An interesting decision has been published by the Tax Tribunal relating to the question whether the deferral of retirement benefits by a pensioner represented an omission to exercise a right, giving rise to a transfer of value for inheritance tax purposes: Fryer (Executor of Patricia Arnold Deceased) v HMRC TC 398.

It will be well known that inheritance tax applies to transfers whereby the value of the individual’s estate is diminished. This concept is extended by Section 3(3) IHTA 1984 as under:

Where the value of a person’s estate is diminished and the value of another person’s estate or of any settled property in which no interest in possession exists, is increased by the first person’s omission to exercise a right, he shall be treated as having made a disposition at the time (or the latest time) when he could have exercised the right, unless it is shown that the omission was not deliberate.

Mrs Arnold had a pension plan. If she died before taking her retirement benefits, the value passed to the trustees of a discretionary trust for her children. She did not take her retirement benefits at the age of 60 in September 2002, the normal retirement date, but died shortly thereafter. She was in fact seriously ill, being diagnosed with cancer in April 2002, but her failure to take her retirement benefits semed to have more to do with the fact that she had no immediate need for the income.

HMRC said that there were three conditions to be satisfied for there to be a transfer of value:

  1. A deliberate omission to exercise a right;
  2. The taxpayers state is diminished; and
  3. The omission caused the value of the settled property to be increased.

There was no suggestion that there was any deliberate tax avoidance. It was simply a matter of reading the legislation, and there was nothing to suggest that these conditions were not satisfied. Mrs Arnold did not fail to exercise her rights by accident; she had expressly rejected the opportunity to exercise the right to take her pension when maturity papers had been sent to her after her normal retirement date, and the value of the pension fund passed to the trust.

The Tribunal decided that the relevant conditions were satisfied and that a transfer of value had been made immediately before Mrs Arnold’s death.

However, this conclusion is troublesome because although it is clear that Mrs Arnold’s estate was diminished by her failing to exercise her right to claim the value of her pension during her lifetime, the settled property was not increased until after her death. The Tribunal said this did not matter – but many people will think that it matters rather a lot.

The whole idea of a transfer of value in this context is that the diminution and increase occur at the same time. Otherwise it does not make sense. The Tribunal regretted that the taxpayer was not professionally represented, and there was a strong implication that not all of the relevant arguments were canvassed before the Tribunal. Maybe this was one of them – and maybe it will be on appeal.

Anyway, this looks extremely serious because anybody who has reached normal retirement age, has chosen to defer taking their pension entitlement (perhaps because it would put them into higher rate tax, or into the 50% rate − or worse, the 60% rate) and then dies before taking the benefits will make a transfer chargeable to IHT. This must apply to an enormous number of people.

There is a concession published by HMRC which they say means that the overwhelming majority of pension arrangements are not affected by this rule. HMRC say they would only make a claim in cases where there is evidence that the taxpayer’s intention of failing to take retirement benefits was to increase the estate of somebody else – for example, having become aware that they are suffering from a terminal illness, they deferred taking retirement benefits. Even then, HMRC say they would not pursue the case where the death benefit is paid to the policy holder’s spouse or dependants.

Although HMRC suggest that their practice will cover the overwhelming majority of pension arrangements, it is clear that their statement is in fact rather narrow – although at least we now know that we can rely on it. Anybody who has deferred taking their pension should pay the closest attention to the HMRC concessionary practice to make quite sure they fulfil every condition – otherwise their family will be in for an unwelcome surprise.