Background:
Readers may recall the “Staveley” Inheritance Tax (“IHT) case on pension transfers. See our February 2017 Pensions Bulletin when we commented on the Upper Tax Tribunal’s January 2017 decision.
Some 21 months later, in October 2018, the Court of Appeal has taken HMRC’s side on the appeal from the Upper Tribunal’s decision. Although HMRC has prevailed, this may not be the end of the story as the Executors have asked the Supreme Court for permission to appeal. Whether permission to appeal will be granted should be known within the next few months. The case already has a very long timescale – the late Mrs Staveley’s pension transfer from her section 32 policy to a personal pension plan occurred in October 2006, a few months before her death.
Summarising the present Court proceedings:
| Date | Proceedings | Winner |
|---|---|---|
| May 2014 | First Tier Tax Tribunal | Taxpayer wins in part |
| January 2017 | Upper Tax Tribunal | Taxpayer |
| 16 October 2018 | Court of Appeal | HMRC |
The IHT provisions about “transfers of value” in the Inheritance Tax Act 1984 (“IHTA”) are complex and the true legal meaning of these statutory provisions, including what constitute transfers of value by “associated operations”, continues to emerge.
In more detail:
IHTA defines “transfers of value” in two ways: actual transfers (Section 3(1) IHTA) and transfers by omitting to exercise rights thereby increasing another person’s estate ( Section 3(3) IHTA). The taxpayer will nonetheless escape IHT if the taxpayer can demonstrate that the disposition was not intended, or made in a “transaction” intended to, confer gratuitous benefit (Section 10, IHTA). The “no gratuitous benefit” get out is not as simple as it looks – “transaction” includes a series of transactions amounting to “associated operations” and “associated operations” is widely defined in Section 268 IHTA.
In “Staveley” the taxpayer argued that Mrs Staveley’s intention in transferring her section 32 pension policy (under which death benefits would be payable as of right to Mrs Staveley’s estate) to a personal pension plan (under which the trustees of the personal pension plan could choose to whom to distribute and chose Mrs Staveley’s sons) did not confer any gratuitous benefit. On behalf of Mrs Staveley evidence was produced that demonstrated Mrs Staveley’s intention in making the pension transfer was to remove the risk of the pension death benefit being paid under her section 32 pension policy to her estate in which case it was thought her former husband would try to claim it.
Despite this evidence the Court of Appeal decided, applying the “associated operations” rule, that one looks at the whole picture and can regard the individual steps as together demonstrating an intention to confer gratuitous benefit (so that there is a transfer of value for IHT purposes) even if not every step is gratuitous. Thus the fact that the pension death benefits ended up with her sons showed an intention on Mrs Staveley’s part not only to keep the pension funds away from her former husband but also an intention to confer a gratuitous benefit on her sons and so the pension transfer was a transfer of value within Section 3(1) IHTA. To ourselves the Court’s reasoning seems unconvincing. It remains to be seen whether an appeal will be permitted so the scope of the Section 10 no gratuitous intent defence can be further explained by the Court.
The Court of Appeal also decided that under Section 3(3) IHTA there had been a continuing omission by Mrs Staveley to take her pension benefits during her lifetime and that this was an omission to take pension rights which caused the estate of another person to increase namely the estates of the sons. The fact that the sons received the death benefits only after the trustees of the recipient personal pension plan decided, in exercise of their discretion, to distribute to the sons was in the Court of Appeal’s view (reversing the Upper Tribunal) not an intervening step which broke the chain of causation. Whether the Supreme Court will agree (if permission is given to appeal) remains to be seen.
How relevant is the Staveley decision to transfers of pension scheme death benefits under the usual modern death benefit rules?
Unlike in “Staveley” most modern pension arrangements specify that the death benefits are not payable as of right to the member’s estate, but instead are distributable by the scheme trustees amongst a class of potential beneficiaries from whom the scheme trustees select the recipient(s). This should make it much more difficult, if not impossible, for HMRC to demonstrate in modern cases that the pension transfer constitutes a transfer of value under section 3(1) IHTA.
HMRC’s basic premise, explained in their Inheritance Tax Manual, is that on a transfer of a pension fund from one scheme to another the member has the theoretical choice of making the transfer to a scheme under which death benefits are payable as of right to the member’s estate OR to transfer to a scheme under which death benefits are distributed at trustees’ discretion. As the member has the choice, HMRC say the transfer of pension rights is in effect a transfer of value. Where the member is in good health HMRC regard the transfer of value as minimal but, if the member is in ill-health at the date of the transfer and dies within 2 years of the transfer, HMRC say the loss to the member’s estate may be significant.
It is very difficult to see how HMRC can be correct in modern cases. Both Sections 3(1) and 3(3) require that the “estate” of the transferor immediately after the transfer is less than it was before the transfer or, in the case of Section 3(3), the estate of the transferor is “diminished” by the transfer. However, in the case of modern day pension scheme rules the value of the death benefits is not in a member’s estate immediately BEFORE the transfer because before the transfer the death benefits are distributable at the trustees’ discretion as a lump sum and/or as a spouse or dependents’ pensions.
In addition, under Section 12 (2ZA) it is now expressly stated that, in the case of a registered pension scheme, omission to take pension benefits is not a transfer by omission under Section 3(3). Likewise, not using drawdown funds is stated by Section 12A (1) not to be an omission under section 3(3).
It remains to be seen whether HMRC will revise its Inheritance Tax Manual to recognise that under modern scheme rules HMRC cannot claim IHT on a pension transfer between registered pension schemes (eg from a DB to a DC scheme) made by a member in ill-health.