This recent Upper Tribunal (“UTT”) case10 examined whether a transfer from a pension scheme in a lifetime to another personal pension scheme, coupled with a failure to take any benefits prior to death, constituted a transfer of value for UK inheritance tax purposes (“IHT”).

In its decision, the UTT examined whether the transfer between the two schemes was done with the intention of conferring gratuitous benefit. On the basis of the facts in this case, the UTT found that there was no transfer of value. It is not yet clear if HMRC intend to appeal this decision.

The decision in this case calls into question the efficacy of the two-year rule on IHT in the area of pension benefits. Pension benefits are generally not subject to IHT. However, if someone dies within two years of a pension transfer when the individual knew of their illness or serious ill-health when the transfer was made, this can give rise to a transfer of value for IHT if the transfer also confers gratuitous benefit on anyone else.

Background

As part of her divorce settlement, the taxpayer gave up her position in her ex-husband’s company and in return she received her share of the company pension fund. At that time she was advised that her best option was to transfer her fund into a buyout policy. Although this would provide her with freedom arounds choice of investments, any surplus made on the fund would be returned to the company on her death. The taxpayer did not want her ex-husband to benefit from her pension fund on her death.

Her pension fund was also over-funded in respect of her level of salary and she was advised that she would have to wait ten years before she could transfer the fund to a personal pension plan, the terms of which would enable the entire value of the fund to be paid to her estate or beneficiaries.

Shortly after her divorce was finalised, she transferred her fund from the company occupational pension scheme into the buyout policy.

In 2004, she was advised that in light of legislative changes expected to come into effect in 2006, she would be able to transfer her fund to a personal pension plan after six years, rather than the aforementioned ten. In 2005, she made a will which provided that her estate was to be divided equally between her two sons. In 2006, she applied for her fund to be transferred to a personal pension plan. As part of that application she completed an expression of wishes requesting that her death benefits be paid equally to her two sons.

The personal pension plan began in early November 2006. Whilst the policy allowed the deceased to have access to lifetime benefits, she died the following month without accessing any of the fund.

In 2007, the scheme administrator exercised its discretion and paid the lump sum death benefit to her two sons in equal shares.

HMRC issued notices of determination to IHT to the deceased’s personal representatives and her two sons (as beneficiaries of the death benefit paid out of the personal pension plan after her death), in respect of two alleged lifetime transfers of value by the deceased.

The alleged transfers of value arose firstly from the transfer by the deceased of funds from one registered pension scheme to another and secondly from her omission to take any lifetime benefits from her personal pension plan.

HMRC sought to charge both events to tax, on the basis that the transfer between schemes was a transfer of value under section 3(1) Inheritance Tax Act 1984 and that the omission was to be treated as a further transfer of value by virtue of section 3(3) IHTA 1984.

The personal representatives and her sons appealed the notices of determination.

The First Tier Tribunal (“FTT”) allowed the taxpayers’ appeal in respect of the transfer between the two pension schemes, holding that on the evidence before it, it was satisfied that in making the transfer the deceased had not had any intention to confer a gratuitous benefit. The transfer was thus prevented from being a transfer of value by section 10 IHTA 1984.

However, the FTT also held that the effect of the omission by the deceased to take lifetime pension benefits had been that her estate had been diminished and the estates of her sons (to whom the death benefits were subsequently paid by the pension scheme administrators) had been increased. This omission was thus deemed to be a transfer of value by virtue of section 3(3) IHTA 1984 and IHT was accordingly payable in respect of it.

The FTT rejected the taxpayers’ argument that the exercise by the scheme administrators of their discretion to decide to whom the death benefits were paid amounted to a break in the chain of causation, holding that it was “virtually inevitable” that the sums would be paid as per the deceased’s expressed wishes.

Both parties appealed against the judgment of the FTT.

Decision

The issues before the UTT were whether:-

1. the transfer from the buyout policy to the personal pension plan was a ‘transfer of value’ which attracted IHT; and
2. whether the deceased’s omission to exercise the right to take lifetime benefits from her personal pension plan was a ‘transfer of value’ which attracted IHT.

It was common ground that the transfer to the personal pension plan had reduced the value of the deceased’s estate. This would constitute a transfer of value, subject to section 10, IHTA (dispositions not intended to confer gratuitous benefit). In order to rely upon section 10 a number of conditions have to be satisfied.

First, the taxpayer has to show that the disposition was not intended to confer a gratuitous benefit on any person.

Second, it has to be shown that the disposition was not made in a transaction (including a series of transactions or any associated operations) intended to confer such a benefit.

Third, it has to be shown either that the disposition was itself made in an arm’s length transaction between unconnected persons or, if not, that it might be expected to be made in a transaction at arm’s length between persons not connected with each other.

The UTT found that all of these conditions were satisfied and that the FTT had been entitled to find that the disposition by the transfer of funds from the buyout policy to the personal pension plan was not intended to confer a gratuitous benefit on any person. The UTT also found that the deceased’s sole motive had been to prevent any further pension funds from benefitting her former husband.

HMRC had argued that the transfer and the deceased’s omission to take lifetime benefits from her pension as ‘associated operations’. The UTT rejected that submission and concluded that the transfer and the omission were unconnected and were not part of any scheme to confer a benefit on the deceased’s sons. The transfer was an arm’s length transaction between unconnected parties.

In the view of th UTT, the surrender and transfer themselves and the personal pension plan, were unexceptional, and the expression of wishes in the personal pension plan was a feature of an arm’s length transfer into a pension of that nature. In the circumstances, the transfer was not a ‘transfer of value’ for the purposes of section 3, IHTA.

The UTT was of the view that the FTT had erred on the issue of causation. Section 3(3) provides that where the value of one person’s estate is diminished and another’s value increased due to the first party’s omission to exercise a right (here, the deceased’s omission to enjoy the lifetime benefits from her personal pension plan), that party will be considered to have made the disposition at the time when they could have exercised their right.

The direct cause in the increase in the values of the two son’s estates was due to the exercise of the discretion of the scheme administrator, rather than the deceased’s omission to exercise her right to lifetime benefits.

The UTT therefore concluded that the conditions of the legislation were not satisfied and the omission could not be treated as a disposition or as a transfer of value.

The UTT allowed the taxpayers’ appeal on the second point. It held that although the omission by the taxpayer to access her pension before her death had been the source of the funds which were paid to the sons, nonetheless it was ultimately the exercise by the scheme administrator of its discretion under the terms of the pension contract which was the effective cause of the increase in their estates. Absent a finding of sham it was only open to the FTT to find that there had been a genuine exercise of discretion by the scheme administrator.

Consequently it could not be said that those estates had been increased by the omission alone, and thus the omission was not deemed to be a transfer of value.

HMRC’s appeal on the first issue was dismissed and the taxpayers’ appeal on the second issue was allowed.

The full judgment in this case is available from: - http://www.bailii.org/uk/cases/UKUTT/TCC/2017/4.html

10 HMRC v Parry & Others [2017] UKUTT 0004 (TCC).