When a will isn’t always the way

If your client has failed to leave a valid or up-to-date will, a deed of variation could be the tax-efficient answer, writes Paul Thompson, tax & estate planning consultant at Canada Life.

We have all done it. Perhaps because it reminds us of our own mortality or maybe because it is just human nature to put things off until the last minute, we delay making a will.

If we leave it until it is too late and we die without leaving a valid will (referred to as dying intestate), the rules of intestacy will decide who benefits from our estate and in what proportions. Just as bad, perhaps, is the will that was made 30 years ago which is now horribly out of date. It is quite likely the out-of-date will or the rules of intestacy applying at the date of death will not reflect the deceased’s intentions or the beneficiaries’ expectations and it may not be very tax-efficient.

Deeds of variation

But all is not lost, provided the affected beneficiaries are able to agree on a more appropriate distribution of the deceased’s estate.

In such circumstances, if the beneficiaries can reach agreement on a more suitable allocation of assets, they can enter into what is commonly referred to as a deed of variation (DoV). This is rather a misnomer since, to be effective, it does not have to be as formal as a deed but it does need to be in writing. It should be remembered that if a DoV is being contemplated, it will not be possible for a beneficiary to create one if they have not reached the age of majority or are not of sound mind. This is one of the reasons why it is unwise to rely solely on a DoV to rectify an out-of-date will after death.

It is important to remember that a DoV may be created merely because the beneficiaries prefer, and agree to, a different distribution of the estate from that specified in the deceased’s will or the rules of intestacy. It may have nothing whatsoever to do with tax, in which case there are very few restrictions on the creation of the DoV. However, if tax is also a factor that needs to be taken into account, a few formalities must be observed.

How to do it

Firstly, the DoV has to be finalised and signed by all relevant parties (see below) within two years of the death of the deceased. It used to be the case that HMRC had to be informed within six months of the creation of the DoV. That requirement has now been replaced by the need to include a statement to the effect that the DoV is intended to be effective for tax purposes.

This statement could make reference to inheritance tax (IHT) or capital gains tax (CGT), or both. HMRC has helpfully included the following suggested wording on its website:

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.

Including this, or a similar, statement, in the DoV will mean that, for the purposes of IHT (and/or CGT), a fiction will be created to the effect that the will of the deceased (or, where applicable, the rules of intestacy) were changed to reflect the contents of the DoV. In other words, it’s rather like a codicil that is written by the affected beneficiaries after the death of the deceased, but takes effect as if it had already been incorporated at the death.

It should be noted that there is no equivalent statement for the purposes of income tax. This is because a DoV can have no impact on income tax liabilities. One consequence of this is that, if the DoV creates a settlement, for example, the settlor(s) for the purposes of income tax will be regarded as the beneficiaries who have created the DoV.

The DoV must be signed by all of the beneficiaries who have a reduced or lost entitlement as a result of the DoV. In addition, where the DoV results in an increased IHT liability, the personal representatives of the estate also have to sign. Such circumstances would be rather unusual, however.