Wills and trusts for parents and carers of people with a learning disability in Scotland    

JOHN KERRIGAN March 2007

need expert advice? email jkerrigan (at) http://www.maxwellmaclaurin.co.uk

Notes for the Contact a Family Seminar

NB: content and advice will change with time - always get up to date professional advice.

 I will shortly invite you to consider why we should all make Wills.  However, the making of a Will has been recognised almost as a “social responsibility” in virtually all civilised societies from time immemorial.   The ancient Babylonians had a code of succession.   Perhaps their reasons for having such a code differs from our own nowadays but none the less it existed.   The Prophet Mohammed also in his teachings demanded that Muslims make Wills.  He recognised that we were all mortal.  In his preachings, he stated that no Muslim should spend no more than two further days on this  world without writing a Will.   I will also today be touching on the question of Trusts.   You may be interested to know something of the historical provenance of Trusts.   They date essentially from the time of the Crusades. A Knight heading for the Holy Lands on realising that he might not return would entrust his possessions to a trusted friend on the basis that if the Knight failed to return, the trusted friend would deal with his estate in accordance with directions left by the departing Knight.  If, however, the Knight was lucky enough to survive the horrific battles in the Holy Lands then, upon his return, his estate would be returned to him.   An interesting footnote to the foregoing is that the Crusaders were known to their Muslim opponents as “Franks” (equally the Muslim armies were not referred to as Muslims but as “Saracens”).  The description of the Crusader Knights as Franks largely reflected the fact that at certain times, the majority of Christian soldiers in the Holy Land were French and yet France does not recognise Trusts nowadays – so much for the romance of history! 

 67% of Scots who die each year do not leave Wills.   Whilst you might expect me to say this, this is a disastrous statistic.  

Why should we all make Wills?

 Freedom of choice

1. The making of a Will is an exercise of “freedom” of choice on the part of the client. Few lay people have any great familiarity with the Laws of Intestacy in Scotland. Our society is much more jealous in guarding individual rights, and the making of a Will is, after all, the exercise of just one such right. In a philosophical sense, it is important that clients should be encouraged to exercise their rights.

 Laws of intestacy

2. The making of a Will involves a series of different choices. An individual who does not make a Will is therefore leaving the succession to his Estate to devolve in accordance with the provisions of the Succession (Scotland) Act, 1964, as amended. Any practitioner who has regularly made Wills over a period of time for clients will know that their clients have little or no knowledge of the Laws of Intestacy and, in fact,may well be operating on the basis of a gross misconception as to what would happen on the client’s death without having made a Will. Common misconceptions are:-

 ·        Where one spouse dies without leaving a Will, the surviving spouse automatically succeeds to the whole Estate of the predecessor. This is, of course, not the formula provided by Sections 8 and 9 of the 1964 Act, as amended, and an explanation that this is so may often be sufficient to persuade a married client that, if only to protect his or her spouse, a Will is vital.

Choice of Executor or Trustees

3. If a Will involves an element of delectus persona insofar as choice of Beneficiaries is concerned it equally involves choice also in relation to the appointment of Executors or Trustees. A feature of many home-made Wills is that no valid appointment of Executors is made. It is important that clients should choose individuals in whom they repose faith and trust for the administration and winding up of their Estate. For various reasons, the Testator might not wish to appoint his or her surviving spouse as Executor (perhaps as they conceive that this would be an undue burden on a grief-stricken widow or widower, or because of the advanced age of both spouses). A client can choose a number of Executors, can appoint substitutes and can decide on the full range of powers to be entrusted to the Executors.   Where a discretionary power is granted, the client can rely on their chosen Executors to exercise that power in a manner of which the client would have approved, and in respect of which the client can leave guidance or direction in terms of a Letter of Expression of Wish.

 Range of beneficiaries

4. A client making a Will can choose to benefit for a wide range of individuals or concerns. For example, if the client is unmarried and has no issue then that client could choose to bestow benefits on old friends or indeed upon a range of Charities whom the client favours, or with whom the client may have had some relationship during  his or her lifetime.   Employees and Charities are not within the Rules of Succession as applied to the “Free Estate” of an intestate deceased. These rules are contained in Sections 1 to 7 of the 1964 Act.

 Financial provision protection

5. In making a Will, a client also has a choice as to when and how their chosen beneficiaries will be entitled to succeed/vest. This facility of a properly made Will is of great importance. A Will can be constructed so as to provide specific formulae for the financial protection of young or financially naïve Beneficiaries or Beneficiaries suffering from mental incapacity.  Most clients are horrified to discover that a child, on attaining the age of sixteen years, can demand as a right that the benefit left to them under a deceased relative’s Will should be made over to them absolutely. In the case of mentally incapax Beneficiaries, not only can appropriate provision be made for their financial support, but this can also be effected on a basis which will not otherwise imperil the incapax Beneficiary’s rights to any valuable Social Security benefits.

Tax planning

6. A properly thought out and constructed Will can form a very valuable part of the client’s tax planning. A client’s Estate, without such planning, might otherwise be liable to Inheritance Tax. Great increases in property values over the past few years have moved many individuals to a position where their Estates would exceed the Nil Rate Band of IHT. Where the Will making process is properly approached, an examination of the nature and composition of the client’s Estate is required. Many individuals still fail to appreciate the actual “cash” value of their dwellinghouses; and when the potential liability is put to the client, he or she will often see the benefits which can be obtained from making a suitably drafted Will,  making use of, at least, part of that client’s Nil Rate Band.

Non-beneficial provisions

7. A Will can include “non-beneficial provisions” which may be of particular concern to the client. These can include specific funeral directions, for which there is no provision under the 1964 Act in relation to an intestate Estate. Interpersonal relationships within a family can often be strained or difficult, and on occasions, disputes and arguments can arise amongst adult children of the deceased as to the proper disposal of their late parent’s remains. Such disputes can, to a large extent, be avoided if the client specifically directs what should happen to his or her remains on death. Equally some clients may wish to donate their bodies (or parts of the same) for scientific or medical research etc. Again, no provision for such ancillary matters appears in  the 1964 Act.

Last statement

Above all else, it should be pointed out that a Will can be the last statement of love, respect and affection which that client has for members of his or her family or others. It is a lasting testament of such feelings and in the author’s view, it is entirely valid to make this essentially philosophical point to the client.

Client Resistance

Clients very often put forward reasons as to why they have not made, and do not wish to make a Will. The legal profession should be in a position to address the client’s viewpoint and to put forward reasoned arguments as to why the client is wrong. The most common arguments put forward by clients might be characterised by the following phrases:-

(i) “I am too young to make a Will” - it is a common misconception that the making of a Will lies within the province of older generations.  In fact, the right to test is a freedom available to all individuals who are capax and of full age (see Chapter 2 infra). A thirty year-old who is married, having young children, may be a high earner. The client may be operating under the type of misconception detailed above (i.e. that the surviving spouse will inherit everything even where there is no Will).   In such circumstances, the potentially adverse affect of intestacy upon the surviving spouse should be carefully explained to the client, as should the rights of young children who might be left to vest in their legal rights and the free estate at the age of sixteen years and thereafter squander their inheritance.

(ii) “I have nothing to leave” – clients, notoriously, will undervalue their Estates. Some clients fail to take into account, for example, the value of Life Assurance Policies which only pay out upon their deaths. One reason for this is, perhaps, that the client does not perceive that he or she will benefit in any way from the funds in question. Similarly, clients will often fail to take into account a legitimate spes successionis as, understandably, clients do not wish to value elderly parents in terms of pounds and pence. Clients who are members of an Occupational Pension Scheme or who have their own Personal Pension Plans often overlook or do not appreciate that death, while still in employment or prior to attainment of the normal retirement age (under the relevant Personal Pension Plan), is likely to result in a sizeable sum of money becoming available. If the Will-making process is approached in a proper, detailed information gathering basis, it can often be demonstrated to the client that he or she has a net worth of which the client had been unaware and which would justify the client in making a Will.

(iii) “I have no one to leave my Estate to” – an individual who is widowed and has no issue might feel that there is no point in them making a Will.  It should be explained to such a client that even where there is no Will, the 1964 Act sets out Rules of Succession. This could mean that  fairly distant relatives, who have not been in contact for many years, benefit. The possible time and expense involved in tracing such Beneficiaries should also be explained to the client. In such circumstances, the Draftsman might consider it appropriate to enquire from such a client as to whether or not he or she would wish to see the benefit of his or her Estate going to some Charity or Charities, or "deserving" old friends etc.

(iv) “My family will do the right thing” – a small number of clients may believe that in making a Will they may be doing no more than precipitating a dispute within their family after death. Such a viewpoint should be seen as a denigration of responsibility and assumes that, notwithstanding the rules of succession, the client’s family will ensure a fair outcome, perhaps reflecting the respective financial positions of adult children etc. It should be pointed out that such an outcome can never be guaranteed and that the entitlement of a Beneficiary on intestacy is in fact a legal right. Having been put to Beneficiaries in that manner, it might be unlikely that they would agree to division of the intestate Estate differing from that for which provision is made under the 1964 Act (even although this would be possible in terms of Section 142 of the Inheritance Tax Act, 1984).

(v) “If I made a Will I would be signing my own death warrant” – there does appear to be reluctance amongst particularly elderly clients to make a Will as some will wrongly assume a causal connection between the signature of the Will and the time of death. This is of course non-sensical and the client should be dissuaded from maintaining such  a superstitious outlook. If the client has fears in this area then perhaps one way to seek to address them (quite apart from bringing some of the arguments outlined above to bear) would be to persuade the client that given his or her feelings, it would only be appropriate for the client to put his or her affairs in order.

(vi) "I cannot afford to make a Will at this time" - such a statement is not normally a reference to the legal fees which may be charged by the Draftsman for preparation of the relevant document.  It reflects some misunderstanding on the part of particularly older clients who know nothing of the rules of ademption etc.  Clients sometime have a gross misconception that if they make a Will incorporating specific bequests then they must at all costs reserve and retain the items so bequeathed until their death.   Obviously it is not the case (unless, of course, the client has contractually bound himself in some way to specifically bequeath the item in question, in which case he may be under some obligation to retain the item) then such client should be told that they are free to deal with their property as they wish.

It is important that Will Draftsmen are able not only to produce documentation which meets the requirements of the willing Testator, but also be in a position to reason with and persuade the unwilling as to why a Will should be made.

The Laws of Intestacy

I have already commented on the fact that very few Scots actually know what would happen to their estates in the event of them dying without leaving a Will.  Very basically, since June 2005 where one spouse dies without leaving a Will the rights (known as “prior rights”) of the surviving spouse are as follows:

Over and above this, the surviving spouse will have a right to claim Legal Rights.  Again where there is surviving issue, these are restricted to one third of the net moveable estate of the predeceasing spouse.  Where there are no surviving issue, the right to Legal Rights amounts to one half of the net moveable estate of the predeceasing spouse.

You will probably gather from this, that in an increasingly wealthy society, this means that the surviving spouse may not be entitled to anything like the whole of the predeceasing spouse’s intestate estate.  Thereafter, those who will succeed to what is known as the “free estate” is governed by the Succession (Scotland) Act 1964; a brief examination of the provisions of the 1964 Act is likely to cause dismay to many individuals.   

One of the most disappointing aspects of the Succession (Scotland) Act 1964 is the seeming disregard of the position of young intestate beneficiaries aged 16 or over.  In terms of Section 1 of the Age of Capacity (Scotland) Act 1991, unless a Will specifies otherwise (effectively by including a Trust provision) when a youngster attains the age of 16, he or she is entitled to demand payment of his or her benefit.  This applies both to where there is a Will and where there is no Will (an intestacy).  Unfortunately, this in my view reflects a legislative disregard for our youngsters.   Just imagine yourselves succeeding to, say, £100,000 when you were aged 16.   Hands up those who think they would still have had £100,000 when they were 25! 

What are Legal Rights?

In Scotland, the right to make a Will has always been regarded as a fundamental freedom.   However, it is not wholly unrestricted.    In Scotland, we have what is known as the doctrine of legal rights.    It is important that an individual maker of a Will should be aware that the terms of that very important document are not absolute.

Purpose

The client making a Will is of course likely to be surprised to find that the devolution of his Estate will not be wholly controlled by the terms of his Will.    Why should this be?     In essence, this is due to the fact that Scottish Law does not wish to allow a situation to arise whereby a spouse or child can be wholly disinherited for no good reason.

Who can Claim?

The range of those who can claim legal rights is restricted to:-

How are legal rights calculated?

Legal rights can only be claimed against the net moveable Estate, valued as at the date of death, of the maker of the Will.   In essence, the Estate of the deceased person is divided into two separate categories being:-

Where the maker of the Will is survived by spouse and children, their respective entitlements are as follows:-

Example

Let us take a typical family situation.   The maker of the Will A owns a dwellinghouse having a value of £200,000.    He has net moveable Estate as at date of death which amounts to £120,000.   He is survived by his spouse B and two children, X and Y.    Neither B nor X and Y can claim against the value of the heritable property.    They can, however, claim their respective entitlement to legal rights as against the value of the net moveable property.    Thus:-

Further Example

Let us take the same family save that unfortunately, A’s child, X has predeceased him leaving two children of his own, D and E.    As before, none of the beneficiaries who can claim legal rights can make any claim against the value of the heritable property.    However, the moveable Estate against which he can claim remains the same.   As before:-

The position changes where either there is no surviving spouse or no children nor issue of any predeceasing children.    The result here is that where there is a claimant, his or her entitlement increases.   Thus:-

The meaning of “Net Moveable Estate”

There is a tried and tested methodology for calculating the value of net moveable Estate as at date of death.   Firstly, the moveable Estate is valued as at date of death.    The figure as so calculated falls to be reduced by deduction of:-

Can a beneficiary claim both legal rights and take his entitlement under the Will?

The answer to this question is “No”.   Under the Succession (Scotland) Act 1964 as amended, unless the relevant Will specifies otherwise, those who are entitled to claim legal rights are put to an election.    If they claim the benefit left under the Will, they forfeit their entitlement to legal rights.    Conversely, if they claim their entitlement to legal rights, they forfeit any benefit left to them under the Will.

The Executor’s obligations

The law on this matter is clear.     Even where, for example, the Testator has made it clear that he does not wish a particular “black sheep” child to have any rights against his Estate, the Executors are obliged to advise all who might have a claim to legal rights of their entitlement.    Whilst it is appreciated that this can be awkward for Executors, their duties are clear.    They are not obliged to encourage a claim to legal rights and similarly, they should not bring pressure on a particular individual not to claim.    Having advised the relevant individuals of their entitlement to claim legal rights, the Executors are required to make available to those individuals of their Legal Agents the information which is required to enable such potential claimants to decide whether or not to claim.   Should an Executor fail in the foregoing respect, he may find himself being pursued by a potential legal rights claimant.

How long does the right to claim subsist?

The answer to this is simple – 20 years.    This can provide Executors with real difficulties where the potential claimant cannot be traced.    In such circumstances, the Executors may have no alternative but to retain on an interest bearing basis a sum to meet the potential claim of that missing beneficiary, notwithstanding the views of, or complaints on the part of, those who are beneficiaries under the relevant Will.

Does the entitlement to legal rights earn interest?

Again, the answer to this is “Yes”.      However, there is no statutory rate and if legal rights are claimed then they will carry a right to interest from date of death to date of payment.    That rate of interest is, however, often difficult to calculate.   Generally speaking the rate is equated to that which the remainder of the Estate gained interest during the relevant period.     Obviously, however, if the remainder of the Estate gained no interest (because it was invested, for example, in Premium Bonds, which are not interest bearing) then there is no entitlement to interest.

Can a claim to legal rights be defeated?

Again the answer is “Yes”.    However, this can be difficult if not impossible to achieve.    Where an individual dies leaving moveable Estate then on the face of it, if there is a surviving spouse and/or children or the issue of predeceasing child, then the right exists.    There are steps which can be taken in an attempt to defeat legal rights but, for the most part, these are impractical or might not be advisable.    For example:-

Is a potential claimant obliged to claim legal rights?

The answer to this is “No”.     There is no obligation to claim legal rights.   In fact, legal rights will normally be discharged where the benefit left to the potential claimant under the Will is greater than the value of the entitlement to claim legal rights.   Similarly, in most stable family situations, children will decline their entitlement to claim legal rights if they perceive that this will prejudicially affect the financial position of the surviving parent.

Conclusion

It is of great importance that the maker of a Will should know of the existence of the entitlement to claim legal rights both on the part of a surviving spouse and children or the issue of a predeceasing child.   If the existence of that entitlement causes concern, then the maker of the Will should seek more specific advice as to his or her position and whether or not any practical steps could be taken to mitigate if not avoid the potentiality of such a claim against his or her Estate to the potential detriment of the chosen beneficiaries under the Will.

IHT Mitigation

Annexed to the copy of the speech which you will receive on application is a copy of my note on IHT mitigation.  This is a note that we send to clients who wish to make Wills, to enable them to be fully briefed (hopefully on understandable terms) as to their options in relation to IHT mitigation and not just in relation to the making of a Will.  However, in making a Will, it is possible to incorporate simple strategies which can, at the end of the day, affect a substantial saving in Inheritance Tax for a family.   At its most simple is the first death legacy.  Where spouses can afford to take this step, the first death legacy could extend to the Nil Rate Band from time to time (although this strategy has to be used with consideration and care).  In particular, use of a Discretionary Will Trust can provide the possibility of substantial IHT mitigation, protection for a surviving spouse and great flexibility. 

Use of Trusts

For the purposes of my address to you I will categorise Trusts as being essentially Lifetime Trusts and Trusts set up under a Will.    

Trusts have a very valuable role to play in estate planning and protection of particularly vulnerable and disabled beneficiaries.  

The main types of Trusts that we will all encounter (both in terms of lifetime and mortis causa trusts) are as follows:

The Bare Trust

This is where on individual effectively holds an asset as a nominee for another.   The true beneficiary can at any time demand that the holder of the asset make it over to him.   Examples of this are:

(a)     Where stockbrokers hold shares belonging to a client in the name of the stockbrokers nominee company. 

(b)    Where Executors hold funds or assets for a young beneficiary pending the beneficiary attaining the age of 16.

Bare Trusts are of little assistance to families where there is an incapacitated child in receipt of benefits. 

The Interest in Possession Trust

Again this type of Trust is likely to be of little interest to a family having a disabled child.   An Interest in Possession Trust is where the beneficiary has the right to enjoy the income from the Trust or to occupy a Trust property.   Again, Interest in Possession Trusts are very common place.  For example

(a)                 They are widely used in divorce settlements;

(b)                They form the basis for many pension trust provisions;

(c)                 They are used in pension splitting in divorce/separation agreements.

(d)                They are often used where an individual is in a second marriage or relationship but has children by a previous relationship.

Until the passing of the Finance Act 2006, every Interest in Possession Trust was likely to be treated in the same manner i.e. on death of the liferenter (the Interest in Possession beneficiary) the value of the Trust estate at that time would be aggregated with his or her personal estate and a tax liability to IHT calculated.  This liability would be apportioned between the Trust and the personal estate of the liferenter.  

For new Interest in Possession Trusts created after 22^nd March 2006, unless they are either Immediate Post Death Interest or Transitional Serial Interest Trusts, they will now fall under the “related property regime” i.e. be treated as Discretionary Trusts. 

The Bereaved Minor’s Trust

This was a new Trust concept introduced by the Finance Act 2006.  

A bereaved minor is an individual who is aged under 18 and at least one of whose parents or step-parents has died.

A bereaved minor’s trust will be a trust held either “on the statutory trusts applying to minor children aged up to 18 on intestacy” ( this is taken from the HMRC customer guide to Inheritance Tax referred to above) or on trusts in similar terms established under the terms of the parents Will or by the Criminal Injuries Compensation Scheme; and in either case, where property is distributed from the Trust it must be to the bereaved minor .

Provided the foregoing “tests” are met, there will be no inheritance tax charges arising where the bereaved minor becomes absolutely entitled to the property in trust on or before their 18^th birthday or where the bereaved minor dies. 

Some of you will have noted the use of parentheses in relation to the first “test”.   Gordon Brown has obviously forgotten that he is a Scot as the “statutory trusts” applying to a child under 18 on intestacy are of course an English concept.   It is unfortunate in my view that we do not have a similar provision in Scotland under the Succession (Scotland) Act 1964 – there is no protection whatsoever but a beneficiary on intestacy who reaches the age of 16 – the Executor Dative has no alternative to pay over if he is unable to persuade the 16 year old beneficiary that some other appropriate course should be followed.

When questioned on this matter, both Gordon Brown and Dawn Primarolo stated that, in their view, individuals aged 18 were, for the most part, sufficiently old to be able to manage their own finances.   I have to say that this is not my personal view nor is it the view of the majority of my will making clients many of whom cringe at the thought of an 18 year old receiving a substantial benefit from their estates.   The Law Society of Scotland did make representations about the bereaved minor’s trust given the provisions of Section 1 of the Age of Capacity (Scotland) Act 1991.   Unfortunately, that legitimate concern appears to have fallen on deaf ears.  

The 18-25 Trust

This again is a new concept introduced by the Finance Act 2006.  

From and after 22^nd March 2006, an 18-25 Trust is created under the Will of a deceased parent or step-parent (but not a grandparent, unless the later had parental rights in respect of the relevant child as at the grandparents date of death) or established under the Criminal Injuries Compensation Scheme in terms of which the property within the Trust is for the benefit of a person aged under 25, with the later becoming absently entitled to the whole of the property on or before their 25^th birthday.

As I have already commented, existing A&M Trusts created before 22^nd March 2006 will only become 18-25 Trusts is they are rewritten so that the beneficiary will become absolutely entitled to the property in trust on or before their 25^th birthday.   Where that step is not taken, then the A&M Trust will fall within the “relevant property regime” and be taxed as a Discretionary Trust. 

IHT will be charged in an 18-25 Trust when:

(a)                 the beneficiary becomes absolutely entitled to property in the Trust between their 18^th and 25^th birthdays;

(b)                Some of the property in the Trust is distributed to the beneficiary; or

(c)                 The beneficiary dies having attained his 18^th birthday.

There are certain exceptions to the 18-25 exit charge the main ones being where the trust estate is distributed to the beneficiary prior to the age of 18.

The HMRC Customer Guide to inheritance tax already referred to gives a very useful example of how to calculate Inheritance Tax, the exit charge being:

“The chargeable amount (which is a loss to the Trust) x the relevant fraction x the settlement rate = tax on the 18-25 exit charge”. 

The relevant fraction is 3/10ths x by as many 40ths as there are successive quarters in the period beginning on the 18^th birthday of the beneficiary and ending on the day before the date of exit from the Trust.  

The settlement rate is tax which would be chargeable with an immediately chargeable transfer of the amount of the exit which happened on the date of the exit expresses a percentage of the value of the settlement.  The value of the settlement is the amount put into the settlement when it was created plus any related settlements (and bear this in mind for the dangers which the related settlement rule can bring) and the settlors cumulative total and the value of the property which has been added to the settlement. 

The example referred to above given by HMRC follows.

Example

The age 18 to 25 trust was set up on 9/1/2000 with £400,000.

There are no related settlements.

The settler had made no other chargeable transfers, so the settlor’s cumulative total is nil.

No property has been added to the settlement.
The 18^th birthday of the beneficiary was on 12/5/2006.

A distribution of £300,000 is made to the beneficiary on 19/8/2010, giving rise to an age 18 to 25 exit charge.

Calculation

Tax on settlement at lifetime rates = £400,000 - £285,000 x 20% = £23,000

Settlement rate (5) = 23,000 x 100 / 400000 = 5.75%

Relevant fraction = 3/10 x 17/40

The tax on the age 18 to 25 exit is

Chargeable amount x relevant fraction x settlement rate

= £300,000 x 3/10 x 17/4 x 5.75%

=£2,199.38 tax

Comments

I think that the above example as set out in the customer guide is very useful not only demonstrating the methodology of calculation of the IHT charge but also by demonstrating that it is by no means crippling.  There are some comments of a general nature that I would make in relation to Discretionary Trusts (not just an 18 to 25 Trust) and these are:

The Discretionary Trust

The Discretionary Trust is a vehicle which many people find confusion.  How can you have beneficiaries in a Trust where they have no rights?   Quite simply, owing to the fact that the law of Scotland allows you to set up a Trust where the beneficiaries have no rights until these are bestowed upon them by the Trustees.   This one feature represents the importance of the use of Discretionary Trusts in relation to the protection of incapax beneficiaries who are receiving various means tested benefits.   As the incapax has no right to claim anything, the fact that he or she is named as a potential beneficiary cannot be used to disallow benefit payments.  This of course means that again an appropriate choice of Trustees (whether in terms of a lifetime or mortis causa trust) is very important.  Well meaning Trustees not properly advised could easily fall into the trap, for example, of mandating income from the Trust to the incapax’s account or making regular payments from income to the incapax.  Such a pattern of behaviour may lead to a claim that the Trust was truly an Interest in Possession one for the incapax, not a Discretionary one – this could lead to loss of very valuable benefits.  

It is often said that Discretionary Trusts are unpopular because they are unfairly treated from the tax point of view.   Is this the case?  

There can be no doubt that from the Income Tax and Capital Gains Tax point of view, payment of those taxes at the rate of 40% appears to be penal.  However, Discretionary Trustees have the right to hold over gains for CGT purposes and properly advised, it is possible that assets can be appointed  into and out of a Discretionary Trust with little or no Capital Gains Tax liability being incurred.   The question of the higher rate of income tax obviously can be off-putting, but again this is really a question of investment strategy.  

Is a Discretionary Trust treated unfairly from the point of view of IHT?  My view is that it is not.   A lifetime Discretionary Trust set up with funds exceeding the Truster’s Nil Rate Band, will be liable to IHT on the excess at 20%.  However, where there have been no previous chargeable transfers and the amount put into the Trust is less than the Nil Rate Band, the charge is calculated at zero per cent.  This can have an important effect for payments of capital out of the Trust prior to the 10 year anniversary of the same and also the periodic charge which next falls to be calculated. 

Discretionary Trusts are subject to 10 yearly and exit charges.  However, it should be borne in mind that the maximum amount of the charge at any time will be 6%.  In relation to the periodic or 10 yearly charges the tax is calculated only after taking into account the Nil Rate Band at the relevant time.  

For the most part, the question which an individual must ask is this – Do I wish to leave the assets within my estate, in which event they will be taxed to IHT at 40% on my death or would I wish to set up a Discretionary Trust where the IHT liability may over a large number of years be very much less in total than 40%? 

The flexibility which Discretionary Trusts offer is also not to be discounted.   It is sometimes suggested that the seemingly penal income and CGT rates on Discretionary Trusts are imposed by the Inland Revenue as a counterbalance to the flexibility offered.   However, it should be borne in mind that a Discretionary Trust can:

Such flexibility coupled with a wide range of powers can be extremely valuable. 

The Disabled Trust

Under the Inheritance Act 1984 Section 89 and the Taxation of Chargeable Gains Act 1992 Schedule 1 paragraph 2, tax concessions were available for disabled persons who were effectively defined as:

“Persons unable to administer their property or manage their affairs by reason of a mental disorder in terms of the Mental Health Act 1986 or who receive an attendance allowance or a disability living allowance”.

The definition has now changed somewhat under the Finance Act 2006 and now includes:

At the time the Finance Bill was being considered, the Disabled Charities did try to have the definition of disabled person extended particularly in England (where it is different) but without great success. 

Insofar as IHT is concerned, the qualifying conditions are:

1.                   That not less than half of the Trust property which is applied is applied for the disabled person; and

2.                   There is no interest in possession in the Trust property. 

The qualifying conditions for CGT are:

1.                   That not less than half of the Trust property that is applied is applied for the disabled person;

2.                   The disabled person is entitled to not less than half of the income from the Trust property; or

3.                   The income from the Trust property may not be applied for the benefit of any other person. 

The affect of a disabled trust coming within the IHT concession is that the 10 yearly or periodic charge is not imposed.   The downside is that the Trust for the disabled person is deemed to be an Interest and Possession (liferent) Trust so that it will be aggregated with the disabled person’s own estate for IHT on his death unless it passes to an exempt person such as a charity.  

I am aware that there are some advisors who take the view that it would be better simply to set up a normal Discretionary Trust than to seek to create a Disabled Beneficiaries Trust because of the foregoing aggregation provisions.  The Finance Act 2006 also introduced an interesting new format of Disabled Persons Trusts.   This allows an individual who will become incapax to set up his own Interest and Possession Trust in advance.  To what extent these provisions will be utilised remains to be seen. 

The importance of choosing the correct Executors/Trustees

Appointment of Executors and Different Trustees

It is quite possible for a testator to nominate Executors for the purposes of ingathering his Estate and to nominate a separate set of Trustees for a quite distinct purpose. For example, a testator may have an incapax child and wish to set up a “Disabled Trust” in terms of Section 89 of the Inheritance Tax Act, 1984. The testator may form the view that specific individuals or Charities (for example Enable) should be appointed for the specific purpose of administering such a Trust and be quite distinct from the Executors themselves. This arrangement would be entirely competent. The Executors would obtain Confirmation, ingather the Estate and distribute the same in accordance with the terms of the Will. Where the Will contains provision for a Disabled or separate Trust having distinct Trustees then the Executors will complete their function by making over the relevant portion of the Estate to those Trustees. Such an arrangement in respect of an incapacitated child might be entirely appropriate where, for example, the relevant Charity appointed to act as Trustee will have special skills in that area which can be brought to bear on a long term basis in the best interests of the incapacitated child.

Although not common (and perhaps not advisable in some circumstances), it is possible for Executors or Trustees to be nominated to administer different parts of the testator’s Estate, for example where the testator has assets in two or more countries (although perhaps the best advice would be for that individual to make separate Wills in each country dealing solely with his or her Estate in each country). It is also possible to appoint Executors or Trustees for a limited period of time. Again, this should be regarded as being inadvisable particularly if the jurisdiction of the appointment is fixed by reference to effluxion of a specific period of time as opposed to the occurrence of a specific event (for example the testator nominating his widow to act as Executor for as long as she remains unmarried).

Perhaps the clearest example of an appointment having a possible limited duration is where an appointment ex officio is made. In such cases, personal traits of the Executor are largely irrelevant and he or she is appointed simply owing to the fact of holding a specific office. Once the individual loses or demits that office then the appointment of that person as Executor/Trustee also lapses.

Voting rights and disputes

The normal position is that Executors and Trustees will reach decisions by majority. In a sizeable or complex Estate the possibility for reasoned disagreement should not be discounted. However, a testator should seek to avoid appointing as Executors and Trustees individuals known to the testator to be at loggerheads and who might allow personal disaffection to colour their respective judgements. Unless the Will specifies otherwise, the majority of the Trustees accepting office and surviving the testator shall be a quorum. For example, if five Trustees are appointed and Section 3(c) of the 1921 Act applies, then the majority will be three. However, a Will can provide that a quorum will be formed by a specific number of Executors and Trustees in such circumstances and if through death or resignation the total number of Executors and Trustees falls below the specified quorum then the quorum provision itself lapses.

Although in the normal case it might be considered to be inadvisable to appoint an Executor or Trustee who lives abroad or who is abroad on business for large periods of time, where such an Executor or Trustee has been appointed then the quorum can be specifically restricted to the majority who shall be at any time within the United Kingdom. Where the appointment is of Executors and Trustees then a similar provision can be made.

Executor or Trustee sine qua non

Where one Executor or Trustee is appointed sine qua non  then no act of administration can take place without the concurrence of that individual, who will have a right to overrule the majority and quorum of the others. Effectively, a sine qua non can veto acts or decisions of the others. The appointment will normally relate to all aspects of administration of the Estate, although it can be restricted to decisions in respect of a particular of Estate (for example how the deceased’s business should be dealt with or how a particular property should be handled). At one time it was thought that where a person nominated to act as Trustee sine qua non declined to accept office or was unable to do so, the very existence of the

Trust might be imperilled. The preferred view appears to be that failure of the Trustee sine qua non should not affect the existence of the Trust. The preferred view in Scotland therefore appears to be that the purposes and existence of the Trust are of prime importance and are not to be frustrated simply owing to inability or refusal of one party to accept office sine qua non.

Powers of Executors and Trustees

In terms of Section 3 of the Trust (Scotland) Act, 1921, an Executor is a Trustee and as such has the normal powers of a Trustee unless contrary intention is expressed in the relevant Will.

Practical considerations for making an appointment

There are various practical pointers which you can offer to clients thus:-

(a)        Clients should appoint more than one Executor/Trustee. Some clients will wish to appoint their Spouse alone to be Executor. In such circumstances the client should be advised to appoint substitute Executors. If both Spouses are killed in a common calamity then in the absence of any substitute appointment, reliance will require to be placed Section 3 of the Executors (Scotland) Act, 1900.

(b)        If the client is elderly, they should be advised to avoid appointing Executors of the same generation. Elderly nominees of the same generation may predecease the testator or can become incapax prior to the testator’s death. In such circumstances it would be advisable to appoint at least one co-Executor or substitute Executor of a younger generation. For obvious reasons of difficulty of communication etc., it is not advisable to appoint Executors who live abroad.

(c)        Clients should avoid appointing individuals who are known to be antipathetic to one another. Whilst such personal antipathy might not impact adversely on the administration of the client’s Estate, there remains the possibility that this could occur.

(d)        Where the client’s Estate is large and/or complex then the client should appoint as Executors/Trustees individuals who shall be able to cope. Where the client is a business person, appointing individuals who have no business experience might be unfair and might impact again adversely on the administration of the Estate.

(e)        Bear in mind a person of full age and capacity can act as Executor. However, a client might be keen that his child should be appointed as an Executor provided that a child has attained legal capacity at the date of the testator’s death. Such a conditional appointment is entirely possible.

The foregoing represent general pointers.  For those of you who have disabled children, there are more particular considerations to be borne in mind.  In particular, you may wish to appoint friends who are good people.  However, they have no experience of dealing with a disabled child.   They have no knowledge of a legislation which applies to Trusts.   Would such an appointment be appropriate?  This is a question which each of you must consider and each your own very personal decisions.  However, from my own perspective, I would recommend that even if you appoint your friends, you should consider appointing a “professional” Trustee.  Normally the Charities who deal with questions of mental incapacity or disabled beneficiaries are prepared to act as professional Trustees.  These charities have great experience and skill in dealing with the needs and requirements of disabled beneficiaries and, moreover, are familiar with the relevant Trust legislation.   I appreciate that some of you may baulk as obviously such professional Trustees will have fees to be met.  However, I have no hesitation in saying to you that my own view is that it is well worth appointing such a professional Trustee where experience, skill and practical approach is invaluable.  Moreover, many of the charities in question can offer great guidance in the actual framing of a Will where a disabled person may be a beneficiary.   Such concerns (without having to engage in research) where benefits etc might be available to a disabled person.  Your best friend Bill may be a great guy but having no experience in dealing with the needs of a disabled person and in particular no understanding whatsoever of the very complex structure of benefits etc which might be available, is likely to be well meaning but not to do the best possible job for that particular disabled person. 

If you think I am overstating the position then I will take a quick straw poll.   What was the decision in the case of Regina v. Barry ex parte Gloucestershire County Council?   Would any of you know how to argue that case if you were having to represent the interests of a disabled beneficiary?  This leads me on to another important topic – the importance of appointing guardians.  In Scots Law, it is not possible to appoint a guardian by Will for an individual (even a disabled or incapax person) who is aged over 16.   In the second segment of my address to you today I will speak briefly on the question of appointment of guardians under the Adults with Incapacity (Scotland) Act 2000.   In this segment I am talking about the appointment of testamentary guardians, who will have the responsibility for bringing up your children until the age of 16; again, similar considerations apply as those in relation to the appointment of suitable executors/trustees.  Guardians to such minor children have a hugely important role to play.  You should not appoint an individual simply owing to the fact that you feel that they would be offended if you did not otherwise do so.  You should appoint the persons who would be best suited to bringing up your children.  Again this applies with particular reference to disabled children.   An individual who is well able to cope with able bodied children may find it extremely difficult to deal with the needs and demands of a disabled child -  careful thought is required here.  

I will conclude this morning by exhorting you to bear in mind what I consider to be the cardinal rules, being:

Finally, for those Star Trek fans amongst you (and I count myself as one of them) in the immortal words of Bridge Officer Spock – live long and prosper.

John Kerrigan

March 2007

Appendix 1                   Note on IHT Mitigation

Inheritance Tax Planning

Inheritance Tax is a “wealth” tax.   It has been with us since 1986. Prior to then, its equivalent was Capital Transfer Tax and before that and for many years the relevant wealth tax was known as Estate Duty.   Basically, unless one of a number of exemptions or reliefs apply, where an individual (taking into account “chargeable lifetime gifts”) leaves Estate exceeding £285,000 (increasing to £300,000 in April 2007) on death, then Inheritance Tax will be charged.   The rate of charge is 40%.

The figure of £285,000 is known as the “Nil Rate Band”.  It is effectively the tax free section of an individual’s wealth which can be passed on without incurring a  charge to Inheritance Tax.  The Nil rate Band is usually slightly increased by the Chancellor each year. The Chancellor has on more than one occasion suggested that over 90% of individuals will not be liable to Inheritance Tax.  This is not my experience of advising individuals in this field and I suspect that the figure in question does not take into account the effect of aggregation of assets between spouses – transfers between spouses are wholly exempt.    Most spouses bequeath their Estate to the survivor.   Thus, if a husband and wife both have personal Estates separately totalling £285,000 ,at that point, neither of them will be liable to Inheritance Tax.   However, if one spouse dies leaving his or her Estate to the survivor obviously, the survivor will on inheritance have an Estate which will be liable to a substantial Inheritance Tax liability on his or her death.

My experience of advising clients over the years has thrown up some interesting features:-

·                    Many clients have never actually properly worked out their net value.

·                    Even with clients who have endeavoured to ascertain and value their assets, they often overlook various potentially valuable assets.

·                    Few clients know the reliefs which will be available to them.

·                    Few clients know about the “gifts with reservation” rules and some have already unwittingly fallen foul of the same.

·                    There is a misconception as to what amounts to a Potentially Exempt Transfer (PET).

·                    Few clients have any idea of the value of making use of Inheritance Tax Policies to cushion/mitigate the effect of Inheritance Tax.

Lets us examine these points:-

Ascertainment and Valuation of the client’s Estate

When an individual dies, the value of the whole of his or her Estate requires to be ascertained for IHT purposes.   Common misconceptions are:-

(i)         The Value of furnishings, personal effects and even jewellery is not taken into account – this is not so and where Inheritance Tax is an issue, all such items require to be properly valued (normally by a skilled valuer).Beware Section 213 of the IHTA 1984.

(ii)         Many clients believe that where they hold property jointly with another (usually their spouse) such joint assets are excluded – not so; even where an individual has only a “partial” interest in an asset (such as a heritable property or a bank account) if Inheritance Tax is chargeable then the value of the interest of the deceased is taken into account in calculating the charge.

(iii)        Clients commonly forget to take into account monies which would be payable under Life Assurance Policies, death in service schemes or Personal Pension policies .Where such benefits come directly back into the Estate of the relevant client, this can in fact move the client from a position of having no liability into perhaps having a substantial liability.   The simple reason that many clients forget about such benefits is that they are not available to the client during his or her lifetime.   Payment of the benefits is triggered only on death.   One example of the potential effect can be seen where a client has assets totalling £200,000.   If the client is employed and is a member of his employer’s Occupational Pension Scheme then very often a sum equivalent to four times the annual salary of the employee at death is payable by way of death in service benefits.   If the client in question is earning £30,000 per annum the death in service benefits will be £120,000.    If these benefits are added back to the client’s other assets (totalling £200,000) the IHT liability will be £320,000 minus the Nil Rate Band (£285,000) – equals £35,000 taxed at 40% - which gives an IHT liability of £14,000.

Overlooked Assets

I have already indicated above the three “potential” assets which are more often than not overlooked by a client being:-

(a)        Life Insurance Policies – whether or not the value of a policy comes back into the Estate of the individual will depend on whether the proceeds of the policy are payable to the Executors/Personal Representatives of the deceased (in which case they will be taxable) or whether the benefit that is expressed to be payable to some other person (in which case they are likely to avoid taxation).

(b)                Death in Service Benefits – see the example which I give above.

(c)                 Sums payable under Retirement Annuity or Personal Pension Policies – normally such policies will provide for payment of a sum where the person who has purchased the relevant policy dies before reaching retirement age.  The sum which is payable will depend on the terms of the policy.   Some older policies provide for simply return of premiums paid.  Other provide for return of premiums paid with interest at an agreed rate thereon.  Most favourably from the point of view of the individual, more modern policies provide for payment of the value of the pension fund at date of death.  This can amount in any case to a substantial sum of money which again may well be expressed to be payable to the Executors or Personal Representatives of the deceased.   If it is then again it will be taxable to IHT.

There are other “potential” benefits which many people overlook. Classic examples of this are:-

(i)          A potential direct inheritance from an elderly relative.   No one really wants to contemplate the death of a loved one, particularly a parent or other elderly family member.   However, as wealth within our society has increased, a greater proportion of the population does have a reasonable inheritance expectation.   Thus, you may again find a situation where a client is not per se liable to inheritance tax having assets of £200,000.    If, however, the client has a reasonable expectation of inheriting another, say, £125,000 from a parent or other relative then the receipt of such an inheritance will move the client from having no liability to having a substantial liability (in the example given IHT would amount to £10,000).   

(ii)                 Clients often fail to mention that they are already beneficiaries under a Trust but that the capital benefit due to them has not yet been paid.

 (iii)                A damages claim – although not particularly common, it is possible that the client is involved in a litigation (for example arising out of personal injury) which, if resolved in the client’s favour, could amount to a substantial sum of money being paid to the client.    Most individuals involved in such claims, particularly where a litigation has been ongoing for a period of time, tend not to “count their chickens” and therefore to overlook the potential benefits of a successful outcome.

From the advisor’s point of view, it can therefore be seen that the client has to be encouraged to be full and frank in his or her disclosure of assets and potential assets.   Some clients can see this as unduly intrusive but the fact of the matter is that without having all the details, an advisor cannot properly advise.   I have already demonstrated a potential situation in which an advisor might conclude that there was no IHT liability when in fact, with a little more information, the advisor would have reached an entirely different conclusion.

IHT Reliefs

Most clients are aware that they have an annual exemption of £3,000.  However, in most cases this tends to be the full extent of the client’s knowledge of the reliefs which are available.  IHT mitigation is not a “one off” operation.   It is an ongoing process and having a knowledge of the reliefs which are available can assist a client to mitigate reasonable sums of tax over a period of time.   Important exemptions which clients should bear in mind are as follows:-

·                    Gifts in Contemplation of Marriage – Parents can gift up to £5,000 to a child in contemplation of marriage.     A grandparent can gift up to £2,500 to a grandchild in contemplation of marriage.    These payments are tax free and are quite separate from the annual exemption.

·                    The Small Gifts Exemption – during any tax year a client can give as many gifts not exceeding £250 as they wish as long as they are to separate individuals   (if you give two gifts of £250 to the same individual only one will qualify for the small gifts exemption).

·                    The Normal Expenditure out of Income Rule

Quite apart from the above, it is important that clients should understand that there are other important reliefs which can be brought to bear thus:-

·                    Agricultural Relief

·                    Business Property Relief – this is not available for investments in businesses which deal in property (for example a property development company) or in investments (for example shares in other companies i.e. an investment trust).

The importance of business property relief cannot be overlooked.    A client who has a business interest worth, say £300,000 and other assets worth £200,000 may perceive that he or she has a huge inheritance tax problem.   If, however, the value of the business interest can be wholly relieved (i.e.  100% Business Property Relief is available) then the client moves from the position of having a potentially large IHT liability to having none.

Potentially Exempt Transfers and Gifts with Reservation

These two matters require to be considered together.     A potentially exempt transfer is a gift or transfer at no consideration.  Provided the gift is made on an absolute basis, without any strings attached and the donor survives for seven years from the making of the gift, the value of that gift will be wholly free of IHT on death after a period of seven years from the making thereof.   If the donor dies within three years of making the gift, the whole value of the gift falls to be brought back into account in assessing the value of the deceased’s Estate for IHT purposes.   For example, at death an individual may have assets worth £240,000.   On the face of it there would be no liability to IHT.   However, the same individual two years prior to death made a gift of £60,000 to a child.   The whole value of that gift requires to be brought back into account – thus the chargeable Estate will be as follows:-   £300,000 minus the Nil Rate Band £285,000 leaving a taxable Estate of £15,000 at which tax is charged at the rate of 40% i.e. the tax charge is £6,000.

In some circumstances, there may still be benefit in making a large gift even although the donor dies within seven years.   This is due to the fact that, in the circumstances hereafter detailed (i.e.the donor has used up his Nil Rate Band)  if the donor dies between three and seven years of making the gift, although the full value of the gift is brought back into account in calculating Inheritance Tax, the rate at which Inheritance Tax is charged on that gift reduces year after year obviously until the seventh year is reached when tax is no longer chargeable.  This Taper Relief only applies where the Nil Rate Band has been exhausted.

Many clients do have a passing knowledge of potentially exempt transfers but can fall into a classic trap.  To most individuals, their single most valuable asset is the dwellinghouse in which they live.     Many individuals have decided that, to take the value of their dwellinghouse out of charge to IHT they will adopt the seemingly simple step of conveying the Title to the dwellinghouse to their children, reserving the right to occupy the dwellinghouse rent free until death.   No only does this not work from the IHT mitigation point of view, it can be disastrous.   The simple reason for this is that the Inland Revenue will apply their “gift with reservation” rules ;the Inland Revenue will not accept such a transfer as being a potentially exempt transfer.   Not only will the Inland Revenue not accept the transfer as being a Potentially Exempt One, they will require that the dwellinghouse be valued as at the parent’s date of death and that value added back to the parent’s other assets to calculate the charge to Inheritance Tax.   For example, a parent conveys his/her dwellinghouse to children when its value is £100,000.   The parent continues to reside rent free in the dwellinghouse and passes on ten years later when the value of the house is £200,000.   Not only will the transfer not be a potentially exempt transfer (even although legal title to the house has passed ten years beforehand) but the Inland Revenue will require that the value of the house as at date of death be added back to the parent’s Estate passing on death to calculate the charge to tax.    Thus, if the parent’s other assets passing on death total £100,000 when the value of the house is added back, the gross Estate is £300,000 leaving £15,000 chargeable to tax – again a tax liability of £6,000.

Dwellinghouses are “lumpen” and difficult assets to deal with from the IHT mitigation point of view.   It would not be true to say that there is nothing which a parent can do with his or her dwellinghouse but some of the schemes involved are complex, costly and some of them are not guaranteed to succeed. Use of a Discretionary Will Trust with a “loan back” arrangement should be considered.

Insurance  

As people get older, the willingness to purchase an insurance product decreases.   However, there are some very valuable insurance products which can be purchased to mitigate the effect of Inheritance Tax on death.

Potential Pitfalls

The mitigation of Inheritance Tax is a worthwhile aim but as with everything else in life, the process is a balance. There are various important considerations which require to be taken into account thus:-

·                    A gift made unthinkingly with a view to saving Inheritance Tax could simply result in an immediate Capital Gains Tax liability.   Capital Gains Tax arises in respect of a “disposal” – many clients wrongly think that it is only of relevance when an asset is sold – this is not the case.  This consideration is of particular importance in relation to investment such as stocks and shares.   A gift of a shareholding is a disposal for Capital Gains Tax purposes.   If the gain in that holding exceeds the donor’s annual exemption for CGT purposes, an immediate Capital Gains Tax liability will have been crystallised.

·                    A part from Capital Gains Tax considerations, care is required in relation to lifetime gifts.  While such a gift can substantially reduce an anticipated Inheritance Tax liability on death, the nature of the asset requires to be carefully considered – for example, if the asset in question is an investment which is producing valuable income then the effect of loss of that income will require to be properly considered.