Judge refuses trustees’ petition to rectify deed of appointment after beneficiaries fell into ‘Frankland trap’

Lord Turnbull ruled that the deed accurately expressed the intention of the trustees at the date when it was executed, and the fact that they fell into the so-called “Frankland trap” as a consequence was outwith the scope of rectification.

The court heard that the late Lady Nickson, who died in 2012, executed a will in October 2004 which provided for the creation of a “nil rate band discretionary trust” in the event that her husband survived her for more than 30 days.

In a letter registered with her will Lady Nickson stated that the “principal object of the trust is to reduce the impact of inheritance tax on my family”.

The trust was duly established and the three petitioners, the deceased’s husband Lord Nickson, David Houldsworth, formerly a partner and then consultant with Brodies LLP, and the couple’s daughter the Honourable Felicity Lewis, were appointed as Lady Nickson’s executors and trustees.

As provided for in her will, the trustees were to hold a discretionary fund being a sum such as would exhaust the nil rate band of inheritance tax.

The income of the discretionary fund was to be made available for the benefit of any of the beneficiaries appointed under the will, but the letter stated that Lord Nickson should be regarded as the principal beneficiary and should receive the net income from the trust unless the trustees saw good reason to do otherwise.

The creation of such a trust was commonplace at the time as a method of reducing the impact of inheritance tax on the death of the first of a married couple.

The transfer to such a trust of an amount equivalent to the deceased’s unused inheritance tax nil rate band was a chargeable transfer to use that nil rate band up.

If the inheritance tax nil rate band was not used in a chargeable transfer at the time of death it was lost forever.

The use of such a discretionary trust was an effective way in which to utilise the two nil rate bands held by the married couple.

But the Finance Act of 2008 made certain changes to the Inheritance Tax Act 1984, the result of which is that a claim can now be made on the second death by the surviving spouse’s executors to transfer any unused nil rate band on the first death, provided that it occurred after 9 October 2007.

A nil rate band discretionary trust can be wound up so as to comply with the provisions of section 144 of the 1984 ACt, with the result that it can be deemed for inheritance tax purposes not to have existed.

If the trust had been wound up in this fashion, with the transfer of the trust assets to Lord Nickson, it would be as if they had been left to him outright and thus exempt from inheritance tax and the unused portion of Lady Nickson’s nil rate band would be carried forward for use on her husband’s eventual death.

In October 2012, a meeting took place at Brodies’ offices in Edinburgh to review Lady Nickson’s will and to discuss the administration of her estate, where advice was given concerning the change in the law which had taken place since her will was executed.

A decision was taken to dismantle the trust by deed of appointment appointing the trust capital to Lord Nickson outright, which was recorded in the Books of Council and Session.

However, the decision in Frankland v IRC STC 1450 meant that the trust required to be dismantled no earlier than three months after the date of Lady Nickson’s death, and no later than two years after her death, in order to benefit from the provisions of section 144.

Accordingly, Lady Nickson’s nil rate band would only be available to her husband’s estate if the deed took effect no earlier than three months after her death.

But those who provided advice to Lord Nickson at the meeting were unaware of the import of the Frankland case and what has been described as the “Frankland Trap”.

In these circumstances the question came to be whether the court could and should permit the deed of appointment to be rectified by adding the phrase: “such appointment to come into effect only on 5 December 2012 (and not before then)”.

If the deed was to have effect as suggested by the proposed rectification, then the trust would have been wound up in accordance with section 144 of the Inheritance Tax Act and Lady Nickson’s inheritance tax nil rate band would be carried forward for use on her husband’s eventual death, but the judge refused the petition.

In a written opinion, Lord Turnbull said: “In the present case the trustees intended to create a right by executing the deed of appointment. They had no intention of delaying the creation of that right as they were unaware of any benefit in doing so.

“The deed of appointment expressed accurately the intention of the trustees at the date when it was executed, since their intention was to create a right to the trust fund absolutely in favour of Lord Nickson. The legal result of the deed being executed was that the trust funds were made available to him, exactly as the trustees had intended.

“Applying the approach identified by Lord Macfadyen (in the case of The Governor and Company of the Bank of Ireland v Bass Brewers Limited and Others (2000)) of identifying what the grantor intended by way of the creation, transfer, variation or renunciation of rights and then asking whether the legal effect of the language used in the deed achieved the result that the grantor intended to bring about, leads to the conclusion that there is nothing to rectify in the deed of appointment.

“The fact that in bringing about their intended legal result the trustees fell into the ‘Frankland Trap’, and failed to achieve the underlying purpose of the whole exercise, seems to me to be a different matter and not within the scope of rectification.”