she had taken her pension resulted in a tax bill for her family. Mrs Arnold’s private pension scheme offered a common scenario. It allowed her to take her pension at any time between age 50 and age 75, and the lump sum death benefit was written into trust. She took it out in November 1995 when she was 53. Sadly, Mrs Arnold was diagnosed as terminally ill in April 2002, five months before her specified ‘normal retirement age’ of 60 (8 September 2002). Just over a year later she died without having taken her pension, so the lump sum passed into the trust for her family.

HMRC decided that the deceased had made a taxable transfer of value, on 8 September 2002, by omitting to exercise a right, as provided under s3(3) of the Inheritance Act 1984 (IHTA 1984), which applies where a person omits to exercise a right and consequently:

  • the value of her estate is reduced, and
  • the value of someone else’s estate or of settled property (in which there is no interest in possession) is increased.

In those circumstances, that person is treated as having made a disposition at the latest time when she could have exercised the right, unless it is shown that the omission was not deliberate, as in s10 below.

The executors appealed. They wished to rely on s10 IHTA 1984. This provides an exception to s3, so that a disposition not intended to confer a gratuitous benefit on someone else will not be treated as a transfer of value. The burden of proof is on the taxpayer. The wording requires that the transaction be at arm’s length (or was such as might be expected to be made in a transaction at arm’s length between persons not connected with each other).

‘All being well, people who “omit” to take their pension before dying under the age of 75 will no longer attract tax as if they had made a gift’
Decision

Clark J decided that:

  • the anti-avoidance provisions of s3(3) IHTA 1984 caught this scenario
  • Mrs Arnold had made a transfer of value by omitting to exercise her right to take her retirement benefits under the plan
  • this diminished her estate, while increasing the value of the trust, as it received the lump sum
  • the exemption under s10 IHTA 1984 did not apply. Quite apart from whether an omission could ever be a transaction at arm’s length, if the omission was a transaction, then the trustees were parties to it and Mrs Arnold as settlor of the trust was connected to the trustees.
  • Mrs Arnold was to be treated as making the disposition on the last date on which she could have exercised her rights. This was immediately before she died, on 30 July 2003, not, as HMRC had argued, on the usual retirement date of 8 September 2002, and
  • the value of the disposal was the asset that had been in her estate, i.e. it was the value of her right to take the benefits, not the full value of the benefits themselves (as claimed by HMRC).

HMRC had warned in 1992 that it would look unfavourably at taxpayers who deferred pension rights (including by omission to take the annuity) within two years of death. Only the family’s financial advisors seemed surprised by the assessment. They represented the executors in the court case. Judge Clark commented that the advisors’ lack of experience of such hearings meant he had to treat the case as if unrepresented. Perhaps this was because, in a tax case, they tried to rely on ‘the principle of fairness’?

1992 Tax Bulletin

The situation fell squarely within the approach laid out in a Tax Bulletin article: ‘Inheritance Tax: Retirement Benefits Under Private Pension Contracts – Section 3(3) IHTA 1984’.

The HMRC view was that generally:

  • most pension arrangements are not affected by s3(3) IHTA 1984
  • it would only consider claiming where the policyholder, by not taking up retirement benefits, intended to increase someone else’s estate
  • the scenario most at risk is where:
  • athe policyholder was suffering from a terminal illness, or so ill that his life was uninsurable; andbat or after that time he took action or deferred taking retirement benefits
  • it would not normally pursue a claim even in the above circumstances if:
  • athe death benefit was paid to the policyholder’s spouse or dependants; orbthe policyholder survived more than two years after making the arrangements.
New problem?

The interpretation of s3(3) was that the question of gratuitous intent was determined at the date of death, at which time Mrs Arnold knew of her ill-health, so it was hard to argue that she didn’t intend a benefit to the trust by not taking her pension. However, between Mrs Arnold’s death and the case being heard, the 1992 Tax Bulletin article was largely replaced by s12(2A) to s12(2G) IHTA 1984, which possibly created a new uncertainty.

The 1992 Tax Bulletin article refers to the policyholder deferring the date for taking retirement benefits within two years prior to death, while s12 IHTA 1984 refers to making an ‘actual pensions disposition’ during that period. A disposition within s3(1) IHTA 1984 is made ‘by doing anything in relation to, or to rights under, the pension scheme’. This seems to imply a positive act, rather than a mere omission to act.

Under s12, Mrs Arnold’s executors could have tried two arguments. It is less clear when the omission to exercise rights occurs. If the omission occurs, e.g. at the earliest possible time at which the rights could be exercised (in her case, as soon as she took out the plan), then that original ‘omission’ might have been saved by lack of gratuitous intent (as she did not then know she would not need a retirement income). Alternatively, Mrs Arnold’s executors could have argued that an ‘actual pensions disposition’ implies a positive act, e.g. an assignment, which didn’t happen.

The removal of the need to take retirement benefits no later than age 75 may lead to more people choosing not to buy an annuity. The ‘unfairness’ of s3(3), as compounded by the uncertainty of s12, would have been an increasingly likely problem.

Should the recipient of a terminal diagnosis have to weigh the effect of s12 on her pension arrangements? Mrs Arnold’s advisor argued that the law sent out a message to the business community, and the public, that this appeared to be a penalty for saving and for not requiring your pension at the earliest possible date.

New law

The comments of the financial advisor may have struck home. HM Treasury issued its Finance (No. 3) Bill pension proposals on 9 December 2010 and hidden in the middle is a gem. Subject to getting Royal Assent (it’s still in the Commons at the time of writing), the relevant s12 IHTA 1984 provisions will be amended by s12(2ZA). This states that ‘where a person who is a member of a registered pension scheme, a qualifying non-UK pension scheme or a s615(3) scheme omits to exercise pension rights under the pension scheme, s3(3) above does not apply in relation to the omission’. So, all being well, from 6 April 2011 people like Mrs Arnold, who ‘omit’ to take their pension before dying under the age of 75, will no longer attract tax as if they had made a gift.

Thanks to Clark J correcting the HMRC interpretation of when the omission occurs, this new law will also cover those who were diagnosed before the law changed and who have not taken their annuity – because their omission will take place on death, after 5 April 2011 (not on the possibly earlier ‘usual pension date’, nor at the earliest possible age) and therefore after the new law will apply.

It should be noted that s3(1) IHTA 1984 is unaffected, so contributions made to pension schemes by a person who knows he is in serious ill-health, and who does not survive the transfer by two years, can still be taxed. This seems fair, until one considers that this could also catch the transfer of pension rights from one scheme to another and lead to arguments about intent.

The future

Clearly, those who receive a terminal diagnosis after this tax year and who omit to take their rights can pass on their pension fund without it being taxed as a gift (provided it has already been written into trust and doesn’t fall into the estate – always worth checking). However, a concession from HMRC to cover those in exactly the same situation, but who died before 6 April 2011, would be welcome. After all, while they’re in such a generous mood, what’s a little more gratuitous intent?


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