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Sins of omission

An omission to exercise a right may be chargeable to inheritance tax and is a more unusual transfer of value than the usual dispositions and gifts. Section 3(3) Inheritance Tax Act 1984 provides that the omission to exercise a right may be treated as a disposition.

In a simple scenario, Mr A has an option to buy land from Mr B at a price which is below its current market value. The right had to be exercised before 31 January 2012. Mr A deliberately fails to exercise the right and effectively decreases his estate (as the right lapses) but increases Mr B's estate (as Mr B's land is no longer encumbered with the option).

For section 3(3) to apply, there must be a 'right' which may be connected with property or may be purely contractual. Rights that are mainly of a personal or non-pecuniary nature are not caught, provided they do not diminish the value of the estate of the person holding the right. On the other hand, for example, where a person deliberately fails to exercise his voting rights in a company meeting which results in a decrease in the value of his shares, HMRC is likely to regard this as a transfer of value within section 3(3), for IHT purposes.

In Fryer v Revenue and Customs Commissioners the judge at the First Tier Tribunal ruled that Mrs Arnold had made a transfer of value when she failed to take any retirement benefits up to her death, two years after reaching her retirement age. Her executors raised section 10 as a defence, arguing that there was no intention to confer a gratuitous benefit. This argument was rejected on the grounds that the transfer did confer a gratuitous benefit on the discretionary trusts which she declared over the pensions transfer plan which she then took out.

The judge ruled that Mrs Arnold' failure to exercise her rights was a 'continuing omission' and the latest time on which she could have done was the date of her death on 30 July 2003. Her omission had to be taken, on the wording at the end of the statute, as being deliberate' ….unless it is shown that the omission was not deliberate'. Mrs Arnold had a valuable right and her omission diminished her estate. The judge accepted that Mrs Arnold did not require the additional pension income and that it was most unlikely that she would opt to exercise her pension rights on the date of her death, even if she had been physically able to do so. The transfer of value was assessed on the basis of the value of the right to opt to take the retirement benefits on the date of her death. On the actuarial evidence, this right was assessed as £89,850, on a pension fund of around £147,000. This is consistent with the principle that a transfer of value is based on the loss to the donor, not on the increase in the recipient's estate, or in this case, the value of the discretionary trust fund.

A change in policy occurred with the introduction of section 2(2ZA) , disapplying section 3(3) where a member of a registered pension scheme, a section 615(3) scheme or a qualifying non-UK pension scheme omits to exercise pension rights. Section 3(3) remains relevant to other retirement schemes such as employer financed retirement benefit schemes and, to other circumstances where there is an omission to exercise a right that diminishes a person's estate and increases the estate of another.

This article first appeared in the STEP journal in November 2013.

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