Why HMRC’s stance that certain pension transfers could be hit with a tax bill has been overturned.
A recent Supreme Court ruling has clarified pension and inheritance tax (IHT) rules, overturning a Court of Appeal decision that backed HMRC’s stance that certain pension transfers could be hit with a tax bill. This means after this ruling HMRC may not charge IHT on an inherited pension that was transferred less than two years before the holder’s death.
What was the quandary?
The debate centred on a case involving the extent to which gratuitous benefit rules mean pensions transferred in ill-health are subject to IHT. HMRC had argued that pensions transferred to someone else within two years of death can be caught by IHT if the owner was known to be in ill health. In 2018 the Court of Appeal held in favour of HMRC that a failure to exercise pension rights and a statement of wishes leaving death benefits to the deceased’s sons were both transfers of value and IHT was due on the entire pension fund (HMRC v Parry and others  EWCA Civ 2266).
HMRC determined that inheritance tax was due on the death benefit, on the basis that both the transfer of funds from a company pension scheme into a personal pension plan, and the deceased’s omission to draw any benefits from the plan before her death, were lifetime transfers of value within section 3 of the Inheritance Tax Act (IHTA) 1984.
However, there are a number of exceptions where dispositions are not treated as transfer of value for IHT, including dispositions not intended to confer gratuitous benefit (s10(1) IHTA 1984), which were not considered in full by the Upper Tribunal.
The Supreme Court admitted the appeal to establish the issue whether HMRC was right to take that view.
What is meant by gratuitous benefit and disposition?
A gratuitous benefit is deemed to occur when a particular action is taken in relation to funds with the intention of reducing the IHT applied on those funds.
The word disposition has its wide natural meaning and includes:
all forms of disposals and transfers of cash and other property
both the creation and the release or other extinguishment of any debt or other right enforceable against a person or his estate.
The legislation expressly defines disposition to include:
a disposition effected by associated operations - IHTA84/S272
a person’s deliberate omission to exercise a right if that omission causes the value of
that person’s estate to diminish, and
another person’s estate (or property held on discretionary trust) to increase, IHTA84/S3 (3)
certain future payments made more than 12 months after a transfer for partial consideration, IHTA84/S262
an alteration of a close company’s share or loan capital, IHTA84/S98.
Some dispositions are expressly prevented from being transfers of value, see IHTM04151.
What is the stance held by Supreme Court to counter the Court of Appeal’s judgement?
The Supreme Court held that Mrs Rachel Staveley and her husband set up a company where she had a pension with the company’s occupational pension scheme. When they divorced, she transferred her pension to another pension scheme. If the pension had remained in the company scheme, on her death a sum would have been payable to her estate and chargeable to inheritance tax.
Just before her death in 2006, Mrs Staveley transferred funds from the pension scheme into an AXA personal pension plan (PPP). The transfer was solely motivated by Mrs Staveley’s desire to ensure that her ex-husband did not benefit from the return to the company of any surplus in the fund. The transfer was therefore not intended to confer a gratuitous benefit on her sons.
Mrs Staveley nominated her two sons as beneficiaries of the death benefit, subject to the discretion of the pension scheme administrator. She did not take any pension benefits during her life and, in those circumstances, death benefit was payable to them.
The relevant statutory provisions are sections 3(1), 3(3) and 10(1) of Inheritance Tax Act 1984.
The Supreme Court has now overturned the Court of Appeal verdict and ruled that the transfer should not be subject to IHT due to the fact that a disposition is not a transfer of value if it is shown that it was not intended, and was not made in a transaction including a series of transactions and any associated operations intended to confer any gratuitous benefit.
What has changed due to this ruling?
Tom Selby, a senior analyst at AJ Bell, commented on the ruling:
after years of wrangling in the courts this ruling finally brings some certainty to people who transfer their pensions while in ill-health
if the Court of Appeal ruling from 2018 had been upheld then defined contribution (DC) pension transfers would have been at greater risk of being hit with a tax charge where the member died within two years of the transfer where the primary motivation was to change provider or reduce annual charges
this protracted case has exposed the complexity and confusion that exists around pensions and IHT
research has exposed a gaping lack of understanding when it comes to gifting and IHT, and this is even more pronounced when pensions are thrown into the mix
it is within the gift of politicians to address this confusion and the common sense solution to this complexity would be to remove pensions from IHT altogether.
Clare Moffat, the head of intermediary development and technical at Royal London, commented:
the Supreme Court decision in the Staveley case has clarified that intention is crucial when a pension transfer or switch is made in terminal ill health
where there is an intention to give benefits which didn’t exist before, such as a DB to DC transfer, it will be subject to IHT.