Instruments of variation

  • Date : June 2012

ABOUT THE AUTHOR: Paul Saunders TEP is Vice President of Wealth Advisory Fiduciary Risk for Barclays in Cheshire and a member of the STEP UK Practice Committee

Instruments of variation (IoV) have been around for over a generation. They are ‘magic’ and achieve many things that would not otherwise be possible. You can wave your wand over your (20-year-old) precedent book and out jumps the panacea. Nice thought!

While IoVs are a part of many practitioners’ world, there are few works published that consider the use and effect of such instruments in any great detail. Also, being such a small area of many, more general, practices, it is not unusual to see recently drafted deeds containing the inheritance and capital gains tax elections dispensed with in 2002.

There are many areas where a lack of understanding about the use and effect of IoVs surfaces. Last year, there were lively exchanges on STEP’s Trusts Discussion Forum (TDF) under the heading ‘interest on legacies under deed of variation’.

The standard definition of an IoV is: a gift out of an inheritance received by the original beneficiary from a deceased person and to which certain benefits can accrue for inheritance tax and capital gains tax purposes, provided that the appropriate statements, as required by the relevant statutes, are included within the document effecting the gift1. The point to take from this is that a gift under an IoV is made by the original beneficiary – the deceased has only a bit part – creating the scene for the IoV perhaps to steal.

So far as I can ascertain, there have been no cases where the courts have had to address the topic (rarely would the amount of interest on its own justify an application to court), nor is there any substantive guidance in the few books dealing with IoVs.

If you look at a simple statement of gift – ‘I, O, give the sum of GBP100 to U’ – does this give U the right to claim interest on that sum if, say, the monies are not paid over for, say, a year? In the absence of any relevant provision, the answer would be no. Even if the gift is set out in a deed, U is a volunteer and, applying the principle of Milroy v Lord2, cannot enforce the gift against O unless O has done something further to perfect the gift.

If U cannot enforce the primary gift, how can they claim a right to interest? Even if the primary gift is satisfied, does this give U any greater right to claim interest where this is not specifically provided for? Extrapolating from the above, if U is to receive interest, this should be set out clearly in the instrument recording the gift, and will be enforceable to the same extent as the primary gift.

How does this fit in with an IoV? When making an IoV, many practitioners focus on the primary gift and the inheritance tax benefits accruing from it. They do not generally ask about interest or income. This is the direction from which the initial question posed on the TDF appears to have arisen. The IoV purported to insert a new ‘legacy’ into the will and the question was whether the general rules on legacies applied.

Leaving aside the exchanges that followed, the first question that comes to mind is: what did the original beneficiary intend? Were they even asked the question? If the question was neither asked nor considered when drafting the IoV, you look to the terms of the IoV to understand its effect3.

If the IoV purports to create a general legacy, why should it not carry interest from the end of the executor’s year? If it is stated to be a payment out of the original beneficiary’s share of the estate, why should it carry any right to interest unless specifically provided for? Both forms of wording will follow a notional variation of the dispositions of the will (intestacy, or otherwise) and provide for the same primary gift to be made.

Where an IoV is made towards the end of the two-year period after the death of the deceased, it seems counter-intuitive that any gift made as a ‘legacy’ should carry interest from the end of the executor’s year. However, if the IoV cloaks the gift in the form of a ‘legacy’, how can any sense be made of this situation? If you redefine the question, instead asking when the legacy is payable, you may travel a different, and more helpful, route.

Whatever else an IoV may do, it cannot take effect before its actual date4, so any gift made under the instrument cannot be payable before the date of the IoV. In which case, Re Scadding5 comes to the rescue, as it confirms that where a legacy is not payable until a future date no interest is due until the legacy becomes payable.

‘If a gift is merely stated to be paid out of the original beneficiary’s share of the estate – but not labelled a “legacy” – it should not carry any right to interest’

At times an IoV will be made once the entitlement of the original beneficiary has been fully or mainly distributed to them. If fully distributed, the estate cannot be liable for any part of the gift (or any interest that might arise on it), regardless of how it may be described. If partially distributed, the estate can only be liable to the beneficiary under the IoV (the new beneficiary) to the extent that it is holding anything due to the original beneficiary.

If no distributions have been made then, again, the new beneficiary can claim no more from the estate than what the original beneficiary was entitled to. Accordingly, if the original beneficiary was, say, entitled to a specific legacy of shares, the value of which has fallen below the amount of a new ‘legacy’ the original beneficiary has created by IoV, the new beneficiary would receive no more from the estate than the value the shares realised6, even if the gift was dressed up as a legacy and it was agreed attracted interest until paid.

So, the position of interest on cash gifts made out of an estate under an IoV where the gift is categorised in the IoV as a ‘legacy’ has been considered. But what is the position when it is not so described?

If a gift is merely stated to be paid out of the original beneficiary’s share of the estate – but not labelled a ‘legacy’ – it should not carry any right to interest unless specifically provided for. However, that does not address the whole question.

Where the original beneficiary is entitled to a share of the residuary estate, their entitlement is to a chose in action for the due administration of the estate (chose). The chose is an indivisible asset representing the beneficiary’s rights as against the executor/administrator of the estate and does not give the beneficiary the right to any specific asset within the estate.

If an IoV is made while the estate is under administration, so the original beneficiary has no right to call for a cash sum to be distributed to them – indeed, at the time the estate might be wholly illiquid – what is the nature of the gift effected under the IoV? Arguably, it is that fraction of the chose representing the cash gift as a proportion of the value of the chose as at the date of the deed.

If there is a gift of GBP10,000 and the chose has a value of GBP40,000 at that time, then the beneficiary under the IoV is entitled to a quarter of the chose, which will carry with it the rights to appreciation (and depreciation) and the appropriate share of the residuary income. It is fair to say that regardless of the technical correctness, or otherwise, of that analysis, the original beneficiary would expect the fixed sum to be paid, provided that the share of residue out of which it is to be paid is sufficient. However, when looking at the right to interest on the fixed sum, it would be beneficial to put the question beyond doubt by including appropriate wording7.

In summary, the fundamental issue is: does O want U to receive the specified cash sum only (which I suspect in most instances will be the case), or should interest be paid on that sum from the date of the IoV (or some other date) until the gift is satisfied. Whichever it is, a simple statement to that effect within the IoV should help avoid uncertainty.

The issue of interest on a gift under an IoV is very much a question of drafting. However, the drafting relies not just on the original beneficiary’s intentions, but also on the need for these to be identified and reflected within the IoV.

Tolley’s Practitioner’s Guide to Legacies (2003), para 7.3
(1862) 4 De GF&J 264
When reviewing IoVs, unless the issue is specifically addressed, I suggest any cash gifts are stated not to carry any right to interest or income until the actual date of payment
Applying Waddington v O’Callaghan (1931) 16 TC 187
(1902) 4 OLR 632
If the original beneficiary decided to satisfy the gift under the IoV in full, the amount by which the amount paid exceeded the proceeds of the shares would be a gift by the original beneficiary and would not be ‘cloaked’ by s142 Inheritance Tax Act 1984
See footnote 3, above

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