We have updated this resource to refer to the ruling that the twin benefits of inheritance tax and gift aid relief are not available on post death variations.
This overview looks at the use of variations to change the distribution of an estate after an individual dies. It explains what a variation is, its advantages and summarises the tax treatment of variations.
This practice note examines the purpose and advantages of a variation to change the distribution of an estate and summarises the statutory provisions that allow a variation to have a retrospective effect for inheritance tax (IHT) and capital gains tax (CGT). It also looks at the tax regimes where there is no retrospective effect, introducing the application of the income tax rules to variations and outlining the taxation of variations in relation to stamp duty land tax (SDLT) and stamp duty.
For a detailed examination of variations in relation to their retrospective treatment for IHT and CGT, see Practice note, After death variations: IHT and CGT (www.practicallaw.com/6-386-4134). For an overview of IHT, see Practice note, Inheritance tax: overview (www.practicallaw.com/3-383-5652).
A variation is a device that is available to a beneficiary of a deceased's estate (www.practicallaw.com/2-382-5620) who wants to alter what he is entitled to receive from the estate, such as land, cash, a share in the residuary estate or a beneficial interest in a trust. In legal terms, a variation is referred to as an "instrument", but in practice it is most commonly called a deed, as in a "deed of variation".
In this note, an entitlement to an estate asset is referred to as an interest in the estate that can arise from:
The terms of the deceased's will or the intestacy rules (www.practicallaw.com/5-382-5685).
The operation of a nomination (www.practicallaw.com/3-382-9137).
The principle of survivorship (www.practicallaw.com/2-382-5899).
A variation works by allowing the beneficiary to rearrange or redirect the interest that came to him originally from the deceased's estate. In effect, the beneficiary is transferring to another beneficiary some or all of the interest he has inherited. This transfer is usually made by way of a gift, but it can also be by exchanging respective interests in the estate or, in rare cases, by selling an interest (see Advantages of a variation).
A beneficiary may want to redirect the assets to which they would otherwise be entitled from a deceased's estate for a number of reasons. For example, to:
Provide for others who are in greater need of funds or other resources than the original beneficiary.
Save tax by:
giving additional assets to a beneficiary who is exempt from IHT, such as a charity either by reducing the overall charge to tax or by giving 10% or more of the net estate to charity so as to benefit from the lower 36% rate of IHT (see Practice note, Inheritance tax: leaving 10% of an estate to charity (www.practicallaw.com/7-500-1086));
redirecting assets qualifying for relief from IHT from an exempt beneficiary to non-exempt beneficiaries so that the relief is not wasted. For example, if a deceased's estate includes assets that qualify for agricultural property relief (www.practicallaw.com/0-383-5823) (APR) and his spouse inherits these assets as part of the residuary estate, then APR is not available because the beneficiary of them (the spouse) is exempt from IHT; or
using the deceased's IHT nil rate band (www.practicallaw.com/1-382-5649) by creating a discretionary trust or making an absolute gift of the value of the nil rate band (see Practice note, After death variations: IHT and CGT: Is a variation creating a nil rate band trust still relevant? (www.practicallaw.com/6-386-4134) ).
As a way of making alterations in the distribution of an estate after death, a variation has several advantages:
It allows the original beneficiary to control the redirection of either all or part of his interest in the estate, for example, to another individual, a charity or a trust that he chooses.
It can be made either during the administration of an estate or after it has been finalised, when assets may already have transferred to the original beneficiary.
It can have a retrospective effect for IHT and CGT purposes, allowing for the variation to avoid charges to IHT and CGT that may otherwise arise in relation to lifetime gifts by that beneficiary provided it is made within two years of the deceased's death. Although a variation may be made by an exchange of assets in an estate and, in rare cases, a sale, it is most commonly made by a beneficiary making a gift of his interest or a part of it. In effect, this is a transfer of value (www.practicallaw.com/2-382-5979) for IHT purposes and a disposal of the asset for CGT purposes. However, if certain conditions are met, the transfer can be treated as having been made by the deceased rather than the beneficiary, consequently avoiding a charge to IHT and CGT on the beneficiary's gift. To make a variation retrospective from death for IHT and CGT purposes, it is necessary to comply with:
section 142 of Inheritance Tax Act 1984 (IHTA 1984) which views the redirection of the benefit as if it were made by the deceased rather than as a chargeable transfer of value or a potentially exempt transfer (www.practicallaw.com/4-382-6100) (PET) made by the beneficiary
Sections 62(6) to (10) of Taxation of Chargeable Gains Act 1992 (TCGA 1992), which, within certain limits, regard the deceased as redirecting the benefit. Consequently, there is no disposal by the beneficiary for CGT purposes. (For treatment of a variation that creates a settlement, see Practice note, After death variations: IHT and CGT: Variation creating a trust (www.practicallaw.com/6-386-4134).)
The provisions in both statutes, which mirror each other greatly, are examined in detail in Practice note, After death variations: IHT and CGT: Conditions for retrospective treatment for IHT and CGT (www.practicallaw.com/6-386-4134). They can be applied to redirect both absolute interests and interests in will trusts or statutory trusts arising on intestacy. The scope of their application is set out in Practice note, After death variations: IHT and CGT: Scope of the retrospective effect for IHT and CGT (www.practicallaw.com/6-386-4134).
By interpreting the variation as being made by the deceased and effective from death, these statutory provisions offer an opportunity for retrospective tax planning by the deceased's beneficiaries. Deciding on whether a variation should be treated as retrospective to the date of death is considered in Practice note, After death variations: IHT and CGT: Planning the variation: issues to consider (www.practicallaw.com/6-386-4134).
Where the asset being redirected was held by the deceased and another or others as beneficial joint tenants, it is important to note that the necessary severance of the joint tenancy to redirect the asset can only be retrospective for IHT and/or CGT purposes. In property law, it is not possible to sever a joint tenancy in real property after the death of a joint tenant. The Land Registry's guidance on this is in the context of applications it receives where nil rate band discretionary trusts are created but it has a general application to the severance of joint tenancies (see LR Practice Guide 70 - Nil-rate band discretionary trusts (www.practicallaw.com/3-501-4062)). For further information on creating nil rate band discretionary trusts by variation, see Practice note, After death variations: IHT and CGT: Is a variation creating a nil rate band discretionary trust still relevant? (www.practicallaw.com/6-386-4134).
An individual who does not want to benefit from an estate can refuse his interest in it completely, that is, he can disclaim it, provided he has not accepted any benefit from it before disclaiming. However, if he disclaims it, he has no control over who should receive the benefit in his place. He must disclaim the whole interest, not just a part of it, unless the instrument (usually the will) governing the distribution of the estate specifically allows for partial disclaimers. For a precedent deed of disclaimer and further information on disclaimers, see Standard document, Disclaimer, deed with drafting notes (www.practicallaw.com/7-501-0745).
The nature and scope of a variation is often misunderstood. Therefore, it is important to stress that a variation is not:
A rewriting of the deceased's will, where there is one.
A redrafting of the intestacy rules.
A device to correct a defective will.
Misconceptions about a variation might arise because it appears to change the rules applying to the devolution of assets when an individual dies. However, a variation does not and cannot operate to alter these rules because, in order to be able to make a variation, the original beneficiary must have some interest in the estate initially, and that interest can only have come to him by the operation of those rules, whether they derive from the terms of the will or rules governing intestacy, nomination or survivorship.
Another source of misunderstanding might be due to the IHT and CGT treatment of a variation, which views the redirection of interests as having been made by the deceased if certain conditions are met (see Advantages of a variation). However, this does not mean that a variation can redirect the interests in an estate before the deceased died. As considered in Wells and Another (Personal representatives of Mrs Glowacki deceased) v HMRC (2007) Sp C 631, in the context of section 142(1) of IHTA 1984, the legislation intends that a variation must reflect a change in the actual disposition of an interest that is part of the estate and which is treated by section 4 of IHTA 1984 as a transfer of value made immediately before death. In other words, it cannot attempt to remove an asset from the deceased's estate so that it is not subject to the notional transfer of value immediately before death.
Another point to note is that the variation must affect the distribution of the estate. Therefore, for example, if a will does not contain the necessary provisions to allow the executors to administer the estate, a variation cannot be used to add the missing provisions unless the provisions themselves fundamentally change the disposition of the estate. Similarly, a variation cannot remove provisions unless they relate to the dispositive terms of the will. For further information on changing the disposition of the estate, see Practice note, After death variations: IHT and CGT: Identifying and varying the original disposition (www.practicallaw.com/6-386-4134).
Income tax legislation does not provide for a retrospective treatment of a variation so that, for income tax purposes, a variation is only effective from the date it is executed. Consequently, the existing rules on the taxation of income and liability to this charge apply. In broad terms, the original beneficiary is assessed on the income up to the date of the variation while the new beneficiary is assessed on the income after the variation. However, a variation can have an effect on these rules on liability to income tax, depending on the type of interest, when the right to income on that interest arises and when it is paid. For example:
A beneficiary of a pecuniary legacy (www.practicallaw.com/8-500-2599) is entitled to interest on the legacy only if it is paid to him after the deceased has been dead for one year (referred to as the executor's year), unless the will specifies that interest should be paid on the legacy from a particular date.
A beneficiary of a specific legacy (www.practicallaw.com/3-383-4737) is entitled to income arising on the legacy from the date of the deceased's death.
A residuary beneficiary is entitled to have his share of income arising from the residuary estate paid to him, whether his interest in the estate is "limited" (that is, confined to the income from the estate) or "absolute" (that is, where he is entitled to a share of the income and capital).
In the first situation, if a variation is made before the executor's year ends but the pecuniary legacy is not paid until after that year, the new beneficiary is liable to income tax on any interest paid to him but the original beneficiary has no liability. By contrast, a specific legatee is liable for tax on the income arising on the legacy from the date of death up to the date of the variation, even though he may be passing the income on, as part of the variation. The liability of the residuary beneficiary before and after a variation is determined by reference to the income actually paid to him, even if it accrued before the variation.
The rules governing liability to income tax, where the variation creates a settlement and the original beneficiary or his minor child are beneficiaries of that settlement, also need to be considered.
For income tax purposes, where a non-exempt residuary beneficiary redirects his interest in an estate to a charity, he is treated as having made the gift, not the deceased. However, if the beneficiary is a higher rate taxpayer, he, as a charitable donor, may not claim gift aid relief where the estate (and by extension, the beneficiary) benefits from a reduced IHT liability due to the exemption from IHT for gifts to charity. For further information on the law that the twin benefits of IHT and gift aid relief are not available on post-death variations, see Legal Update, No gift aid relief on variation of estate where re-directed gifts reduce IHT (www.practicallaw.com/4-503-2433).
For more information on the income tax rules applied to a variation see Practice note, After death variations: income tax (www.practicallaw.com/6-517-2446).
There is no retrospective treatment of variations in relation to SDLT or stamp duty but they are generally exempt from both taxes because neither regime imposes a charge on a gift of property and, with one exception, a variation is essentially a gift (since it must not be underpinned by consideration if it is to have a retrospective effect. See Practice note, After death variations: IHT and CGT aspects: No consideration from outside the estate (www.practicallaw.com/6-386-4134).) The one exception is where the consideration is either another variation (for example, where the beneficiaries exchange assets in the estate) or a disclaimer.
Where a variation involving land is made for no consideration and the deed of variation is made on or after 1 December 2003, it is exempt from SDLT (paragraph 1, Schedule 3, FA 2003).
Where a variation is made for consideration, it is exempt from SDLT, provided that both the following conditions are met:
The variation involving land is made within two years of a deceased's death.
The consideration given is not made in money or money's worth but is in the form of making of another variation. (This condition does not appear to allow for consideration that is in the form of disclaiming (as opposed to varying) an asset of the estate.)
(Paragraph 4, Schedule 3, FA 2003.)
For further information on SDLT, see Practice note, Tax data: stamp taxes: Stamp duty land tax (SDLT) (www.practicallaw.com/6-385-5907).
Stamp duty relates to assets other than land and does not apply to a deed redirecting assets that is made on or after 1 December 2003 for no consideration unless the variation redirects stock, shares, marketable securities or certain interests in partnerships (see section 125, FA 2003).
Where the variation redirects any stock, shares or any other of the above assets, stamp duty applies but there will be no actual liability to ad valorem (www.practicallaw.com/6-107-6369) stamp duty provided there is no consideration. For deeds executed on or after 13 March 2008, there is no longer any need to include a certificate of exemption under the Stamp Duty (Exempt Instruments) Regulations 1987 (SI 1987/516) (1987 Regulations) (paragraph 3, Part 1, Schedule 32, Finance Act 2008). There is no requirement to present the deed to the Stamp Office (www.practicallaw.com/9-107-7536) for adjudication to confirm that no stamp duty is payable.
Where consideration forms part of the variation, as it does when it is made in return for the making of another variation, it is exempt from stamp duty where it meets the conditions to qualify for exemption under section 84(1) of Finance Act 1985. These are broadly the same as the conditions necessary for the variation to be treated as retrospective for CGT purposes (see the following sections of Practice note, After death variations: IHT and CGT (www.practicallaw.com/6-386-4134):
For further information on stamp duty, see Practice note, Tax data: stamp taxes: Stamp duty (www.practicallaw.com/6-385-5907).