A deed of variation is a legal document which can be utilised where a person has received an asset via a Will (including a trust within the Will) or the intestacy rules, but the person would like to vary how they benefit or redirect who benefits from the asset. Providing the formalities of the deed are fulfilled then any entitlements given up will, in effect, be treated as having taken place on the donor’s death, ie effectively rewriting the Will.

There are a number of reasons why a deed of variation may be used to redirect assets as described above, but primarily it is for tax planning opportunities. Some examples of this are discussed later in this article.

Example

Mr Jones dies and leaves a valuable painting, worth £50,000, to his son John Jones. John Jones is wealthy in his own right and has his own inheritance tax (IHT) issues. Therefore, John Jones executes a deed of variation redirecting the ownership of the painting to his adult daughter, Jane Jones. Assuming all formalities are adhered to, then for IHT purposes, it is as if the gift had been left directly to Jane.

Anyone who receives an asset via a Will or intestacy can execute a deed of variation providing they have mental capacity and are considered legally capable (ie they are age 18 in the UK). All parties who hold a beneficial interest in the asset that is to be redirected must be party to the agreement.

Example

Peter has included a Will trust within his Will, which provides an income for life to his wife Grace and on her death the assets providing the income should be held for Mary and Joe, Peter and Grace’s children. Grace does not require the income so would like to ‘vary’ her right in favour of the children.

Where minor beneficiaries are required to be party to a deed of variation, unless consent is gained from the Court, it is not possible to execute a deed of variation.

For a deed of variation to be effective for IHT and capital gains tax (CGT) purposes the following formalities need to be fulfilled:

• The document must be in writing and executed as a deed.
• The deed of variation must be executed within two years of death.
• The deed should refer to the part of the Will or intestacy being varied and be signed by all those who would or might have benefited from the original provisions.
• The deed should clearly state which inheritances are affected and how they are changing. This may be best achieved by setting out the original position and then the revision.
• The deed should not be for consideration of money or money’s worth (ie in lieu of money or an asset which represents money).
• The deed should contain a statement that ‘the variation is to have effect for either CGT only, IHT only or IHT and CGT as if the deceased had made it’. An example of the wording provided by HMRC is ‘the parties to this variation intend that the provisions of section 142 (1) Inheritance Tax Act 1984 and section 62(6) Taxation of Chargeable Gains Act 1992 shall apply’.
• The deed should contain an exemption certificate for variations of stocks, shares or marketable securities. For example, ‘I/We certify that this instrument falls within category M in the schedule to the Stamp Duty (Exempt Instruments) regulations 1987.’

If the asset that is subject to the deed of variation has changed, it is still possible to do a deed of variation.

Example

Christopher was left £100,000 in his father’s Will. Not needing this money, Christopher invested the money into a life assurance investment bond. Six months later Christopher was discussing his own potential inheritance tax liability with his financial adviser. They recommended that as Christopher had no need for this money that he execute a deed of variation in relation to the £100,000. It was still possible to do this even though the £100,000 had been transferred to a life assurance investment bond.

Yes. Generally such a trust would be a discretionary trust. Any variation into a trust made by a valid deed of variation for IHT purposes will have effect for IHT. Any person who executes such a variation will automatically become the trust settlor for income tax and CGT purposes but not IHT purposes.

Example

Let us assume Harvey executes a deed of variation on his father’s Will, creating a discretionary trust. The trustees invest into a life assurance investment bond and request withdrawals. For income tax purposes, Harvey is deemed to be the settlor of the trust created under the deed and is therefore assessable to income tax if a liability arises.

A draft deed for a discretionary trust is available from Skandia for consideration by a legal adviser.

Since 1 August 2002 it is only necessary to inform HMRC of a deed of variation if the tax position is changed by the variation.

If the tax liability is changed by the variation, a copy of the deed of variation along with a completed checklist, known as ‘IOV2 Instrument of variation’ should be sent to the Capital Taxes Office which dealt with the IHT account previously. HMRC also ask that their reference number or the full name of the deceased and the date of death is quoted in correspondence. The checklist is available from the HMRC website www.hmrc.gov.uk/cto.

Nil-rate band (NRB) planning

One of the main reasons for using a deed of variation prior to the UK Budget 2008 was to ensure that the NRB was used between spouses/civil partners*.

Example

Mr French dies and leaves his whole estate, an amount of £500,000, to his spouse. Although there is no IHT due on Mr French’s death, Mrs French’s estate is now worth £1,000,000 and on her death 40% IHT will be due on amounts over the NRB.

Historically, a deed of variation could have been executed which, for example, could have left Mr French’s NRB to the children and the rest of the estate to his spouse – this would still mean no IHT was due on Mr French’s death but less tax should now be payable on Mrs French’s death. Mrs French could still have benefited from the trust but the trust assets would not form part of her estate for IHT purposes.

However, the Finance Act 2008 included legislation to allow the transfer of a deceased spouse’s or civil partner’s* unused NRB to the surviving spouse or civil partner, up to 100% of the current NRB at the time the survivor dies. This option to transfer a deceased spouse’s or civil partner’s unused NRB will be effective for death of the survivor on or after 9 October 2007.

It may still be appropriate to execute a deed of variation to mitigate IHT.

Example

Tony’s father has left him £100,000 in his Will. Tony does not require the money and would like to skip his generation and pass the money to his children. A deed of variation can be used to achieve this and any gift will be deemed to be from Tony’s deceased father and not from Tony.

Double death variations

It is possible to vary assets in an estate once; however, if a husband and wife die within two years of each other, it is possible to effect a deed of variation in respect of both Wills.

Both the husband and wife’s executors along with the beneficiaries must be party to the deed for IHT purposes.

Deeds of variation and civil partners

All rights between husband and wife equally apply to registered civil partners as defined by the UK Civil Partnership Act 2004, since 2 December 2005.

Pre-owned assets tax

Pre-owned assets tax (POAT) does not apply to deeds of variation because the settlor for IHT purposes is regarded as the deceased person.

Will
A Will is a legal document which allows an individual to detail how their assets are distributed following their death. It also names the person(s) who will be responsible for administering the distribution of the deceased’s estate. These people are known as the executors or legal personal representatives.
 
Intestate/intestacy
If you die in the UK without leaving a valid Will, ie intestate, the so-called rules of intestacy applicable in the jurisdiction to which you or your property are subject will dictate who benefits from your estate and to what extent. The rules of intestacy vary from one country, including England and Wales, Scotland and Northern Ireland, to another.

Estate
This covers all the assets that a person owns (or, in some cases, is treated as owning) at the time of their death, less their liabilities. Their estate may also include the value of any property they have given away if either the gift they have made is subject to conditions or restrictions, or they keep back some benefit for themselves.

Legal personal representative (LPR)
A general term used to describe both executors and administrators.

Executors
The persons appointed in the deceased’s Will to supervise the administration and distribution of the deceased’s estate in accordance with their last Will and testament.

Administrators
The persons appointed by the High Court to supervise the administration and distribution of the deceased’s estate in accordance with the intestacy rules applicable to the deceased’s domicile.

Beneficiary/Beneficiaries
The beneficiaries are the individuals or groups of people named under the trust. These are often children, or other family members. Depending upon the nature of the trust, it may also be possible to include future generations, such as grandchildren as yet unborn.

Discretionary trust
A discretionary trust is a trust where the assets are not held for the benefit of one or more named beneficiaries. There is simply a list of persons and bodies that may potentially benefit. The trustees then have complete discretion over who benefits and when they benefit as they see fit.

Nil-rate band (NRB)
The nil-rate band is not fixed and has, historically, increased year-on-year. Currently the first £325,000 (for the tax year 2010/11) in an individual’s estate is taxed at 0% for IHT purposes. This is known as the NRB. Any assets above the NRB may be liable to IHT at 40%.

Settlor
The settlor is the person who sets up the initial investment. You can be a settlor either on your own (as a single settlor) or with someone else, such as a spouse or civil partner (as joint settlors). The settlor(s) transfers the ownership of the assets to their chosen trustees. Some trusts need to be established by means of a loan where the settlor(s) lends the money to their trustees to invest.

Trustees
The trustees are the legal owner(s) of the assets, and manage the assets for the benefit of the beneficiaries. They are also responsible for dealing with the trust fund on the settlor’s death.

Following the changes introduced by the Finance Act 2008, allowing the transfer of unused NRBs between spouses/civil partners on death, it is likely that the use of deeds of variation will reduce. However, tax mitigation is not the only use of a deed of variation and it should still be considered as part of long-term financial planning.

* As defined by the Civil Partnership Act 2004.