Last month I reviewed a potential IHT scenario, where a widower is faced with a potential IHT tax bill of £340k: to arise on his death based on a chargeable estate of £1.5million. What action could be done to mitigate this anticipated liability?
Our widower’s current estate has £750k held as cash and securities generating annual income –it is well likely surplus income is building up:
- Use the IHT relief known as Normal Expenditure out Income
This comprises gifts made out of surplus income which are exempt from IHT liability provided the following criteria can be met:
- The gift (of surplus income) is part of the normal expenditure of the donor
- The gift is made out of income (taking one year with another)
- The gift must the leave the donor with sufficient income to maintain his/her usual standard of living
The following comments may assist in fulfilling the tests:
Gifts must be “regular” – the legal term is “habitual” –this could be quarterly or annually (say post 5 April –once the previous tax year’s assessable income is determined) as gifts are made out of “net” income.
The key criteria is that “regularity” must be shown –an individual cannot commence such an exercise say in year one and then change their mind in year two: it is acceptable for the quantum of such gifts to be varied; (say if earned or investment income should reduce as long as there is a clear “surplus” of income still available).
What is “income” and how long does it remain to be treated as “income” –there is no statutory definition but the HMRC (IHT) manual has recently been revised in this connection:
“taking one year with another” –as soon as income is “spent” or “invested” it ceases to be income –if income has “languished” in a current account, for two years, it is deemed by HMRC to be capital! (there is no official authority for this time period but the very act of transferring “income” to a deposit account will probably have “accumulated” it in the view of HMRC)!
Note especially that the popular recourse of extracting 5% withdrawals from a capital Investment Bond will not satisfy this “income” test for HMRC purposes; nor will the annual return of a capital proportion from a Purchase Life Annuity be accepted.
Practical Issues:
Detailed record keeping is paramount (of income and expenditure): HMRC do provide such a schedule, which is part of the IHT 400 Form required on death; but can be usefully adopted to provide a clear audit trail of such income / expenditure together with surplus income available –but HMRC do not publicise this!
Gifts out of surplus income are not required to be reported to HMRC –Capital Taxes Office –during lifetime; but have to be claimed by the deceased’s executors on death (viz the IHT 400 form). The onus is on the taxpayer (his personal representatives) to prove that income gifts were made out of surplus income to the satisfaction of HMRC. Unless appropriate, clear and identifiable records, have been kept, it is highly likely any such claim will fail! HMRC are absolutely meticulous in assessing such criteria have been met –any “weakness” will invariably fail and the exemption lost!
The tax payer should always produce a written declaration of intent to make such a series of gifts from his surplus income (viz to whom –the amount and the time interval/s envisaged).
This is a most valuable relief from IHT; but it is essential that the qualifying criteria are strictly followed to be successful!
Next month- using securities held on AIM –to qualify for (IHT) Business Property Relief
Andrew Murdoch (ACIB, AIFP, Dip PFS, TEP, Solicitor)
(The content of this article is only intended as information and should not be considered as legal advice. Andrew Murdoch cannot be held liable for any loss caused by any act or omission as a result of information in this article).
