Taxation and Financial Considerations

for the Vulnerable Client

Law Society of Ireland

Solicitors for the Elderly Ireland

29 November 2011

Aileen Keogan

Solicitor & Tax Consultant

www.aileenkeogan.ie

“I intend to live forever, or die trying” Groucho Marx

Our society is ageing. Today’s 20 year olds are twice as likely as their parents to live to the age of 100. If you seek to fund a pension, an actuary will ignore the CSO tables that averages our living to age 80/82 and apply an industry standard for annuity funding where the assumption is that you will survive to age 100. This is on the basis that actuarily there is more chance that the very lifestyle today which allows you to fund a pension will keep you living for longer.

However it is becoming increasingly more difficult to fund this living. The Government has committed itself to increasing the age for paying State pensions from 65 to 68 over the next number of years, it is currently at 66. We were advised that the Fair Deal Nursing Home Scheme would allow everyone to afford a place in a nursing home. However, while the Subvention Scheme which applied free nursing care on a means test basis was abolished to be replaced by the Fair Deal, shortly after the launch of the Fair Deal, a ceiling was put on its funding and those in need of care are now on waiting lists to either enter nursing homes or have got in but must fund it themselves while on the waiting list. If you were prudent to have set aside funds in a private pension, you are now seeing these pension funds diminish through hidden administration costs, through cutbacks on the tax reliefs in the initial funding of the pensions, in annual pension levies and in surcharges where the pension is not drawn down annually after retirement. Coupled with that the pension funds have been decimated by the collapse of the investment market over recent years, where the value of ‘blue chip’ shares has been wiped out in the banking crisis. For those with disabilities, the current austerity measures are resulting in considerable cut backs.

So, if we are living longer, can we afford to do so? It is increasingly important to maintain what we have. As solicitors, we should seek to assist our elderly and vulnerable clients to ensure that what they have they hold as best they can so that they can afford to live.

The following is a checklist of issues that you should have regard to for your clients to ensure that they are able to maintain their assets without unnecessary taxes and without making themselves financially vulnerable into the future.

Pressure to gift

Gifts to family members and others

In light of the increasing rates of CGT and CAT and the likely proposed changes in the upcoming Budget 2012, families are concerned with the taxes that might arise on an inheritance in the future. Parents are themselves concerned with the taxes that their children will have to pay. Many are also conscious that their children have heavy mortgages and are under financial pressure to make ends meet. This can put an elderly person under moral pressure to use his own savings to put the child in funds to meet his debts and to do so in as tax efficient a manner as possible. This may be pressure of the parent’s own doing or more dangerously could be pressure brought to bear on the parent by a child himself. Either way however it is important that we as solicitors to such an elderly parent to ensure that the parent reflects fully on the implications of what he is proposing to do in making a gift to his child out of his own savings.

Can he afford to do without those savings now?
Can he afford to do without those savings later if he gets less of a return on his pension and other income?
Can he afford to do without those savings later if his outgoings increase such as having to fund for care in the home or in a nursing home for himself and his wife?
If the parent himself is making the gift, conscious of borrowings he himself has made, and thereby seeking to ‘protect’ his savings by gifting them on, is the creditor protection legislation likely to apply to render the gift void? Is he solvent without recourse to the gift assets?
If he is wanting to help his child pay his mortgage, is the mortgage likely to be paid off in full out of this gift or will that be just ‘good money going after bad’ where the bank will foreclose eventually?
If the child is married, how stable is the relationship between him and his spouse? Financial pressures can strain a marriage. Will the gift end up spent in divorce/ separation payments?
Is the child generally under financial pressure in relation to other borrowings, not just his family home where the parent is helping him out? If so, should the payment be routed through a form of asset protection trust so that the family home is protected?
Is the parent hoping to get back equity in the house when times come good and if so should it be a gift at all? Would a secured loan or a purchase of an interest be more appropriate?

These are matters that should be fully discussed with the elderly client before advising on the procedures in making a gift to ensure that it will be effective and a proper thing to do.

1.2.Ensure no cost to client

If the gift to be made will trigger CGT, it is important to bear in mind the seeming inequity of the CAT/CGT set off under s 104 CATCA03 and protect the client making the gift. In this relief where a gift is made which also triggers a disposal for CGT purposes, the CGT remains payable by the donor whereas the donee not only gets the gift but also gets the relief of the credit for the tax. The donee’s tax can be significantly reduced if not eliminated yet the donor is left with the tax bill.

Consideration should be given to structure the gift to shift the burden of the tax payment onto the donee. This can be done by providing that there is a partial sale of the asset for a consideration that equates to the amount of the CGT that the donor has to pay. That is not to say that the consideration is the payment by the donee of the donor’s CGT which in such a case results in no deduction for the consideration, albeit the credit is available. In the slides there is an example of how both a deduction and consideration can result in the parent not being out of pocket for the tax and indeed a tax saving is achieved.

Realising cash & asset protection

Often an elderly client is asset rich but cash poor. While this was more prevalent in the height of the Celtic Tiger as the assets felt more valuable, still where there is equity in a house and where there are ongoing costs (and indeed if the Fair Deal scheme taking 15% of your house over 3 years seems too much) clients may seek to release the equity in their homes.

The equity release schemes promoted by the banks and other lending institutions may no longer be available in these difficult economic times and in a way that is no harm given the concerns that have abounded in relation to these. The Guidelines issued by the Law Society (Conveyancing Committee May 2008 “Equity Release Schemes Guidelines”) suggest that, given the significant dangers identified by them in relation to these schemes, they should be treated with extreme caution and that a solicitor should have particular regard in the first instance to whether the money is really required, whether it is for the benefit of any other person, and whether safeguards are in place. Indeed the solicitor should explore any other options available and consider whether this is truly a ‘last resort’ method of raising cash.

Rights of residence can pose considerable difficulties and are not recommended as a solution to release equity or pass on assets for the following reasons.

as to whether proper value is being received for giving up a house where only a right of residence is maintained. If this is being done to pass on the house for tax saving purposes, then is this correct for the donor as he may need to use the house sale proceeds later to fund his living?
as it is not necessarily the most tax efficient structure to adopt. Where there is a gift element involved a further benefit is taken on the death of the holder of the right of residence on the value at date of death. Such a value may be significantly higher than the value when the right was created. The tax rates may also have increased.
as it is important for tax reasons that the right of residence is not made exclusive. It may however be a huge worry for an elderly person that others would have the right to live in the house also.
as a precaution, if going this route, the solicitor acting for the donee/purchaser should ensure that the owner of the right of residence executes an Enduring Power of Attorney to ensure that the house can be sold where consent of the owner of the right of residence is required.

The sale of a reversionary interest is generally a more tax efficient way of releasing equity allowing protection for the elderly client by ensuring reasonable value being obtained, security of living in the house and tax efficiency for the purchaser of the reversionary interest. Usually this is better done as a sale to whoever is likely to inherit the house so that the payment in advance of monies will be offset by the perceived reduction in CAT (as there would then be no CAT on the death of the life tenant). It is best confined to the house only to ensure that Principal Private Residence Relief is available for CGT purposes in the hands of the Reversioner on a later sale. The method of the sale can appear to be complicated but is fundamentally a sale of a future interest. If it is necessary for the purchaser to borrow to fund the purchase, care should be taken to avoid the property itself being charged.

Complicated structures

Separately for tax planning reasons, again particularly in light of the increasing capital taxes to date and as anticipated in Budget 2012 and future budgets, a parent may be introduced to a tax planning ‘structure’ that seems an eminently sensible matter to undertake. Care should be taken to ensure that your client, the elderly person involved in the structure, understands what it is all about and what the purpose of the complications are likely to achieve.

The difficulty is that often there are considerable tax and financial risks associated with complex structures. In such cases, is your elderly client able to cope with the risks? What may be somewhat low risk in the mind of a middle aged person could prey more on the mind of the elderly person. Therefore the likes of the general anti avoidance caveat given to clients may sit uncomfortably on the mind of your client, putting unnecessary stress on him. Tax is not always certain and the question of whether to utilise the facility of an expression of doubt or a protective notice in itself can cause stress and anxiousness to all involved (even the advisers!) but possibly more so to the elderly client.

An example of this is the sub-sale schemes put in place for the CAT/CGT set off after the two year hold period was introduced. In some cases put and call options were used to bind the ultimate sale after two years. In these cases questions arose

as to whether this would be caught as anti avoidance, so the CGT would not be effectively set off in reducing the CAT, and the consequences at that time of secondary liability
the CGT had still to be paid by the donor/parent at the beginning of the transaction even though no sale had gone through
there was a risk that the ultimate purchaser would not complete despite the option rights because the purchaser is insolvent
whether the tax was overpaid depended on valuations. Were the values correct at the time of the gift so no refund would be available now even if the sale has fallen through - the gift was made at the height of the market?

Where holding periods are required for tax planning purposes, e.g. in the case of business relief, agricultural relief, dwellinghouse relief or where there is a doubt or risk, care should be taken to ensure that the elderly client is comfortable in taking the risk particularly where the risk will impact on him if it comes to pass. The risk tolerance profile of an elderly person is often much lower than that of the younger generation.

Where there are complicated structures for tax purposes, you should ensure that when acting for the elderly client (who is receiving your legal advice independent from the advice given to the child) that the taxation advice is addressed to your client and not the child so that the taxation adviser outlines the risks for your elderly client.

Correct tax payments – rates and reliefs

The following is a list of various reliefs and special provisions for the elderly or those with a disability. As the list is amended annually, it is best to obtain updated details from the Revenue website, www.revenue.ie, where all conditions are clearly set out.

It is recommended that the elderly client should seek formal advice from an accountant or other person best qualified to file income tax returns if the income received is not from a source that will deal with the tax payable on a PAYE basis.

Income tax

The Universal Social Charge(USC) 4% rate only applies (not top rate 7%) for age 70 plus or if hold medical card (if under 70). This USC is not chargeable on income that is already subject to DIRT or payments from the Department of Social Protection

In the year of death of a deceased there will be adjustments to the credits for income for a widow(er) where the couple had previously filed under joint assessment. It is recommended that in the year of death, when seeking to finalise the pre death income and capital gains tax position and seeking a Revenue letter of no audit so as to be able to distribute and close a probate file, an accountant be engaged who could then ‘put order’ on the matter for the surviving spouse in future dealings with Revenue.

Other reliefs that would be relevant from time to time are

Dependant relative relief
Incapacitated child tax credit
Employed person taking care of incapacitated individual
Home Carer’s tax credit
Medical Insurance relief
Medical expenses and income tax

Capital taxes

Again advice should be taken if required to assist in ensuring that the conditions to capital tax reliefs are fully availed of. The obvious ones available for vulnerable adults are as follows

Exemption from CAT for benefits taken for the support, maintenance, education of minor child where both parents have died s82(2) CATCA03

Exemption from CAT for benefits taken exclusively to discharge medical expenses of a permanently incapacitated individual s84 CATCA03 [but note Revenue interpretation of the legislation that the benefit must state the qualifying purpose].

DTT – exempt levies if the discretionary trust is made exclusively for the benefit of persons and for the reason that all such persons are because of age or improvidence, or of physical, mental or legal incapacity incapable of managing their own affairs s17(1)(d) CATCA03

By way of example a tried and tested solution to offer a parent seeking to protect a vulnerable child is to create, either during the parent’s lifetime or under the Will, a specialised trust for that child’s benefit which can avail of the above specific tax reliefs and also protect the child financially and put structure to his finances. Indeed it is a useful asset protection structure for the child in the event of the child incurring liabilities (in the case of the improvident child) and for the moment in the event of the child seeking means tested State benefits. This can be a valuable protection for the person with a disability, particularly where the giving of a weekly allowance to a person with a disability can give that person a sense of dignity that he has his own (albeit small amount of) money and can spend it as he wishes, quite apart from the valuable medical card, free transport, heat and phone allowances and the possibility of obtaining funding for accommodation, sheltered or otherwise, that come with the package of benefits once the means test is passed. Each of these add on benefits is valuable in the financial sense as each reduces the costs that would otherwise have to be funded elsewhere. Obviously this is subject to State cutbacks on the funding of these benefits and therefore there is still a need to have a pool of funds set aside in the specialist trust.

The typical specialist trust usually incorporates a discretionary trust with a limited class of beneficiaries together with a shorter than usual trust period where the trust can expire on the death of the person with the disability. This shorter period avoids a trigger of Discretionary Trust Tax (levies) at the death of the person with the disability.

Compliance issues

Surviving spouse

In light of the heavy surcharges for late filing of returns and interest, the penalties for the underpayment of taxes and the risk of publication as a named tax defaulter in the national press, it is imperative to be tax compliant.

It may seem obvious to us all that returns should be filed but, in the case of an elderly person recently widowed whose spouse had looked after all the paperwork, either the task may be too daunting and therefore it may be ignored or the need to file may just never occur to the survivor.

As already mentioned it is advisable that the elderly client seek formal advice from an accountant or other person best qualified to file income tax returns at least to ‘put order’ on the matter for a beneficiary in future dealings with Revenue.

It would be useful to inform the client that if a tax refund is available or a capital loss can be claimed (to set off against a future gain), this should be done at the very latest by 31 December of the fourth year of the year of assessment in which the claim first arose. For example in relation to expenses incurred today, November 2011, these should be claimed back on or before 31 December 2015 or else the refund is lost altogether.

Trustees

Likewise where a trust for a vulnerable person is created, the trustees should be made aware of their ongoing requirements to file income tax and capital gains tax returns and, to the extent there are distributions, for the exemptions to be claimed. The exemptions are available but usually on a claims made basis and not automatically and the four year time limit rule also applies in such instances.

The Attorney under an Enduring Power of Attorney (“EPA”)

The Attorney (as appointed under a registered Enduring Power of Attorney) should take care to act in accordance with his powers and his fiduciary duties in financial matters.

General authority

Assuming the Attorney is given general authority to act and his powers are not specifically restricted under the EPA, then the Attorney has power to do all things on behalf of the donor which the donor can do by attorney in relation to the donor’s financial and business affairs.

The term “affairs” is defined in the Power of Attorney Act 1996 (“POA 1996”) as the “business and financial affairs” of the donor which term is then not defined in any useful manner. Therefore the common meaning should be attributed to the term. Interestingly the legislation goes on to define “personal care decisions” (Section 4 POA 1996) as including “housing, social welfare and other benefits” (see paragraph (g) of the definition of personal care decision in Section 4 POA 1996) and the power permits another attorney to be appointed in relation to such personal care decisions. This could lead to conflict between say social welfare affairs that relate to the payment of benefits. As the matter of finances is entrusted to the ‘general attorney’, in my view, while the issue of what type of welfare benefits should be accepted and used by the donor should rest with the ‘personal care attorney’, the actual receipt of monetary benefits should rest with the ‘general attorney’.

The Attorney has power to do all things on behalf of the donor which the donor can do by attorney in relation to the donor’s financial and business affairs. The extent of the authority conferred by an enduring power is therefore a matter firstly for the general law. In Clauss v Pir 1988 1 Ch 267 the meaning of the equivalent provision in the UK at that time was considered and held that the attorney could not lawfully swear an affidavit on the donor’s behalf. The donor can lawfully do most things by attorney except

Where statute requires the evidence of the donor’s signature; or
Where the donor’s competency to do the act arises by virtue of holding some office, public or otherwise; or
Where the donor’s own authority or duty to do the act is of a personal nature, requiring skill or discretion for its exercise.

Therefore the attorney cannot sign the donor’s Will, act as a trustee on behalf of the donor or, in the case of a solicitor donor, advise clients in the capacity as attorney of the solicitor.

Fiduciary Duties

Attorneys are fiduciaries of the donor. In such case the general rule encapsulated in the maxim ‘delegatus non potest delegare’ (which translates roughly as “a delegate cannot delegate”) applies so that the attorney who himself is a delegate cannot in turn delegate his role as attorney. Nevertheless, as the attorney does not have to possess any particular business or financial skills in taking on the role of caring for the business and financial affairs of the donor, the attorney should be mindful of his fiduciary duties to act prudently and therefore should and has power to engage or employ competent advisors such as a solicitor, auctioneer, accountant, investment adviser. The rule that has therefore emerged from case law on trustees who are also restricted in delegating is that trustees may employ an agent where this is in accordance with the ordinary custom of business and this should be the situation for attorneys. They must exercise reasonable care in selecting the agent and must exercise their own discretion in making the selection. However the trustee may only delegate ministerial or administrative functions and he must personally exercise his fiduciary discretions. In practice it can be difficult to identify the precise boundary between the administrative functions (which may be delegated) and discretionary functions (which may not).

The expression "fiduciary duty" is properly confined to those duties which are peculiar to fiduciaries and the breach of which attracts legal consequences differing from those consequent upon the breach of other duties. A fiduciary is someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence. The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his fiduciary. This core liability has several facets. A fiduciary must act in good faith; he must not make a profit out of his trust; he must not place himself in a position where his duty and his interest may conflict; he may not act for his own benefit or the benefit of a third person without the informed consent of his principal. This is not intended to be an exhaustive list, but it is sufficient to indicate the nature of fiduciary obligations. They are the defining characteristics of the fiduciary. The nature of the obligation determines the nature of the breach. The various obligations of a fiduciary merely reflect different aspects of his core duties of loyalty and fidelity. Breach of fiduciary obligation therefore connotes disloyalty or infidelity. Mere incompetence is not enough. A servant who loyally does his incompetent best for his master is not unfaithful and is not guilty of a breach of fiduciary duty.

Three specific rules apply to fiduciaries

The double employment rule

A fiduciary who acts for two principals with potentially conflicting interests without the informed consent of both is in breach of the obligation of undivided loyalty; he puts himself in a position where his duty to one principal may conflict with his duty to the other. This is sometimes described as "the double employment rule". Breach of the rule automatically constitutes a breach of fiduciary duty. Given that the donor of a power in the case of a registered enduring power of attorney cannot give informed consent, the attorney should not put himself in a position to act for another principal in conflict with the donor.

The no inhibition principle

Even if a fiduciary is properly acting for two principals with potentially conflicting interests, he must act in good faith in the interests of each and must not act with the intention of furthering the interests of one principal to the prejudice of those of the other. This is sometimes called "the duty of good faith". Given that the donor of a power in the case of a registered enduring power of attorney cannot act for two principals, one of whom is the donor, this rule should be less relevant to the attorney as he should not be in that position in the first place.

The actual conflict rule

Finally, the fiduciary must take care not to find himself in a position where there is an actual conflict of duty so that he cannot fulfil his obligations to one principal without failing in his obligations to the other. If he does, he may have no alternative but to cease to act for at least one and preferably both. The fact that he cannot fulfil his obligations to one principal without being in breach of his obligations to the other will not absolve him from liability - "the actual conflict rule".

All of the above however could be circumvented by application to the Court under s12 POA1996 for the Court to “authorise the attorney to act for the attorney’s own benefit or that of other persons than the donor ….” with such restrictions and conditions as the Court may impose.

3.2.3 Limitations on powers?

As already mentioned while an attorney has the power to do what the donor can do, this is governed by the general law and therefore is limited. Practical issues as follows arise

Instances already mentioned are that the attorney cannot make the Will of the donor. Interestingly that may change to the extent that the Mental Capacity Bill 2010 introduces the concept of the Statutory Will, albeit the Court will be involved in such a case.

There is a potential for conflict when the attorney must consider whether assets must be sold to meet the needs of the donor e.g. if the family home is to be sold to fund nursing home expenses. If the attorney has family who are or he himself is living in the family home, will he want to sell it? What if the attorney knows he will inherit the house under the Will of the donor as a specific bequest and the sale will defeat that inheritance by virtue of the doctrine of ademption)? What if the solicitor is instructed to sell the house and is aware that the house is the subject of a specific devise in the Will of the donor – should he tell the attorney that the bequest will be adeemed? These are difficult issues and in the overall the question should be how best are the needs of the donor served in whether the house should be sold or not.

Can the attorney carry out tax planning for the donor? Is he obliged to do so to minimise the tax? Again in this situation care should be taken to see who is actually benefitting from the tax planning, the donor or another? The attorney is likely to have the power to do so if it is in the best interests of the donor but not however if there is any element of a gift being made by the donor to another. This is because of the statutory prohibition on gifts as dealt with below. This is again subject to the possibility of the attorney applying to the Court under s12 POA1996 for the Court to “authorise the attorney to act for the attorney’s own benefit or that of other persons than the donor ….” with such restrictions and conditions as the Court may impose and indeed applying for “directions with respect to the management or disposal by the attorney of the property and affairs of the donor”.

Can the attorney file returns and appeal tax assessments issued by Revenue? The attorney can sign as agent for the donor and, if it is in the best interests of the donor to appeal an assessment can do so, in as much as the attorney can litigate on behalf of the donor in the general sense. Care would obviously need to be taken to ensure that the attorney has sufficient knowledge of the facts of what the donor had filed previously with Revenue to ensure that the case at issue is solid.

Must the attorney file tax returns for the donor? As the attorney is under a duty to protect the assets of the donor, he is obliged to ensure the donor is tax compliant particularly in light of the heavy surcharges for late filing of returns and interest, the penalties for the underpayment of taxes and the risk of publication as a named tax defaulter in the national press.

Can the attorney act on behalf of the donor who is appointed a trustee? An attorney appointed under the POA 1996 cannot act as trustee. This power must be given to the attorney by statute (such as is available in England).

The power of the tenant for life to sell settled land was removed under the Land and Conveyancing Law Reform Act 2009 and now trustees have full powers of an owner to sell or otherwise deal with land held in trust under s 20 of the 2009 Act. However the power under s20 could be qualified, restricted or varied under s20(1)(b) of the 2009 Act and more powers given back to the tenant for life.

It is important when drafting a trust which transfers the powers from the trustees to the tenant for life to provide for how the powers are to be exercisable in the event of the tenant for life lacking sufficient mental capacity such as authorising an attorney under an enduring power of attorney to exercise those powers. If the trust deed is silent on this and the tenant for life were to subsequently lose capacity and the powers were required to be exercised, the trustees would be required to apply to Court to dispense with the powers of the tenant for life even if the tenant for life had executed an EPA. In addition the tenant for life should be encouraged to make an enduring power of attorney while that person has the mental capacity to do so to enable the attorney to deal with the powers granted.

Can the attorney act as personal representative to an estate on behalf of the donor? The POA 1996 is silent on this and indeed on the question of the attorney continuing the administration of an estate in the event the donor loses capacity in the course of administering the estate of another. In England in the case where a donor is entitled to apply for a grant and he loses his mental capacity, the attorney under the equivalent EPA can do so for the use and benefit of the donor. There seems no reason why this cannot be done in Ireland as the Probate Rules envisage grants being taken out by attorneys but it is not clear. The Law Society Guidelines on EPAs indicate that the attorney under an EPA has no right but possibly that is indicating no automatic right to do so.

The remuneration of the attorney is only permitted if expressly authorised by the EPA itself. However expenses of the attorney are permitted.

The attorney must produce accounts in accordance with s12 POA 1996, keep the accounts of the donor separate from the attorney’s personal accounts and would be best placed to maintain an inventory of assets to produce to the donor’s personal representative on the death of the donor.

The attorney’s powers cease if he becomes a bankrupt and his appointment is not allowed if he is a bankrupt when applying for registration of the EPA.

Nov 2011 | Vulnerable Adults - Financial and Taxation Issues Lecture

1.2.Ensure no cost to client