Using power wisely

More and more people these days are executing a lasting power of attorney. This passes power over to those named attorneys to deal with the person’s property and welfare should the individual become incompetent to act for themselves. In this article, we refer to the person who has executed the power of attorney as the donor and the person(s) who have power to act on the donor’s behalf as the attorney(s).

In a number of cases, the donor may be a person whose estate is of such a size that there will be an inheritance tax (IHT) liability on death. In such circumstances, the attorney may wish to take steps, on behalf of the donor, to reduce that liability. The question therefore arises as to whether the attorneys can make gifts and, if they can, what factors should be considered?

Alternatively, the attorney might consider making IHT-efficient investments on behalf of the donor – for example investments that qualify for IHT business relief once owned for two years. Although the issues here are not as complicated as those that apply to gifts, there are still important considerations that need to be taken into account.

Unfortunately, space does not permit us to cover this aspect in this article. Before we examine the rules on gifts in detail, it is important to consider three important points:

(i) In this article we look at the position of attorneys – the same principles apply to deputies – people appointed by the Court of Protection (CoP) to look after the financial and welfare decisions of others.

(ii) Only attorneys who have power to act in relation to the donor’s property and financial affairs can make gifts. This will not apply to attorneys appointed only to make health and welfare decisions.

(iii) Different rules apply to powers of attorney in Scotland. We cover this briefly below.

The ability to make gifts 

In the light of some recent judgments by the CoP, the Office of the Public Guardian for England and Wales updated its legal guidance for professional deputies and attorneys on making gifts of a protected person’s property. The new guidance is included in Public Guardian practice note PN7 updated on 18 January 2018. It does not make any new rules but clarifies the position on gifts and confirms that the power to make gifts by an attorney (acting under a lasting power or an enduring power) or a deputy is very limited.

1.1 Best interests of the donor

It is a fundamental requirement of the law – section 4 of the Mental Capacity Act 2005 (MCA 2005) – that any action taken by an attorney must be in the ‘best interests’ of the donor. This includes the issue of making gifts – see 1.7 below. Because people’s circumstances vary so much, the bestinterests test is a subjective one.

1.2 What is a gift?

First, it is necessary to consider the meaning of ‘gift’, as it can have a wide ambit. A gift will occur when an attorney transfers ownership of money, property or possessions from the donor to other people, without full payment in return. A gift can include:

• Using the donor’s property to create a trust.
• Selling a property for less than its market value.
• Making an interest-free loan out of the donor’s funds – here the waived (lost) interest counts as a gift.
• Redirecting an inheritance received by the donor using a deed of variation.

1.3 The general rule

The general rule, covered in 1.5 below, is that attorneys can only make gifts on behalf of the donor:

• in some limited situations as set out in 1.5; and
• if the value of each such gift is not unreasonable having regard to all the circumstances and, in particular, the size of the donor’s estate.

For any gifts not covered by the statutory exceptions (1.5 below) or de minimis exceptions (1.8 below), the attorney needs to apply to the CoP before proceeding with the gift. The CoP has the power to either approve or refuse an application.

1.4 Donor’s capacity

The overriding principle of the MCA 2005 is to protect the right of an individual to make their own decisions whenever it is possible to do so. Before making a gift, an attorney must therefore consider the extent to which the donor can take part in the decision to make it.

If the donor has the capacity to make a gift, then they should normally make the gift themselves (because of the limits imposed on an attorney in making a gift). If the attorney considers that the donor has capacity to decide whether to make a gift, records should be kept of the steps taken to justify that view, in case of later challenge. However, an attorney must still use care and caution even if an apparently mentally capable donor decides to make a gift. If a substantial gift is involved, the attorney would be advised to seek independent advice or arrange for a mental capacity assessment (under MCA 2005), or both.

If the donor lacks capacity, then any gift that is to be  made will need to be made by the attorney.

1.5 When can gifts be made by the attorney?

An attorney is only authorised under the legislation to make gifts of the donor’s property in the limited circumstances permitted by section 12(2) of MCA 2005.
This states:

(2) The [attorney] may make gifts…

(a) on customary occasions to persons (including himself)
who are related to or connected with the donor, or
(b) to any charity to whom the donor made or might have
been expected to make gifts,
if the value of each such gift is not unreasonable having
regard to all the circumstances and, in particular, the size
of the donor’s estate.

(3) ‘Customary occasion’ means…

(a) the occasion or anniversary of a birth, a marriage or the
formation of a civil partnership, or
(b) any other occasion on which presents are customarily
given within families or among friends or associates.

(4) Subsection (2) is subject to any conditions or restrictions in
the instrument.

In short, to qualify for the statutory exception, any gift
made by the attorney must be:
- To a person related or connected to the donor.
- Made on a customary occasion.
- Be of reasonable value.

For attorneys acting under an enduring power of attorney, similar, albeit slightly narrower, exceptions apply and are detailed in paragraph 3(3) of Schedule 4 to the MCA 2005.

1.6 Gifts that are reasonable

Often the most difficult point will be whether the gifts are reasonable. This expression is not given a definition in MCA 2005 and so much will depend on the circumstances. However, the Office of the Public Guardian provides general guidance on the factors that need to be considered in this respect.

These include:

• The effect of the gift on the person’s financial situation. This extends to not only their current and future income, assets, capital and savings but also their present and future financial needs.
• Is the gift in the person’s best interests? (see 1.7 below)
• Are all members of the family being treated equally? If not, is there a good reason for this?
• Whether the attorney could be considered to be taking advantage of their position (such as by making gifts only to themselves or their family). 
• The degree to which the donor and the proposed recipient of the gift are connected or related.
• The donor’s previous history of gifting and The contents of the donor’s Will – this is indicative of the donor’s wishes.

1.7 The best interests test

A decision on the donor’s best interests is different from considering what the donor would decide if they had capacity. Thought needs to be given to:

• The donor’s past actions in making gifts (or loans) of a particular size and on a habitual basis before they lost capacity.
• The donor’s life expectancy.
• The possibility that the donor will have to pay for care costs or care-home fees in the future.
• The amount of the gift – in particular, the gift should be affordable and not exceed what would be normal on a customary occasion.
• The extent to which any gifts might interfere with the inheritance of the donor’s estate under their Will, or without a Will if one has yet to be executed and
• The impact of IHT on the person’s death. Particular care needs to be taken if an attorney is thinking of making a gift from the donor to themselves. Here, there is an obvious conflict of interests and consequently more chance of the attorney being called to account for their actions.

1.8 Gifts and IHT planning

While an application to the CoP will usually be required if the proposed gift is outside of the attorney’s statutory authority, following the case of MJ and JM and the Public Guardian [2013] EWCOP 2966, the CoP recognises that there are exceptions to this general rule. These de minimis exceptions apply when the statutory authority would be infringed in such a minor way that it does not justify a court application.

The de minimis exceptions cover the annual IHT exemption of £3,000 and the annual small gifts exemption of £250 per person, up to a maximum of (say) 10 people in cases where:

(a) The person has a life expectancy of less than five years
(b) The individual’s estate is worth more than the nil rate band for IHT purposes (currently £325,000).
(c) The gifts are affordable, taking into account the donor’s care costs, and will not adversely affect their standard of care and quality of life.
(d) There is no evidence that the person would be opposed to gifts of this value being made on their behalf.

However, being able to gift these small amounts without the permission of the CoP does not mean that an attorney can carry out more substantial IHT planning without the CoP’s permission – even if the gift would be covered by a different IHT exemption.

In McDowall and others (executors of McDowall, deceased) v Inland Revenue Commissioners [2003] SPC00382, an attorney appointed under a Scottish general power of attorney (which, under Scots law, survived the donor’s incapacity) made substantial unauthorised gifts from the incapable donor’s estate during the seven years before the donor’s death. The Special Commissioners held that the unauthorised gifts were voidable, on the basis that they could have been ratified by the donor before his death if he had had capacity. As a result, immediately before his death, the donor’s estate included the right to have the unauthorised gifts set aside and, for IHT purposes, this right was equal in value to the gifts themselves. The unauthorised gifts were therefore ineffective for IHT purposes and their value was added back into the donor’s IHT estate on death.

A power of attorney in Scotland is very strictly construed and attorneys are only authorised to act within the powers stated. If the power of attorney does not expressly contain a power to gift, then no gifts can be validly made. Under English law, as we note above, restricted gifts are permissible under section 12(2) MCA 2005 and the CoP can authorise gifts outside of those permitted by section 12(2) mof the MCA 2005 (see below).

However, despite the differences, it is thought that the result in the McDowall case is likely to have been the same under English law (whether made under a lasting power of attorney or a registered enduring power of attorney).

So, a financial consequence of the attorney making gifts outside of their authority is that theoretically the value of the (voidable) gift will be aggregated with the deceased’s estate for IHT purposes (although the issue will probably only be relevant if the validity of the gift is queried). Further, if the unauthorised gifts are challenged (perhaps because the recipients of the gifts are not beneficiaries under the deceased’s Will), then they may need to return the gifts to the deceased’s estate.

There could be many practical problems with recovering gifted sums, and this is certainly not a position in which attorneys should put themselves.

1.9 Gifts to a trust

The ability of an attorney to make gifts is restricted to gifts to “persons who are related to or connected with the donor”. If the view is taken that a trust is not a person (although technically the gift is to trustees of the trust), an attorney should not make gifts to trusts without prior approval from the CoP. This applies equally to situations where the donor will have an interest in or retain rights under the trust arrangement.

It should also be remembered that for these persons (although not for IHT purposes), the making of an interest free loan is deemed to be a gift of the interest waived (see 1.2) and this would therefore also preclude an attorney from entering into ‘loan-only’ trust arrangements on behalf of the donor without prior CoP approval.

1.10 Special cases

It should be apparent that if an individual lacks capacity and there is likely to be a substantial IHT liability on their death, the only option is to make an application to the CoP for authority to make a substantial gift.

Historically, a key difficulty with such applications has been how to argue that a substantial gift of the donor’s funds can in any way be in their best interests, as required by section 1(5) of the MCA 2005. However, where the incapacitated person is very wealthy, and it is certain that the proposed gift can be made without jeopardising their current or future financial position, the question arises as to why they should be denied the right to make gifts for IHT-planning reasons just because they are incapacitated?

The recent CoP case of In the matter of JMA ([2018] EWCOP 19) demonstrates that these types of application can succeed. The application was for various gifts totalling £7m made with a view to reducing the IHT liability on the incapacitated person’s (JMA’s) £18.6m estate. The gifts included a £6m gift to the applicant himself – JMA’s son and attorney, who was also the main beneficiary of his mother’s (JMA’s) estate.

The judge took into account a variety of factors including the affordability of the gift, JMA’s life expectancy, her family circumstances and the source of the wealth.

In dealing with the concept of best interests, the judge adopted the usual ‘balancing exercise’ approach of weighing the factors in favour of and against making the gifts, declining to treat tax mitigation as a pro or con in its own right.

While this was an unusual case, it does demonstrate that bringing such applications before the CoP should not be dismissed simply because the tax savings will be enjoyed by others.

1.11 Retrospective approval

If an attorney makes a gift that is beyond the scope of their powers (and for which approval should therefore have been sought) and they subsequently discover their oversight, they can apply to the CoP for retrospective approval. Sometimes these applications are voluntary, but sometimes they occur because of an investigation by the Office of the Public Guardian (which has powers to investigate if it has concerns – see 1.14).

Where gifts are disallowed on a retrospective application, it is likely that the attorney will be ordered to repay the money personally. Depending on the facts of the case, the court may also order the removal of the attorney.

1.12 What if the power of attorney expressly permits gifts?

Before the power of attorney can be used, it must be registered with the Office of the Public Guardian. If the power contains an invalid provision – such as one that permits the attorney to make gifts that are outside of their statutory remit – the provision will be invalid and will need to be removed before the power can be registered.

Previous decisions on severance applications by the Public Guardian provide some insight on whether or not words will need to be deleted:

In Re Barac [2013] MHLO 142 (LPA), the words “After having taken full regard for my financial welfare and security I want my attorneys to take sensible steps to protect my estate from the effects of taxation and be able to create trusts where beneficial” were severed on the ground that they contravened section 12 of the MCA 2005.

However, in JG (Case No. 12911940), the court found that the words “I would like my attorneys to consider Thomas G (my son) as my main priority when making decisions” did not prevent the document from being registered, as they constituted a simple expression of preferences that did not in any way bind the attorney.

The same stance was taken in DH (Case No 12911905), where the words used were: “I would like my grandchildren to be each given £1,000; I would like any funds left over to be equally shared between my children S, P and C.”

1.13 Deprivation of assets

When assessing whether a resident should contribute towards their care costs, the local authority can look for evidence of cases where there has been deliberate so-called deprivation of capital and assets. This will, in general, include cases where an attorney has made a gift on behalf of a donor if that gift was made with the intention of avoiding local authority care charges.

1.14 The impact of making an unauthorised gift

To minimise the likelihood of a challenge, attorneys should make sure that the donor’s money and property are kept separate from their own or others. They should also keep a record of transactions made on the donor’s behalf, particularly if the attorney lives with the donor and shares any costs or bills.

Challenges are most frequently made by those who have ‘missed out’ as a result of the attorney’s gift, for example, a relative who would have otherwise benefited under the donor’s Will, or even perhaps HMRC because of a reduction in an IHT liability on the donor’s death.

If gifts are made that go beyond the attorney’s authority without prior approval from the CoP, the Office of the Public Guardian may:

• Apply to the CoP to have the attorney removed.
• Apply to the CoP to suspend the attorney and to freeze the accounts of the donor for their protection.
• Instruct the attorney to apply to the CoP for retrospective approval of the gift (only in circumstances where the Office of the Public Guardian considers that such an application would have a reasonable chance of success).
• Ask the attorney to arrange for the gifts to be returned.

Ultimately, the CoP may refer the matter to the police or other appropriate authorities. This may result in a court hearing, where the attorney would be expected to go to explain their actions. The judgment may be reported and the anonymity of the attorney may be lifted. Legal action may be authorised against the attorney to recover the gifts or their monetary value.

Summary

As will hopefully be appreciated, the ability for an attorney to make gifts on behalf of a donor is limited. The position in relation to making IHT-efficient investments (not gifts) is more optimistic but there can still be complications.

This highlights the importance of implementing IHT planning sooner rather than later on the (incorrect) assumption that this can happen under a lasting power of attorney. If an attorney does propose to make gifts that are not covered by the statutory or de minimis exceptions, prior approval of the CoP must be sought before such gifts are made. 

John Woolley of Technical Connection/St. James’s Place.