On the face of it, HMRC’s recent report into gifting behaviour brings few surprises. The research found (perhaps as expected) that people were more likely to have gifted in the two years prior to the interview where they:
- were older (24% of those aged 70 and over had made a gift compared to only 3% for those aged between 18-29 years)
- had children (15% of gifters had children compared to 7% without)
- were in a higher income bracket (24% on income of £45,000 or more could gift compared to only 8% with income less than £17,500) or
- were in a higher wealth band (33% of people with assets worth more than £500,000 gifting compared to 5% with assets worth less than £100,000).
However, what is more surprising – or perhaps simply concerning – is that people’s knowledge of inheritance tax (IHT) rules and exemptions was relatively low.
Whilst 81% of those surveyed were aware that a donation to a charity or a qualifying political party was an exempt gift, 62% wrongly believed that giving a gift of £1,500 to a niece or nephew in consideration of marriage was exempt. When looking at the wedding/civil ceremony gifts the limits vary depending on the relationship of the donor to the recipient. A parent can give a child £5,000, a grandparent can give a grandchild or a great grandchild £2,500, but everyone else can only give £1,000. Having different amounts depending on your relationship to the person getting married can cause confusion.
A majority (54%) incorrectly believed that IHT will always be payable on gifts over £3,000 given in the seven years before death. During their lifetime an individual can gift £3,000 each tax year – known as the annual exemption. Any part of the annual exemption which is not used can be carried forward one year and used in the next tax year. The carried forward amount can only be used once the current year’s annual exemption has been used. Gifts over the annual exemption in any tax year might be subject to IHT but it is dependent on the value of the gift and the type of gift.
Let me explain. During lifetime an individual can make an outright gift to another individual, or to a specific trust such as a bare or disabled persons trust. These types of gifts are known as potentially exempt transfers and, provided the donor survives seven years, the gifts become exempt. However, if the donor dies within seven years, it is then no longer potentially exempt, becoming chargeable, and needs to be included in the estate for the IHT calculation. When calculating IHT the gifts sit at the bottom, in chronological order, with the rest of the estate on top. So, if the gift is covered by the deceased’s available nil rate band there will be no tax to pay on the failed gift. However, as the failed gift can use all, or some, of the available nil rate band the estate may have more IHT to pay.
In addition, gifts known as chargeable lifetime transfers (CLTs), which can create an IHT liability during the lifetime of the donor, may also be chargeable to IHT. CLTs are normally gifts made into trusts, rather than gifts made outright to individuals. Where the total CLTs made in a rolling seven year period exceeds the IHT nil rate band (currently £325,000), an entry IHT charge applies. This amounts to 20% of the excess over the available nil rate band and falls on the trustees to pay from the trust property. Then if the donor dies within seven years of making the CLT the gift needs to be included in the estate for the IHT calculation. If tax is payable on death, there is a credit for any lifetime tax but remember if the liability on death is less than the rate paid during lifetime there is no refund.
In order to gauge people’s knowledge of inheritance tax, various questions were asked. Interestingly 63% of those surveyed were unaware that in 2018/19, as a married couple or civil partners, on their deaths they could leave up to £900,000 to their children without them having to pay inheritance tax.
In 2015 the Conservative election manifesto was for families ’to be able to pass on up to £1m per couple completely tax-free, providing for your children and grandchildren, giving families across Britain more security’.
Since 9 October 2007 any unused nil rate band can be transferred to a surviving spouse or civil partner. Currently the nil rate band is £325,000 meaning that if everything is left to the survivor on first death there would be a £650,000 nil rate band on second death.
In order to meet their manifesto an additional nil rate band was introduced from April 2017 – known as the residence nil rate band (RNRB). Initially, the RNRB was set at £100,000 but increases by £25,000 each year until it reaches £175,000 in April 2020. Like the nil rate band, any unused RNRB can be transferred between spouses and civil partners to be used when the survivor of them dies. So, for the tax year 2019/2020 a married couple or civil partners potentially have a combined nil rate band of £950,000 (the survey is based on 2018/19 tax year).
However, as entitlement to the residence nil rate band is subject to certain conditions there is a lot of confusion on when it can be claimed. The property needs to be left to direct descendants; but what does direct descendant mean? People are aware that it includes children, grandchildren and more remote descendants; however less are aware that it also includes step, adopted, fostered and a child to whom the deceased was appointed as a guardian or a special guardian when the child was under 18.
Another condition is the tapering principle, where an estate is valued at more than £2 million; the RNRB will be progressively reduced by £1 for every £2 that the value of the estate exceeds the threshold. In determining whether the £2 million threshold is breached, it is necessary to ignore reliefs and exemptions. This means that business relief and agricultural relief are ignored when determining the value of the estate for the RNRB, even though they are taken into account to calculate the liability to IHT. However, as the £2 million is based on the value of the assets owned at the time of death, it does not include any lifetime gifts made by the deceased, even if they were made within seven years of death and are included in the IHT calculation.
Whilst the research shows gifting being used as we would have expected (to support family members), the quiz within the report highlights that people are unaware of the various exemptions and reliefs available, so getting the right advice is paramount to affect tax planning.
Kim Jarvis is a Technical Manager at Canada Life. She has worked in the life industry arena for over 20 years, with experience in trusts and their taxation, product development, the impact of new legislation on the industry and delivering training. She is an affiliate of the Society of Trusts and Estate Practitioners and a Chartered Insurer.