Regular generosity can save tax

Inheritance Tax planning is all about reducing the value of your estate. The trouble is, transferring wealth to your family isn't a simple matter of making gifts as you'll usually have to wait seven years before they're exempt. But did you know some gifts, no matter how valuable, are exempt straightaway?

What's in a gift?

Why is there a problem? The calculation of Inheritance Tax (IHT) on death will depend upon what so-called chargeable transfers (which could include gifts) were made by you in the seven years before your death. These come back into your estate for the purpose of calculating the tax due. So the more gifts that can be brought into the calculation the better it is for the Taxman. There is even a statutory obligation on personal representatives of a deceased's estate to make this as complete as possible. However, there are some gifts that are exempt from IHT.

IHT exemptions

The gifts exempted from IHT are: (1) Small gifts. A miserly £250 per donee in any tax year. (2) Annual exemption. To the extent that transfers of value in any one tax year do not exceed £3,000 they are exempt from IHT, but this only goes against the first transfer you make in that year. (3) Gifts on consideration of marriage. The exemption is £5,000 per parent, £2,500 per grandparent or remoter ancestor and otherwise £1,000.

Although useful, these don't really add up to much each year. There is, however, a fourth exemption, which might suit you better which is for normal expenditure out of income.

What's normal? A transfer is exempt if it was made out of your net income but still leaves you with sufficient to maintain your usual standard of living (i.e. without resorting to capital). A good example is paying for a life insurance policy to benefit your offspring. Proving that your gift is normal expenditure out of income is the best solution for a gifting habit.

Taxman's view

Leading case. Traditionally, the Taxman has argued that a pattern of expenditure over the last three years had to be demonstrated to get the exemption, although leading case law has disproved this (Bennett and others v IRC). The judgment in this case came up with seven useful pointers as to what is normal expenditure.

Intentions are clear. We think the most relevant pointers are: firstly, you can make a single payment to start a commitment or demonstrate your intention. You don't have to do this each year, but your initial resolve must be for it to continue. Secondly, the expenditure does not have to be fixed (e.g. the vet bills for or the stabling of a horse), nor need the recipient be the same on each occasion (e.g. your generosity can be spread around the family or amongst needy friends).

Paperwork. Your intention to make the gift should always be evidenced in writing. This could be as simple as a letter to your dependant/friend or as formal as a deed drawn up by your solicitor. A letter should say something like "In recognition of your love and affection I resolve to settle your (e.g. costs of running a stable) for the foreseeable future. Signed on / / ." This makes your intentions clear to everyone, especially the Taxman.

Conclusion. If you intend to make gifts, the advice is, once you've started, keep on doing it. This is because gifts classed as normal expenditure out of income are exempt from IHT. It's better to give £1,000 a year (e.g. to hire a stable) for the next ten years than just £10,000 this year (e.g. to buy into one). However, you need to make your intentions clear from the outset so some paperwork is essential.

A "small" gift once a year is better than a "big" one, say, every ten years. So once you've started, keep on doing it. This is because gifts classed as normal expenditure out of income are exempt from Inheritance Tax.

If you need any more information or advice about inheritance tax, please don't hesitate to get in touch on 0191 386 4786

Regular generosity can save tax

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