Section 263 Inheritance Tax Act 1984 Life Assurance Policies and Annuities Associated

Spc00605

Section 263 Inheritance Tax Act 1984 – life assurance policies and annuities – associated operations – statement of practice E4 – whether medical evidence questionnaire constitutes “full medical evidence”

THE SPECIAL COMMISSIONERS

AMANDA CLARE SMITH

ANDREW JOHN SMITH

MARK VALENTINE SMITH

DUNCAN JOHN VINCENT GODFREYAppellants

- and -

THE COMMISSIONERS FOR

HER MAJESTY'S REVENUE AND CUSTOMS Respondents

Special Commissioner:Nicholas Aleksander

Sitting in London on 21 November 2006 and 15 March 2007

Mr Mark Smith in person and for Mr Andrew Smith and Ms Amanda Smith

Mr Godfrey did not appear and was not represented

Mr Colin Ryder, Assistant Director, Capital Taxes Office for the Respondents

© CROWN COPYRIGHT 2007

1

DECISION

The Appeals

1.Ms Amanda Smith, Mr Andrew Smith, Mr Mark Smith and Mr Duncan Godfrey (“the appellants”) appeal against four notices of determination, each dated 10 July 2006.

2.The Notice of Determination relating to Ms Amanda Smith was in the following form:

"The Commissioners of Her Majesty's Revenue and Customs have determined

In relation to

a)Three policies of life assurance numbers ASS0065774. ASS0064784 and ASS0064792 and three annuity policies numbers ANN0037311, ANN0037320 and ANN0037322 all issued by The Equitable Life Assurance Society and dated 8 November 1996.

b)Three Declarations of Trust made by Sir John Cyril Smith ("the Deceased") and Lady Shirley Ann Smith and dated 10 October 1996.

c)A single premium with profits life assurance policy number BND0020549 issued by The Equitable Life Assurance Society and dated 28 October 1996.

d)A Declaration of Trust made by the Deceased on 10 October 1996.

e)The death of Lady Shirley Ann Smith on 23 October 2000.

f)The death of the Deceased on 14 February 2003.

That:-

1.The issue of the three policies of life assurance at the same time as the purchase of the three annuities at a) above and the vesting of those policies of life assurance under the terms of the declarations of the three declarations of trust at b) above shall be treated as a transfer of value by the deceased having regard to section 263 Inheritance Tax Act 1984; and

2.The policy of life assurance at c) above held at 14 February 2003 by the trustee of the declaration of trust at d) above falls to be treated as property to which the deceased was beneficially entitled immediately before his death having regard to section 102 Finance Act 1986".

3.The Notices of Determination in respect of the other Appellants were in substantially the same form.

4.Mr Colin Ryder, Assistant Director, Capital Taxes Office represented HM Revenue & Customs. Mr Mark Smith represented himself, his brother Mr Andrew Smith, and sister, Ms Amanda Smith. Mr Godfrey did not appear and was not represented, but wrote to the Tribunal Centre prior to the hearing requesting that the appeal be heard in his absence. A bundle of documents was produced at the hearings. The background facts are not in dispute.

The Background Facts

5. Ms Amanda Smith, Mr Andrew Smith and Mr Mark Smith are the children of Professor Sir John Smith and his wife Lady Shirley Smith. Mr Godfrey is a co-executor of Sir John’s estate. Sir John and Lady Shirley took out three policies of life assurance coupled with three annuities in October 1996. The issue is whether in doing so they made a transfer of value to their children at that time. This appeal relates solely to whether Sir John made such a transfer.

6.On 10 October 1996 The Equitable Life Assurance Society ("Equitable") issued to Lady Shirley an "Illustration" titled "The Equitable Investment Plan With Profits". The Illustration was in the following form:

"The Plan

The plan comprises a guaranteed temporary annuity and an endowment assurance. The objective is to achieve capital growth over a selected period of years in a sound and tax efficient way from the investment of a lump sum.

How the lump sum is applied

A temporary annuity and an endowment assurance are effected. The sum invested is used to meet the first annual premium for the endowment assurance and to purchase the temporary annuity, which turns your capital into income on an attractive basis. The income is designed to provide the remaining premiums for the endowment assurance policy, which converts the income back into capital.

Female aged 61 years and three-quarters (born 14 October 1934) but under 62 years

Male aged 74 years and three-quarters (born 5 January 1922) but under 75 years.

Income tax rate applicable to top slice of income20%

Amount of investment£33333

Period of investment10 years

This illustration is on a with-profits basis, and uses the same rates of return as other insurance companies' illustrations, but uses the Society's own charges. The figures are only examples, none is guaranteed and they do not represent the minimum or maximum amounts. The eventual benefits will depend on how the investments perform and may be more or less than those shown. Do not forget that inflation would reduce what you could buy in the future with the benefits arising.

Temporary annuity

Purchase price £29126.00

Gross annuity payable annually in arrear for 9 years or until the prior death of both annuitants £4443.07pa

Capital content not subject to tax£3266.00pa

Taxable content£1177.07pa

Income tax, if at 20% of taxable content (see note 1)£235.41pa

Net income per annum from temporary annuity£4207.66

Endowment assurance with profits

Sum assured on survival to the end of 10 years or on the prior death of both lives: £38357 plus profits

Normal annual premium£4207.00"

7.The Illustration continued with projected benefits from the plan and examples of benefits if the plan was surrendered prior to maturity, and other sundry information, none of which are relevant to this appeal.

8. At the foot of the Illustration was a box as follows:

"APPLICATION FOR THE INVESTMENT PLAN

Please complete and sign this section if you wish to apply for the policies illustrated (see note 2). You should also complete the relevant proposal form."

This was signed by Lady Shirley and dated 10 October 1996. The notes referred to in the body of the Illustration followed the signature box, but are not relevant to the appeal.

9.Lady Shirley and Sir John completed three proposal forms (in identical terms), which were each signed and dated 10 October 1996. Each was for an annuity to be purchased for £29,126 and a with profits endowment assurance for a sum assured of £38,357. Section D of the proposal forms included six questions relating to Sir John and Lady Shirley's health. In addition they each completed separate medical evidence questionnaires.

10.Lady Shirley and Sir John also executed three Trust Declarations (each dated 10 October 1996) over any "with profits endowment assurance" to be made under the proposals. The beneficiaries of the first trust were:

"Amanda Clare Smith

(a)if she shall predecease the settlors or the survivor of them or

(b)if the settlor or either of them shall survive to the terminal date specified in the policy then for the benefit of and in trust for the settlors in equal shares if they shall both survive to the said terminal date but otherwise for the benefit of and in trust for the last of the settler to die absolutely".

11.The other two trusts were in similar terms, save that Andrew John Smith and Mark Valentine Smith were substituted respectively for Amanda Clare Smith as the named beneficiary.

12.The applications were reviewed by the Equitable. The Equitable considered the medical information in the proposal forms (including the medical evidence questionnaires). In accordance with the Equitable's internal guidelines, they were prepared to issue the life assurance policy and annuity in respect of Lady Shirley without further medical evidence. However, the answers given by Sir John in respect of his medical evidence questionnaire were such that (with Sir John's consent) they arranged for a medical examination with Sir John's GP.

13.On the basis of the report from Sir John's GP, the Equitable issued the three life assurance policies and the three annuities that are the subject of the Notices of Determination on 8 November 1996. The Equitable confirmed in correspondence in 2003 that the life assurance policies would have been issued on the same terms had the annuities not been purchased.

14.By Deeds of Appointment dated 4 April 1999, Mr Mark Smith was appointed as an additional trustee of the three trusts referred to above.

15.Lady Shirley died on 23 October 2000. Sir John died on 14 February 2003.

The Law

16.Under section 3, Inheritance Tax Act 1984 ("IHTA"), a transfer of value is a disposition made by a transferor as a result of which the value of his estate immediately after the disposition is less than it would have been but for the disposition. Section 2 provides that a transfer of value which is not an exempt transfer is a chargeable transfer. Chargeable transfers are chargeable to inheritance tax by section 1. Where the transfer of value is a gift to another individual it is a potentially exempt transfer under section 3A. However where the transferor dies within seven years of making the potentially exempt transfer, the transfer becomes chargeable under section 3A(4).

17.Sir John died within seven years of the life policies and the annuities being effected.

18.Section 263 IHTA applies to annuities which are purchased in conjunction with life policies. The provisions which are now contained in section 263 were originally enacted to address the avoidance of Estate Duty through the use of "back-to-back policies". The mischief addressed by section 263 is described succinctly in the Revenue's Inheritance Tax Manual at paragraph IHTM20371:

"What happens in the typical case is that someone in poor health buys an annuity for their own benefit for a lump sum and at the same time buys a life policy on their own life but for the benefit of someone else. The annuity is used to pay the premiums on the life policy. The idea is to make the transfer to the beneficiary non-taxable by making use of the normal expenditure out of income exemption under Section 21 IHTA 1984. However, someone in poor health would not normally be able to take out life assurance at normal premium rates because it would be financially disadvantageous to the insurance company. The only way the company would agree to write a life policy whose sum assured was substantially in excess of the premiums paid was if it derived an even greater benefit from an associated transaction, in this case the annuity taken out in conjunction with it. With the linked annuity, the health or life expectancy of the life assured would not matter to the company because it would benefit from either the annuity or life policy depending on how long the policyholder lived. So without special statutory provisions a tax-free transfer of capital would take place by using an exemption designed for the transfer of income. Linked annuity and life policies are termed 'back-to-back policies'."

19.The relevant provisions are in section 263(1) IHTA:

"(1) Where-

(a) a policy of life insurance is issued in respect of an insurance made after 26th March 1974 or is after that date varied or substituted for an earlier policy, and

(b) at the time the insurance is made or at any earlier or later date an annuity on the life of the insured is purchased, and

(c) the benefit of the policy is vested in a person other than the person who purchased the annuity,

then, unless it is shown that the purchase of the annuity and the making of the insurance (or, as the case may be, the substitution or variation) were not associated operations, the person who purchased the annuity shall be treated as having made a transfer of value by a disposition made at the time the benefit of the policy became so vested (to the exclusion of any transfer of value which, apart from this section, he might have made as a result of the vesting, or of the purchase and the vesting being associated operations)."

20.The three life assurance policies and annuities issued by the Equitable satisfy the requirements of paragraphs (a) to (c) of section 263(1). The three life assurance policies were taken out on the joint lives of Sir John and Lady Shirley in October 1996; the three annuities were purchased at the same time by Sir John and Lady Shirley; and the benefit of each of the three life assurance policies was placed in trust for the benefit of each of Sir John and Lady Shirley's children respectively. In consequence (unless the exception for non-associated operations applies), Sir John is treated as having made a transfer of value.

21.In order for the section not to apply, the Appellants must prove that the purchase of the annuities and the making of the life assurance policies were not "associated operations". The term "associated operations" is defined by section 268 IHTA. The relevant provisions for the purposes of this case are in section 268(1):

“(1) In this Act "associated operations" means, subject to subsection (2) below, any two or more operations of any kind, being-

(a) operations which affect the same property, or one of which affects some property and the other or others of which affect property which represents, whether directly or indirectly, that property, or income arising from that property, or any property representing accumulations of any such income, or

(b) any two operations of which one is effected with reference to the other, or with a view to enabling the other to be effected or facilitating its being effected, and any further operation having a like relation to any of those two, and so on,

whether those operations are effected by the same person or different persons, and whether or not they are simultaneous; and "operation" includes an omission.”

22.It was agreed, both by Mr Ryder for the Revenue and by Mr Smith for the Appellants, that paragraph (a) of section 268(1) is not in point. The annuity and the life policy are not the same property, and paragraph (a) only applies to operations which affect the same property. The question that needs to be determined is whether the purchase of the annuities and the making of the life assurance contracts fall within paragraph (b), namely were they made (i) with reference to the other; (ii) with a view to enabling the other to be effected; or (iii) with a view to facilitating the other being effected?

23.Mr Smith argued that the purchase of the annuities and making of the life assurance policies were not associated operations. He addressed each of the three tests in turn. First he argued that they were not purchased and made with "reference to" each other. I was referred to the decision of the High Court in Rysaffe Trustee Co (CI) Ltd v Inland Revenue Commissioners [2002] STC 872. This was a case which related to a settlor making five discretionary settlements by five separate trust instruments, each dated with a different date, in the belief that inheritance tax liabilities falling on the settled property would be lower than if he had made one settlement. Park J decided that there were five separate settlements for inheritance tax purposes (which decided the point in issue, and was upheld on appeal). But he went on to consider (in case he was wrong), at page 898, whether the formation of the five settlements were "associated operations":

“[36] What I have said so far is enough to mean that this appeal should be allowed, but in case I am wrong I wish to continue and consider the part of Dr Brice's decision in which she holds that the establishments of the five settlements and the subsequent transfers of parcels of shares to the five settlements were all associated operations. It is, I think, clear that she concludes that there were ten operations (five payments of £10, and five transfers of parcels of shares), and that each operation was associated with all of the other nine. This would not be a surprising conclusion since all the ten operations were part of a single scheme, but, having studied closely the detailed wording of s 268, I believe that the conclusion is not correct. I have already set out the text of s 268(1), but for convenience I repeat it here.”

[Here Park J quotes the provisions of section 268 which I have given above.]

“[37] A helpful way to approach the matter is to begin with one of the transfers of a parcel of shares, say the transfer of 'parcel 1' to settlement no 1. That transfer was certainly an 'operation'. The question is: with what other operations was it associated within the meaning of para (a) or (b) of s 268(1)? The question can be covered by asking it in detail of three other operations, as follows. (i) Was the operation of the transfer of parcel 1 to settlement 1 associated with the operation of paying £10 to settlement 1? The answer to this question is: yes, by virtue of para (b). The conclusion can be reached in either of two ways. First, the transfer of parcel 1 to settlement 1 was effected 'with reference to' the earlier payment of £10 to settlement 1 because the shares were transferred to be held on the trusts of the settlement created by the payment of the initial sum of £10. Second, the initial payment of £10 was effected with a view to enabling the later transfer of shares to be effected, because the purpose of the initial payment was to have a settlement in existence as the receptacle later for a holding of shares in Richard Utley Ltd. I comment before moving on that this conclusion would not in itself assist the Revenue's case. It would still mean that there were five settlements, not one. (ii) Was the operation of the transfer of parcel 1 to settlement 1 associated with the operation of transferring other parcels of shares to other settlements, say the transfer of parcel 2 to settlement 2? This seems to me to be the critical question. It has to be considered by reference to the detailed contents of paras (a) and (b) of s 268(1). Unless Dr Brice was right in her view that the two parcels were the same property (and in my respectful opinion she was not right, for the reasons which I have explained in [32] above), the first part of para (a) ('operations which affect the same property') cannot apply. The transfer to settlement 1 was an operation which affected parcel 1; it did not affect parcel 2. The transfer to settlement 2 was an operation which affected parcel 2; it did not affect parcel 1. The two parcels were not the same property, so the two operations did not affect the same property. The later wording in para (a) is plainly inapplicable. Turning to para (b), there are three effective parts of it. Taking them out of order, the second and third plainly do not apply. Neither transfer was effected with a view to enabling the other transfer to be effected. Nor was either transfer effected with a view to facilitating the other transfer being effected. The first part of para (b) refers to 'any two operations of which one is effected with reference to the other'. The argument is not so clear cut here, but on balance I do not think that this part of the paragraph applies either. It is true that each transfer was a part of one plan or scheme, but the transfer of parcel 1 to settlement 1 made no reference to the transfer of parcel 2 to settlement 2; and vice versa. Each transfer was effected in the knowledge that the other was being effected as well, but that does not seem to me to be the equivalent of saying that each transfer was effected 'with reference' to the other. So, with an acknowledgement that the contrary may be arguable because of the imprecise expression 'with reference to the other', my answer to this question (ii) is: no.”