Pensioner Robbed by HMRC

Inheritance Tax Laws

The HMRC successfully robbed a dead pensioner last year. In Fryer & Others (as PRs of Patricia Arnold deceased) v HMRC (2010) UK FTT 87 (TC), HMRC successfully contended that inheritance tax should be paid by an estate on the value of her pension because of the failure of Mrs. Arnold, who was terminally ill, to take the pension immediately
prior to death.

Mrs Arnold was born in 1942. In 1995, she declared a discretionary trust of her pension plan for a class of beneficiaries, including her children. She could take her pension benefits at any time between 50 and 75. If she died before taking her benefits, then the value of the benefits would pass to her trustees. The normal retirement date for her policy was 8 September 2002. Some months prior to this, she was diagnosed with advanced cancer. She died on 30 July 2003.

HMRC’s case centred upon whether Mrs Arnold had made a transfer of value for the purposes of section 3(3) IHTA 1984 by failing to draw down her retirement benefits prior to her death. Section 3(3) stated:-

“Where the value of a person’s estate is diminished and that of another person’s estate, or of settled property in which no interest in possession subsists, is increased by the first 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”.

The tribunal decided that she had deliberately omitted exercising a right and therefore inheritance tax should be paid.

The value of Mrs Arnold’s pension fund was £147,342. If she had opted to take the maximum lump sum immediately prior to her death, this would have amounted to £51,800. If she had then opted to buy a lifetime annuity on an impaired life guaranteed for ten years, this would have amounted to £9,554 per year. The commuted value of that guaranteed income stream will be between £61,500 and £68,000.

The right to take the benefits and the benefits themselves were clearly incapable of assignment. Thus a market value for such rights must be postulated despite the impossibility of selling that asset.

Nevertheless, an annuity guaranteed for a ten year period and based on Mrs Arnold’s state of health could, in theory, have been available, despite her lack of life expectancy as at the date of death. The notional hypothetical purchaser would require some form of discount on the assumed value, partly to take into account the fact that he was buying a right, rather than the benefits themselves, and partly as a commercial incentive to enter into the transaction.

The benefits potentially available to the purchaser by acquiring the rights would be the lump sum and the annuity. The lump sum was £51,500. Adopting the hypothetical value of £68,000 for the guaranteed ten year annuity on the impaired life, this would give a total of £119,800. Allowing a 25% discount that a hypothetical purchaser would require, this would entail consideration of £89,850 as the value of the omitted right. The Tribunal concluded that inheritance tax should be paid on that sum as at the date of death.

Comment

1. The 1992 Tax Bulletin highlighted, inter alia, that HMRC would target situations such as the present one, where a terminally ill person deferred taking their pension benefit which had the effect of enriching the beneficiaries of the death benefit, and those beneficiaries were not
either the surviving spouse or persons financially dependent on the deceased. Interestingly, it took HMRC more than 15 years to come up with a matter they thought was appropriate to bring forward as a test case to substantiate their 1992 analysis.

2. The practical implications of the legal argument, that a person in their final illness should exercise their rights to take the pension and lump sum on their death bed, amounts, in commercial terms, to expecting the terminally ill person to make a massive bonfire of a material part of that pension pot. The philosophy behind HMRC’s approach is that the tax relief on pensions is intended to provide a pension on retirement for that individual and not a windfall for beneficiaries of the potential pensioner in respect of undrawn pension pots past retirement age. Although the value of the pension benefits in this case amounted to £147,342, the dutiable value of the property amounted to just over 60% of this.

3. This hard case provides a wake-up call for those over the pension vesting age as to the potential inheritance tax exposure of their estate if they omit to exercise their right to take their pension benefits in such circumstances.

4. This case also highlights how successive cash strapped Governments are increasingly casting envious eyes over the prospect of easy grazing on the lush financial pastures of undrawn pensions of those dying past the relevant vesting date.

Source: Paul Stibbard (London), Baker Mckenzie

Avoiding Inheritance Tax

How to avoid paying inheritance tax.

If you are an expat and living overseas, you can avoid inheritance tax via a transfer into a Qualifying Recognized Overseas Pension Scheme. A QROPS pension transfer can be organized by your independent financial advisor. A transfer into a QROPS avoids UK income tax, capital gains tax and inheritance tax. Dividends tax can also be avoided. But, be careful, not all QROPS are created equal and you should be aware of the rules and charges which are applied to the QROPS.

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