INTRODUCTION
Transfers between registered pension schemes can be problematic for members on many fronts, but not usually due to Inheritance Tax (IHT). The exception is where the member concerned is knowingly suffering a terminal illness, as the Supreme Court’s recent decision in HMRC v Parry illustrates (judgment on 19 August 2020) relating to the late Mrs Staveley (“Mrs S“).
The timescale is relevant, and unfortunate. In summary:
| Year 2000 | Mrs S divorced and her share of the company pension scheme put into a “section 32” pension policy. |
| October 2006 | Mrs S became terminally ill. |
| November 2006 | Mrs S transfers her pension benefits to a personal pension scheme. |
| December 2006 | Mrs S dies. |
| April 2012 | HMRC issues IHT tax assessments. |
| 2012 – 2019 | Case heard by First Tier Tax Tribunal, Upper Tax Tribunal, Court of Appeal and finally by the Supreme Court on 31 October 2019. The Supreme Court takes 10 months to issue their judgment on 19 August 2020. |
HISTORY
Readers following this area will understand that, as Mrs S died in December 2006, her death occurred under the old IHT “omission to exercise a right” legislation. The HMRC attacked on two fronts and the Supreme Court’s decision on each front is shown in italics below:
- the November 2006 transfer either on its own or with other steps as associated operations, was a transfer of value (section 3(1) Inheritance Tax Act 1984 (“IHTA”)) and the ‘defence’ of no gratuitous intent (section 10 IHTA) did not apply;
Supreme Court: by 3/2 majority the Court disagreed with HMRC and so HMRC failed on this front.
- there was a transfer by Mrs S omitting to exercise her right to draw her pension benefits before her death (section 3(3) IHTA);
Supreme Court: on this point the Supreme Court was unanimous: under the legislation as it stood in 2006 when Mrs S died, there was a gift by omission and IHT was payable.
MODERN TIMES
One is unlikely to find the circumstances in Mrs S’ case replicated in modern times; the IHT “omission to exercise a right” legislation has been changed, and the circumstances of Mrs S’ transfer were largely motivated by “commercial reasons” – an acrimonious divorce and worries about part of the pension fund ending up back with Mrs S’ husband’s company unless transferred to a different pension scheme.
Does this mean transfers between schemes by members with reduced life expectancy are beyond the reach of IHT?
Unfortunately not according to HMRC. HMRC have revised their IHT Tax Manual to reflect their understanding of Mrs S’ case. Even though ‘modern’ transfers are usually from schemes under which the member is not entitled as of right to the death benefit (unlike in Mrs S’ case where under the section 32 policy she was entitled as of right), HMRC maintain that such transfers can constitute the relinquishment of old rights and the creation by gift of new rights under the recipient scheme. This remains to be tested in the Courts. Advice should be taken in this complex area in which our Pension and Private Client Teams have considerable experience.
The Supreme Court also commented on how the IHT omission to exercise a right legislation works – this continues to be of potential relevance to transfers of pension benefits under unregistered pension schemes and also for other IHT purposes.
Our Private Client Team highlight that the Supreme Court decision seems to have confirmed that if a terminally ill client switches between two fully flexible defined contribution schemes for commercial reasons with no change in beneficiaries where it was not intended to produce gratuitous benefit, s.10 IHTA 1984 would apply. However, where there is an omission to draw benefits (if this is applicable) s.3(3) IHTA 1984 can apply unless the personal representatives can prove the omission was not deliberate. It is intention that is a decisive factor when a pension transfer is made when someone is in ill health. It is not unusual for those at the end of their life to want to make their affairs simpler for those close to them. The administrative process of consolidating pensions should not cause more IHT although appropriate legal and tax advice should always be taken especially where the transfer is from a defined benefit (final salary) scheme to a defined contribution scheme.
The commentary of the Supreme Court on the “associated operations” element of the s.10 “gratuitous benefit” exemption is also interesting and highlights the need to take care when there could be contributory elements to a transfer which together illustrate an intention to confer gratuitous benefit. In this case, due to the specific facts, the subjective intention of Mrs S in transferring to the personal pension scheme was based on commercial reasoning, not a wish to benefit her sons, but it is easy to see that other cases without this particular fact pattern could be decided very differently. In particular, although a dissenting judgment, Lord Hodge raised the possibility of whether the completion of an expression of wishes form could be considered as an “operation” that is associated with a transfer. What it is clear is that the issue of “associated operations” in the context of pension transfers is not clear cut and advice will be needed taking into account the facts and motivations in each particular case.
To summarise, pension transfers can be of very considerable value and may result in the family benefiting from the (large) capital value of the pension fund in a way which would not be possible, had the transfer not been made and the pension benefits remained in a final salary scheme.