Mark McLaughlin looks at ‘precatory trusts’ and outlines their treatment for inheritance tax purposes.
It is generally accepted wisdom that individuals should have a will, so that they can decide what happens to their money and any other assets (e.g., the family home) when they die.
Your flexible friend!
Wills can offer some flexibility for inheritance tax (IHT) purposes. For example:
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A ‘deed of variation’ broadly offers a two-year window for an adult beneficiary to rewrite a disposition from the deceased’s will. The variation is treated as having been effected by the deceased.
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A ‘discretionary will trust’ broadly allows distributions to be made within two years of death without an IHT charge out of assets settled on the discretionary trust by the will. The distribution is treated as having been made under the deceased’s will.
Of course, this flexibility is subject to certain conditions and requirements (in IHTA 1984, ss 142 and 144), which are not addressed here.
A special request
A less well-known IHT provision (IHTA 1984, s 143) applies where the testator (A) expresses a wish that property left by will to a legatee (B) should be transferred by B to others (C), and B complies with that request within two years of A’s death. The effect is that the property is treated for IHT purposes as having been left by A’s will to C. Furthermore, there is no transfer of value by B.
This type of arrangement is often referred to as a ‘precatory trust’. However, there is no formal trust, which is why this special rule exists (IHTA 1984, s 143).
Friend or foe?
A ‘precatory trust’ can be an IHT friend or foe.
For example, a testator (Susan) decides to leave assets (her collection of Rolex watches) to her brother Frank to distribute (without imposing a binding legal trust or obligation) among Frank’s adult children as he sees fit. If this informal trust or request is carried out within two years of Susan’s death, no additional IHT is payable beyond what was due in respect of Susan’s estate.
On the other hand, if Susan left the watches to her spouse subject to a ‘letter of wishes’ requesting that within two years the spouse makes an onward gift of the watches to their nieces and nephews, there could be IHT (or additional IHT) to pay on Susan’s estate.
Care is needed to satisfy the requirements for this special IHT treatment. For example, in Harding and another (executors of Loveday, deceased) v IRC [1997] STC (SCD) 321, it was held (among other things) that treating trustees of a will trust as legatees was not within the context of the special rule, and no evidence was found that an appointment from the trust was what the deceased had wanted (thus failing one of the conditions).
HMRC considers that the testator’s request need not be in writing (see HMRC’s Inheritance Tax Manual at IHTM35171). However, in practice, the request is often made by a ‘letter of wishes’. Furthermore, HMRC guidance instructs its officers to refer to its technical specialists any cases where freehold land (or land interest) is transferred and the taxpayers claim that the special rule applies (see IHTM35173).
Practical tip
Be careful when dealing with the administration of the deceased’s will to ensure that any assets for which the special ‘precatory trust’ IHT treatment is sought are distributed within the two-year statutory window.
