We have rebranded Retirement Advantage products as Canada Life. Visit our Retirement Account and Home Finance pages.
Please be aware the Canada Life International offices will be closed from 5pm Friday 21st December, re-opening at 9am on Thursday 27th December. Then closed from 5pm on Friday 28th December and re-opening at 9am on Wednesday 2nd January 2019.

Inheritance tax briefing note 1

Gifting as part of normal expenditure out of income

As inheritance tax (IHT) is a tax on capital transfers, if gifts are made out of surplus net income andmeet strict criteria, they will qualify as being exempt transfers. There is no seven year clock and they do not even impact the £3,000 annual IHT exemption.

The exemption is a valuable one which is often overlooked when undertaking tax planning. It does not disturb any other exemptions, nor does it constitute a chargeable transfer and can be used to prevent an IHT problem arising or getting worse.


What must be considered when dealing with normal expenditure out of income?

 

The legislation, in section 21 of the Inheritance Tax Act 1984, exempts transfers if, taking one year with another, it can be shown that the gifts:

  • formed part of the deceased’s usual expenditure
  • were made out of income, and
  • left the deceased with sufficient income to maintain their normal standard of living

The exemption is only available for gifts made out of net income and it should be emphasised that it does not apply to gifts made out of capital. This includes 5% investment bond withdrawals, even if held under a discounted gift trust and the capital element of purchased life annuity payments. The donor could not give away income and then rely on capital to meet their normal expenditure.

 

Bennett and others v IRC (1995)

 

The legislation, in section 21 of the Inheritance Tax Act 1984, exempts transfers if, taking one year with another, it can be shown that the gifts:

The exemption rules were considered in Bennett v IRC [1995] STC 54. In this case, the court identified several points to consider:

  • normal expenditure’ means when it took place it was part of the settled pattern of expenditure adopted by the donor;
  • ‘settled pattern’ can be shown from the expenditure of the donor over a period of time or by showing that the donor assumed a commitment or adopted a firm resolution, in relation to future expenditure and has then made gifts in accordance with that commitment;
  • there is no fixed minimum period to establish the relief;
  • where there is no formal commitment or resolution, it may be necessary to show a series of payments (three will usually suffice, two possibly);
  • there can be some variation in the pattern, but to claim the relief it must be shown that the donor intended a pattern to exist and to remain for a period of time, barring unforeseen circumstances;
  • the amount of the transfer does not have to be fixed; the amount does not need to be to the same person each time; the amount may be fixed by a formula such as a percentage of earnings or a figure such as ‘what is left over after paying nursing home fees’;
  • tax planning does not disqualify the expenditure, almost the reverse; if the taxpayer can show that he entered into a series of gifts having taken advice, and intending to make use of the relief in s.21 IHTA 1984, it will help that he took the advice in claiming the relief;
  • HM Revenue & Customs (HMRC) interpret net income as meaning income after tax and normal outgoings.

Record Keeping

 

It is important to check that there is scope for exempt regular gifts to be made and in this respect you could use the specific form that HMRC use for checking the exemption. IHT 403 incorporates a schedule, on page 6, which may be used to substantiate the claims to this relief.

Evidence should be kept to support a claim for this exemption to avoid the necessity to review old bank account records and suchlike to piece together a history of gifting. We have produced a Gift Record sheet for this specific purpose.

Reporting rules

 

To determine whether a report is required, the donor needs to add together any gifts made under this exemption in the preceding seven years with any chargeable lifetime transfers made in the same seven year period. If the total exceeds the donor’s nil rate band, a report is required using form IHT100.

HMRC will review the exemption at this time to confirm it meets the requirements and confirm their conclusion in writing.

Otherwise, if the total described above does not exceed the donor’s nil rate band, which is likely in the majority of cases, a report will not be required during the donor’s lifetime.

Where the total is within the donor’s nil rate band, HMRC will only consider the exemption after the death of the donor. The executors of the deceased’s estate will need to include a claim that the regular gifts should be treated as exempt as ‘gifts out of income’ using form IHT400 as well as form IHT403, as referred to above.


Typical planning objectives


These could include:

  • Can be used to regularly save into a policy written in trust
  • As the test is based on the donor there is
  • the potential to move large sums out of
    their estate
  • Can be used to prevent an IHT problem arising or preventing one from getting worse

This briefing note has been prepared for professional adviser use only.

The information regarding taxation is based on Canada Life’s understanding of applicable legislation, law and current HMRC practice as at February 2018. We recommend investors take their own professional tax advice.

This briefing note can also be viewed as a PDF

 

This website is for UK professional advisers only and is not approved for use by private customers.

Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

Canada Life International Limited and CLI Institutional Limited are Isle of Man registered companies authorised and regulated by the Isle of Man Financial Services Authority.

Canada Life International Assurance (Ireland) DAC is authorised and regulated by the Central Bank of Ireland.

Stonehaven UK Limited and MGM Advantage Life Limited, trading as Canada Life, are subsidiaries of The Canada Life Group (U.K.) Limited. Stonehaven UK Ltd is authorised and regulated by the Financial Conduct Authority. MGM Advantage Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority.