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 gift. 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 Lord, 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 effect.
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 date, so any gift made under
the instrument cannot be payable before the date of the IoV. In
which case, Re Scadding 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
realised, 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 wording.
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.