A case of Russian roulette
The recent outcome of the HMRC V Parry and Others (A3/2017/0687) judgement from the Court of Appeal clearly demonstrates that gambling on legal outcomes can be a risky business. With two outcomes in your favour, you feel luck is on your side, and then bang it’s all over, with the only winner being HMRC.
Now it has always been HMRC’s view that when a member transfers from one pension scheme to another the member surrenders their rights under the existing scheme in return for their rights in the new one. The implication of this is that the member brings to an end any existing trust that applied to their death benefits in the original pension scheme. As the member can control which new pension provider they use, they can determine what new trust the death benefits are subject to. In theory, the member could, under the new pension arrangement, direct the death benefits to their own estate. In all likelihood, however, the new arrangement will exclude the member’s estate as a beneficiary and as such there is a potential loss to the member’s estate. On this basis HMRC treats the transfer of the pension rights as a transfer of value under the Inheritance Tax Act (IHTA) 1984 s3(1).
If the member is in good health at the time of the transfer it is deemed that the rights to the death benefits are of negligible value as it is assumed the member will live to take their pension. However, if the member is knowingly in poor health at the time of the transfer and dies within two years of doing so, the rights to the death benefits have a significant value and will be treated as a chargeable transfer. This can appear to be particularly harsh when transfers have been made for such reasons as to gain access to pension freedoms or a more competitively priced product. The idea that such benign actions could generate an Inheritance Tax (IHT) charge seems unjust when no IHT benefit was created.
In the Parry case, in November 2006 the late Mrs Staveley transferred a s32 plan to a personal pension whilst suffering from cancer, and then sadly died the following month. Mrs Staveley’s executors argued that no transfer of value had taken place as the exemption under IHTA 1984 s10 would apply and there was no intention to confer a gratuitous benefit. Mrs Staveley’s only aim was to ensure her ex-husband could not benefit from her pension and transferring from the s32 would have ensured this could not happen. Both the First Tier and Upper Tier Tax Tribunals accepted this argument.
The fact that there was a clear IHT benefit as the s32 plan would have formed part of Mrs Staveley’s estate but the SIPP would not, did appear to be a very favourable outcome. Based on this ruling, it did not seem unreasonable to now believe that transfers between say a defined benefit scheme and a defined contribution scheme, where the member was in poor health, and provided there was no IHT benefit, would be beyond challenge.
The Court of Appeal, however, took an opposing view in that although Mrs Staveley’s primary consideration was to ensure her ex-husband did not benefit from her pension, they deemed that whilst secondary, there was sufficient intention to confer gratuitous benefit to her sons. The s10 exemption therefore could not apply and so there was a transfer of value. Based on this outcome it would appear that s10 exemption is unlikely to be able to be used as a defence.
The impact of this ruling by the Court of Appeal is that when advising clients in poor health with a presumed life expectancy of two years or less, very careful consideration has to be given when contemplating transferring one pension scheme to another. The implication of a potential IHT liability will always have to be considered, and in many cases this may make the transfer simply unattractive.
It does seem inappropriate to penalise someone in poor health from wanting to transfer their pension, especially when in reality there is no change to their IHT position, and there is a strong argument for the current regime to be reviewed. Perhaps this is a point the Office of Tax Simplification can consider as part of their actual review of IHT, although this may be where the real game of chance lies.
This article first appeared on Professional Adviser