Cases of Interest – November

Inheritance Tax, Pensions, Gratuitous Intent and Associated Operations

This recent decision of the Court of Appeal ([2018] EWCA Civ 2266) examines the role of gratuitous intent, associated operations, and omissions, in the context of Inheritance Tax and pensions.

Background

In her working life Mrs Staveley together with her husband built a successful company called Morayford Ltd. She and her husband went through an acrimonious divorce and as part of the divorce settlement Mrs Staveley was granted a pension in the form known as a “section 32 buyout policy”.

Sadly, Mrs Staveley later began to suffer from a terminal illness. This caused her to consider what would happen to her pension upon her death. What concerned Mrs Staveley, in particular, was that a surplus in the pension fund under the section 32 policy could potentially pass back to Morayford Ltd so that Mrs Staveley’s former husband might benefit from it. Mrs Staveley wished to avoid this result. In April 2006 the law changed, such that the surplus could not revert to Morayford. Therefore if Mrs Staveley had died with the policy in place a lump sum death benefit would have been payable to her estate and chargeable to IHT. Under the terms of Mrs Staveley’s will her two sons would have ultimately benefited from the death benefit (after the deduction of IHT) in equal shares.

Mrs Staveley was apparently ignorant of this change in the law. She had received advice prior to April 2006 that transferring the section 32 policy to a personal pension policy, or PPP, would prevent the fund from reverting to Morayford. In October 2006 she therefore effected such a transfer. The PPP scheme rules provided that if Mrs Staveley held uncrystallised funds at her death then a lump sum death benefit would be payable. The scheme administrator had a discretion as to how to distribute the death benefit amongst a defined class. However as part of the transfer process Mrs Staveley filled out a nomination form expressing her wish that her two sons should receive the death benefit in equal shares. Evidently, the death benefit would no longer form part of Mrs Staveley’s estate at death and so would not be subject to an IHT charge at that time.

Following the transfer from the section 32 pension to the PPP Mrs Staveley did not exercise her rights to draw upon the pension. Mrs Staveley then died in December 2006. About six months after her death the scheme administrator paid the death benefit to Mrs Staveley’s two sons in accordance with the nomination.

HMRC was then confronted with the question as to whether Mrs Staveley had unwittingly spirited her pension fund outside of the IHT net. As noted above, there was no question of the death benefit forming part of Mrs Staveley’s estate at death. Had Mrs Staveley therefore made a transfer of value during her lifetime which would be chargeable to IHT? HMRC considered that she had. It issued notices of determination on the basis that Mrs Staveley had made two transfers of value:

(1)   The first was a result of the transfer of funds from the section 32 policy to the PPP in November 2006. The notice asserted that the transfer of value amounted to £405,694. This was less than the total sum invested in the PPP since Mrs Staveley still had a right to take pension benefits before her death and in particular a ten-year annuity.

(2)   The second arose as a result of Mrs Staveley’s omission to draw any benefits from the PPP by the time she died. The notice asserted that this omission meant that the remaining value of the investment in the PPP, being £302,498, was lost to Mrs Staveley’s estate. The assertion, therefore, was that there had been a further transfer of value in this amount.

The battleground

Section 3(1) of the Inheritance Tax Act 1984 (“IHTA 1984”) defines a “transfer of value” as, “a disposition made by a person … as a result of which the value of his estate immediately after the disposition is less than it would be but for the disposition”. In relation to the first alleged transfer of value (the transfer from the section 32 policy to the PPP) Mrs Staveley’s executors did not dispute that the transfer was a “disposition”, or that it reduced the value of Mrs Staveley’s estate. Instead they relied upon the relief in section 10 IHTA 1984 in respect of “dispositions not intended to confer gratuitous benefit”.

Section 10 IHTA provides that, notwithstanding section 3, a disposition is not a transfer of value, “if it is shown that it was not intended, and was not made in a transaction intended, to confer any gratuitous benefit on any person”. For this purpose “transaction” is widely defined so as to include, “a series of transactions and any associated operations”. (It is a further requirement of section 10 that the disposition was made in a transaction at arm’s length between unconnected persons or that it was such as might be expected to be made in such a transaction. In the event this element was not considered by the Court of Appeal.)

Whether section 10 was satisfied therefore formed the battleground in relation to the first alleged transfer of value (the transfer from the section 32 policy to the PPP).

As for the second alleged transfer of value (Mrs Staveley’s omission to take pension benefits), this focussed on the provisions of section 3 IHTA 1984 dealing with omissions. Specifically, section 3(3) provides that, “where the value of a person’s estate is diminished and the value of another person’s estate … is increased by the first-mentioned person’s omission to exercise a right, he shall be treated for the purposes of this section as having made a disposition at the time (or latest time) when he could have exercised the right, unless it is shown that the omission was not deliberate”.  By the time the case reached the Court of Appeal there was no dispute that: (a) the value of Mrs Staveley’s estate was diminished by her failure to take pension benefits before her death; and (b) Mrs Staveley’s omission to exercise pension rights was deliberate. The remaining issue was therefore whether Mrs Staveley’s sons’ estates had been increased by Mrs Staveley’s omission. In particular, did the discretion vested in the scheme administrator as to how the benefits should be paid (meaning that the benefits might not be paid to the sons) prevent the sons’ estates being increased by Mrs Staveley’s omission? In other words, was the scheme administrator’s discretion a sufficient break in the chain of causation such that section 3(3) could not apply? This formed the battleground in relation to the second alleged transfer of value.

The first alleged transfer of value: the transfer of funds from the section 32 policy to the PPP, intention to confer gratuitous benefit and associated operations

The Court of Appeal held unanimously that the transfer of funds from the section 32 policy to the PPP was a transfer of value because the requirements of section 10 were not satisfied. However, the reasoning of Newey LJ (which represents the ratio on this point, as Birss J agreed with him) was different from the reasoning of Lady Arden.

The majority’s reasoning accepted that at first instance the First-Tier Tribunal (FTT) had found as a fact that Mrs Staveley was not intending to improve her sons’ position when she transferred funds from the section 32 policy to the PPP. Mrs Staveley was solely motivated by a desire to ensure that the funds in the section 32 policy would not revert to Morayford and, by extension, her husband. IHT planning did not form part of Mrs Staveley’s motivation and she did not see the transfer as giving her sons anything better than they would otherwise have received. Furthermore, section 10 should be interpreted widely. One must ask whether the overall effect of the disposition was intended to be favourable to, or advantageous to, the recipient of the “benefit”. Section 10 could therefore apply unless the transferor was intending to put the recipient in a better position than he would otherwise have been in. Mrs Staveley had no such intention, and therefore section 10 could seemingly apply.

However, the majority ultimately found for HMRC on the basis of “associated operations”. As noted above, “transaction” is widely defined in section 10 so as to include, “a series of transactions and any associated operations”. In a nutshell, even if Mrs Staveley did not have a gratuitous intent in making the transfer from the section 32 policy to the PPP, she did have such an intent when she omitted to draw pension benefits up until the time of her death. This omission was an associated operation, and this could ‘infect’ the transfer to the PPP with a gratuitous intent. Looking at the point in greater detail:

(1)   The FTT had found as a fact that conferring on her sons a greater benefit than otherwise was one of the factors in Mrs Staveley’s decision not to access her pension fund. Moreover, this was Mrs Staveley’s intention at the time of the transfer to the PPP. Mrs Staveley’s failure to take benefits was therefore intended to confer a gratuitous benefit.

(2)   Section 268 IHTA 1984 defines “associated operations” so as to include, “two or more operations of any kind, being operations which affect the same property…”. Mrs Staveley’s failure to take benefits was an “operation” (since the definition of operation includes an omission) and it affected the same property as the transfer to the PPP.

(3)   The FTT was mistaken in considering that there was no intent linking the transfer to the PPP and the omission to take benefits. The transfer and the omission were both motivated by a desire on Mrs Staveley’s part that her sons should have the death benefits that would be payable if she did not draw a pension in her lifetime. Whilst Mrs Staveley did not see the transfer to the PPP as improving her sons’ position, and she made the transfer out of a desire to sever ties with Morayford, the only reasonable conclusion was that she also intended the PPP to be a means by which the death benefits could be passed to her sons.

The failure to take pension benefits and the transfer to the PPP were therefore each properly to be seen as forming part of and contributing to a scheme intended to confer gratuitous benefits. Section 10 did not therefore prevent the transfer to the PPP from being a transfer of value.

Lady Arden agreed with the reasoning of the majority on the “associated operations” point. However, she differed in her reasoning in that she would have found for HMRC on the basis that section 10 was not satisfied even without resort to “associated operations”. For Lady Arden the FTT had made a, “clear finding by implication” that Mrs Staveley had executed the nomination in favour of her sons on transfer to the PPP with the intention of giving her sons a gratuitous benefit. The FTT had then made an error of law in concluding that this intention did not prevent section 10 from applying on the basis that the intention did not relate to “newly conferred benefits”. On Lady Arden’s construction of section 10, the section would be inapplicable if the transferor intended to confer on someone a legal right which they would not otherwise have had, whether or not the person would have had equivalent or better rights but for the disposition. It did not matter therefore that prior to the transfer to the PPP the sons were already entitled to the death benefits under Mrs Staveley’s will.

Thankfully the majority of the Court of Appeal expressly and persuasively disagreed with this line of reasoning. Birss J pointed out that Lady Arden’s approach involved finding or imputing the presence of a second motive on the part of Mrs Staveley associated with the transfer, whereas the FTT had rejected the presence of a dual motivation. Both Newey LJ and Birss J also considered that Lady Arden’s construction of section 10 was too narrow. One must simply ask whether the overall effect of the disposition was intended to be favourable or advantageous to the recipient of the “benefit”. A disposition designed to give a person only what he was to receive anyway or its equivalent, let alone less, cannot be fairly described as intended to “confer” a “benefit”. Therefore, in the absence of resort to “associated operations” Mrs Staveley had no intention to confer a gratuitous benefit on her sons.

The second alleged transfer of value: the omission to take pension benefits and causation

The Court of Appeal spoke with one voice, being the voice of Newey LJ, in finding for HMRC on the second alleged transfer of value. For section 3(3) IHTA 1984 to be applicable a person’s estate must have been increased “by” the omission in question. The sons’ estates had indeed been increased “by” Mrs Staveley’s omission to take benefits before she died. The sons’ estates would not have been increased but for Mrs Staveley’s omission. In addition, the Court of Appeal held that the exercise of the scheme administrator’s discretion did not break the chain of causation as the administrator was, “doing no more than it was obliged and could be expected to do”. It may have been the case that the increase in the sons’ estates was also caused “by” the exercise of the administrator’s discretion, but that did not make it inappropriate to see the estates as having been increased “by” the omission. The one did not preclude the other.

Lady Arden added that she did not agree with HMRC’s attempt to establish a rule that the administrator’s discretion would always be left out of account. Rather, the determination of whether there was an increase in the beneficiaries’ estates as a result of an omission must depend upon an assessment of the relevant facts. In the instant case the decision for the administrator was relatively straight forward. The nomination had been recently made and was consistent with Mrs Staveley’s intention as stated in her will. But it would be possible to envisage cases where the nomination was made a long time before death or where events had occurred which would lead the administrator to consider that the wishes of the deceased should not be followed. In those situations, the court may consider that more weight has to be given to the discretion of the administrator in deciding whether section 3(3) is fulfilled.

The future

This decision provides a degree of welcome clarity in this area of the law. The Court of Appeal has refused the parties permission to appeal to the Supreme Court, but there remains a real possibility that the parties will seek, and obtain, permission to appeal from the Supreme Court itself.