A deed of variation is a written document in which a beneficiary redirects all or part of what they inherit under a will or the intestacy rules. If it is made within 2 years of the death and contains the right statements, it is treated for inheritance tax and capital gains tax as if the deceased had made the gift, so the beneficiary is not treated as making a gift of their own. If the variation increases the inheritance tax due, a copy must reach HMRC within 6 months of the deed being made.
What a deed of variation does
Without a variation, a beneficiary who passes on part of an inheritance makes a gift in their own right. For inheritance tax, the gift can be taxed if they die within seven years, and a gift into most trusts can be taxed immediately. For capital gains tax it can be a disposal at market value.
Section 142 of the Inheritance Tax Act 1984 changes that. Where, within two years of a death, the dispositions of the deceased's estate are varied by an instrument in writing, the Act applies "as if the variation had been effected by the deceased". Section 62(6) of the Taxation of Chargeable Gains Act 1992 does the same for capital gains tax: the variation is not a disposal, and the rules apply as if the deceased had made the variation.
The rules apply to dispositions "whether effected by will, under the law relating to intestacy or otherwise", so a variation can rewrite the intestacy rules as well as a will. They also apply whether or not the estate has been administered or the property already distributed.
The conditions
- Two years. The deed must be made within two years after the death;
- In writing, by the beneficiary. It must be made by the person giving up the benefit. Any beneficiary left worse off by the change must agree to it;
- The statements. For inheritance tax, the deed must contain a statement by all the relevant persons that they intend section 142(1) to apply. For capital gains tax, a separate statement that the persons making it intend section 62(6) to apply. The two are independent, so a deed can be made effective for one tax and not the other;
- Personal representatives where tax increases. If the variation results in more inheritance tax, the personal representatives are "relevant persons" and must join in the statement. They can refuse only if they do not hold enough assets to pay the extra tax;
- No consideration. The variation must not be made in return for money or money's worth, other than another variation of the same estate;
- Charities. Where property is redirected to a charity, the charity must be notified of the deed.
HMRC's checklist IOV2, for variations signed after 1 August 2002, walks through these conditions. A formal deed is common, but a letter that meets the conditions is enough.
Telling HMRC
If the variation means there is more inheritance tax to pay, section 218A requires the relevant persons to deliver a copy to HMRC within six months of the day the instrument is made. The personal representatives will also need to reflect any variation in the estate's inheritance tax figures, whether it increases or reduces the tax.
Why families use them
Common reasons are practical as much as tax-driven:
- Skipping a generation. A surviving child who does not need the money redirects it to their own children, keeping it out of their own estate without starting a seven-year clock;
- Using exemptions. Redirecting assets to a surviving spouse or civil partner, or to charity, can reduce the tax on the estate. Where 10% or more of the net estate goes to charity, the rate on the rest falls from 40% to 36%;
- Thresholds. Rearranging who inherits the home can affect whether the residence nil-rate band is available. With it, the threshold can reach £500,000 rather than the basic £325,000;
- Fixing a will. Providing for someone the will left out, or setting up a trust the deceased would have wanted;
- Capital gains. Redirecting an asset that has risen in value since death, so that passing it on is not a disposal by the original beneficiary.
Income tax: where variations do not work
There is no income tax equivalent of section 142. HMRC's trusts manual is explicit that deeds of variation "do not change either the general law position or the income tax position". In particular, a beneficiary who varies an inheritance into a trust, or for their own children, is the settlor for income tax purposes.
That matters most where parents redirect an inheritance to their own minor children. Under section 629 of the Income Tax (Trading and Other Income) Act 2005, income from a settlement paid to or for a settlor's minor child is taxed as the settlor's income, unless the total for the year is no more than £100. For capital gains tax, too, where property would have passed outright to the beneficiary, HMRC treats that beneficiary as the settlor of a trust created by the variation.
Practical points
Diarise the two-year deadline from the date of death, because it cannot be extended. Make sure every beneficiary who loses out signs. Consider the inheritance tax, capital gains tax and income tax effects separately, as they do not always point the same way. Where the estate is also paying tax, the executors will need to factor the change into the inheritance tax account; our guides to inheritance tax rules and to the role of an executor explain how the estate's liability is worked out and paid.
Acumon's estate and probate team works with families and their solicitors on variations, including the tax calculations before and after the change. For wider planning, including whether a trust created by variation makes sense, see our inheritance tax planning service.