A Deed of Variation (“DOV”) (sometimes called an Instrument of Variation or a Deed of Family Arrangement) is a Deed, made by the beneficiaries of an estate, who wish to redirect or restructure the way the Will (or lack of..) disposes of the estate of a deceased person.
A DOV is a useful tool in inheritance tax (“IHT”) planning. If a parent (let’s call her “Liz”) leaves money in her Will to her son (let’s call him “Charles”), then as a result of her death Charles is wealthier. The inherited money will form part of his estate for IHT purposes when he eventually passes the money (or any new assets purchased with the money) to his daughters Williamina and Harriett. The same assets could therefore be hit by IHT twice on the way down to Williamina and Harriett (i.e. in both Liz’s and Charles’ estate).
Let us say that Charles is concerned about the level of his new found wealth and is worried about the IHT bill that will arise when he dies. Whilst he could give some of the inherited money away to Williamina and Harriett, unless the amounts involved are relatively small, he would have to survive those gifts by seven years before they become irrelevant for IHT purposes. To get round this Charles could execute a DOV. The DOV is like a game of “let’s pretend” for IHT purposes. If it is made within two years of Liz’s death and makes it clear that it is intended to have the effects specified in statute then it will be treated for IHT purposes as if Liz had given the money straight to Williamina and Harriett and not Charles. Magic….. no seven year period for Charles to have to survive by and Williamina and Harriett have their money. If Charles is concerned about the IHT bill but may want access to the funds he could again execute a DOV creating a discretionary trust of which he, Williamina and Harriett and their future children are all beneficiaries. Provided the trust is administered properly Charles can access the trust assets as and when he needs to but without those assets forming part of his own estate for IHT purposes. Charles will need to carefully consider the income tax position if Williamina and Harriett are minors or there is a chance of him having any other children .
There can also be some fiction for capital gains tax (“CGT”) purposes also. Let us say that Liz gave Charles shares in ABC plc in her Will and that when she died they were worth £100,000. Let us say a year after Liz’s death the shares are worth £150,000. If Charles transferred the shares to WIlliamina and Harriett then he would have to pay CGT on the increase (i.e. the £50,000 by which the shares have risen in value). If he transfers the shares by DOV (which would make sense from an IHT perspective) and includes a correct CGT election in the DOV there would be no CGT liability arising on the transfer of the shares to WIlliamina and Harriett. Williamina and Harriett will however have to pay CGT on any increase in the value of the shares if they dispose of the shares. This would be by reference to the original £100,000 value at the date of Liz’s death. If Charles had made capital losses in previous years which he can offset for CGT purposes and those losses happen to be £50,000, he would be better transferring the shares by DOV but not making a CGT election. The same result ensues but with one important difference. WIlliamina and Harriett take the shares under the DOV but their acquisition cost for any subsequent CGT calculation will be by reference to the value of the shares at the date of the DOV and not at the date of Liz’s death (i.e. £150,000 instead of £100,000). This could save CGT for them later down the line. What worries me is that a number of solicitors and accountants include the CGT election in a DOV without really considering the CGT issues in the round.
Having covered a couple of the fictions (which are entirely for tax reasons) it’s time to consider some facts. If Charles executes a DOV in favour of anyone this is a gift by him for the purposes of the Insolvency Act and for the purposes of assessments for care home charges/means tested benefits. This could lead to arguments about avoidance and trying to obtain advantages by redirecting assets. Again, quite worryingly, a number of people (including professionals) seem to think that the fictional status of a DOV for tax purposes (i.e. pretending the deceased had disposed of their estate differently) applies for all other purposes. It doesn’t.
For advice on Deeds of Variation please contact us on 01756 793 333 and ask to speak to a member of the private client department.
Partner, Wills, Trusts and Probate