RegulationJan 22 2015

Showing resolved intent

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Showing resolved intent

Whenever an adviser meets a new client there are three matters that should always be on the agenda: does the client have in place an up to date will, a lasting power of attorney (LPA) and – for inheritance tax purposes – a letter documenting an intention to gift surplus income?

A recent article in a national newspaper suggested readers should encourage their elderly parents to put in place an LPA. The incentive mentioned was that it would save about £5,000 in the costs that would be paid if a parent became mentally incapacitated and an application had to be made to the Court of Protection to appoint the adult child as a deputy in order to administer the financial affairs of the parent.

But beyond the initial application for the appointment of a deputy, there are the costs of seeking advice about – and complying with – the ongoing obligations imposed, such as filing annual accounts. In a recent case, Senior Judge Lush estimated these at roughly £2,000 to £3,000 pa for a panel deputy until the death of the patient.

Mental incapacity can strike suddenly and unexpectedly. There is a good argument that almost every adult, whatever the age, should have an LPA in place.

The immediate IHT income exemption

Similarly, where the client is expected to pay inheritance tax (IHT) on death and is making or is prepared to make gifts, obtaining the immediate IHT income exemption for (or for some of) those gifts should be considered by the adviser.

The law is set out in section 21 IHTA 1984, as explained in Box 1; this provision is now well known. Not so well known is that there are two ways in which making a gift as “part of the normal expenditure” of the taxpayer can be shown. These alternatives were set out in the case of Bennett & others v IRC in 1994. There is a very brief summary in the IHT Manual at paragraph 14244.

And Box 2 contains part of the judgment of Mr Justice Lightman in this important case, highlighting the alternatives for showing a pattern, either by “reference only to a series of payments” or by “proof of the existence of a prior commitment or resolution.”

After a client’s death there is a minefield of challenges to cross before HMRC will accept that the s21 exemption can apply. It is the lack of appreciation of how technically complex it is to use the exemption successfully that creates the biggest hurdle.

Particularly difficult are single gifts that are irregular, for example house deposits to adult children, even if made from income, whether that income is accumulated to some extent from earlier years or not.

HMRC’s IHT Manual at paragraph 14242, in considering “pattern of gifts”, states that HMRC staff “must leave out of consideration any gift clearly made for some special purpose.”

In the same paragraph HMRC goes on to instruct that, “There is no set time span over which the taxpayer must show the pattern of giving. A reasonable span would normally be three to four years. However you can consider a longer period if this helps the taxpayer to show that the gifts were normal.”

The advantages of a resolution

The proper use of a resolution, as opposed to relying on a pattern building up from past gifts, can make it possible for the s21 exemption to apply to what HMRC would otherwise argue was a “single” gift. The resolution enables the taxpayer to state what he or she regards as “normal” and the pattern he or she intends to create.

The letter contains an example of a detailed statement of resolve from a taxpayer addressed to his two children as his executors. It is phrased on behalf of the taxpayer and his wife and should be signed and dated by both husband and wife at the bottom of each page and at the end of the statement.

You should always keep in mind the importance of complying with the resolution and regularly updating it, so the resolution records what is happening and why any changes have occurred from what was initially envisaged. Box 3 shows five of the more important factors an adviser should consider when helping a client use this exemption.

Technical points

Finally, there are some technical points that must be kept in mind. Key among these are:

- It is possible for a gift to be made from surplus income and not to qualify for the s21 exemption.

- The burden of proving (on a balance of probability basis) that the s21 exemption applies is on the taxpayer’s personal representatives.

- Turning up adequate proof after the death of a taxpayer of an intention to gift surplus income – beyond the existence of the gifts themselves – is often not possible.

- Detailed documentation of a resolve to use the s21 exemption creates flexibility, primarily because it sets out the pattern of giving that the taxpayer intends to follow and should put beyond doubt that a regular commitment to gift has been made.

- At the time of documenting the resolve the client should be in reasonable health. Unlike a will that can be made at any time prior to death, the resolve to commit to gift must be made with a reasonable prospect of building up the envisaged pattern of gifting. However…

- …once a resolution is in place, if a client’s health suddenly deteriorates and there is a wish to gift accrued surplus income, that can be done and be effective to achieve the s21 exemption. (But ensure that the gift is part of the intended and stated pattern and is completed before death.)

- Importantly as with any proposed gift, discuss the problems that will come with the death, divorce or debt (“the three Ds”) or mental incapacity of the intended recipient and the alternative of using trusts.

- If mental incapacity of a donor does occur, then attorneys need a court order to continue to make any gift whichis “not of a reasonable amount on customary occasions.”

Interpret this conservatively and keep in mind that if not observed the gifts are ineffective for IHT.

In a recent case (Re PC, heard on 30 October 2014) Senior Judge Lush described proceeding without such an order as “unprofessional conduct” and for this breach and other reasons, revoked a LPA a patient had given to her two sons.