Patrick reviews the recent High Court judgment of Vaughan-Jones v. Vaughan-Jones  EHC 1086 (Ch) in which a defective deed of variation was rectified by the court.
Richard Vaughan-Jones died on 18 October 2009 and, under his will, he left his estate to his wife and three sons in equal shares.
On 13 October 2009, Mr Vaughan-Jones’s widow, his executors and his three sons signed a deed of variation, varying the terms of his will so that all of Mr Vaughan-Jones’s residuary estate was left to his wife.
When a deed of variation is properly executed, the terms of the will that are replaced by the terms contained in the deed are treated as though they had always been in the will for inheritance tax and capital gains purposes i.e. the estate’s tax liabilities are calculated with reference to the replaced terms (this is known as the “writing back effect”).
A perfectly executed deed of variation will meet the following criteria:
- it will be in writing;
- it will be signed by everyone whose entitlement from the estate is altered by the changes that the deed makes to the terms of the will;
- it will be signed by the executors of the estate if it changes the estate’s tax liabilities;
- it will have been signed within two years of the date of the death of the person who has passed away if it is to be effective for tax purposes;
- no consideration (i.e. money or money’s worth) will pass to any of the parties to the deed in return for making the deed; and
- the deed will state that the writing back effect applies to the terms of the deed with reference to the relevant legislation.
The reason that the terms of the will were varied in Mr Vaughan-Jones’s estate was to lower the estate’s inheritance tax liability. Anything that you leave to your spouse or civil partner is not subject to inheritance tax (this is known as the “spouse exemption”). In this case, the estate’s inheritance tax liability was reduced greatly because more of the estate was subject to the spouse exemption than under the original terms of the will.
Effective tax planning is the most common reason for creating a deed of variation.
The legal issue
The solicitor who drafted the deed of variation for Mr Vaughan-Jones’s family failed to include a vital clause in the deed he drafted. The missing clause needed to specify that s.142 Inheritance Tax Act 1984 and s.62(7) Taxation of Chargeable Gains Act 1982 were being applied to the deed for the writing back effect to apply to the estate.
This has been the law in England and Wales since the Finance Act 2002 was enacted and applies to all deeds of variation created after 1 August 2002.
The solicitor administering Mr Vaughan-Jones’s estate submitted the estate’s inheritance tax return to HM Revenue and Customs (“HMRC”), the error in the deed was spotted and HMRC refused to apply the spouse exemption. As a result, three quarters of the value of the residuary estate was subject to inheritance tax (before the application of any other inheritance tax reliefs) and the estate’s inheritance tax liability was therefore assessed at £232,000 rather than £32,000.
The application to the court
The solicitor who drafted the deed of variation died on 2 January 2014 and a new firm of solicitors were instructed to finish administering the estate.
The new solicitors made an application to the court to rectify the deed of variation based upon evidence from the previous solicitor’s file that the family’s intention was for the writing back effect to apply to the deed.
Rectification is an equitable remedy which allows for parties to a deed to apply to the court to rectify the deed where it fails to carry out their intentions either because of a clerical error or because of a failure on the part of the person preparing the deed to understand the instructions.
The firm relied upon the fact that the solicitor who drafted the deed was under tight time constraints (the deed was signed five days prior to the second anniversary of Mr Vaughan-Jones’s death) and was relying on an old precedent that predated the implementation of the changes to the law that were effective from 1 August 2002, resulting in a clerical error. In the alternative, the solicitor had failed to keep up to date with the relevant law.
The court’s decision
The court decided that there was convincing evidence that all of the family members who were parties to the deed had intended for the writing back effect to apply for inheritance tax purposes, but the court was not convinced that they intended the writing back effect to apply for capital gains tax purposes.
To be eligible for rectification, the court held that there must be:
- a real issue that needs to be resolved between the parties (i.e. that rectifying the deed will make a real difference); and
- convincing evidence that the intention of the parties to the deed was to create the document as it would be in its rectified form.
In this case, the real issues to be resolved between the parties were twofold. First, the inheritance tax liability of Mr Vaughan-Jones’s estate would change substantially depending on if the deed was rectified. Secondly, Mr Vaughan-Jones’s three sons were at risk of having made substantial lifetime gifts that would affect the inheritance tax position of their own estates if they died within seven years of making the deed i.e. before 13 October 2016. The reason it could affect the sons’ estates is that any gifts made in the seven years before death are included as part of a person’s estate when it is valued for inheritance tax purposes, subject to a taper relief depending on how many years prior to death the gift was made.
The convincing evidence that could be relied upon in this case was the testimony of one of the sons that he was advised and understood that the purpose and effect of the deed was to mitigate inheritance tax and the attendance notes that the solicitor who drafted the deed had kept of his conversations with the family members who signed the deed. The attendance notes clearly showed that the point of creating the deed was to lower the estate’s inheritance tax liability by increasing the amount of the estate that would qualify for the spouse exemption.