Rollingsons

An under utilised exemption from IHT is gifts that qualify under the normal expenditure of income rules.  For those taxpayers with relatively high income (or business owners who have an element of discretion as to whether to retain profits, within the business, or pay out as annual dividends or salary); it be can be advantageous to apply this useful exemption.

A gift, out of net income, should qualify for this exemption if (it complies with certain conditions):

·         The gift was part of the normal expenditure of the donor; and

·         that (taking one year with another) it was made out of income; and

·         that after allowing for such transfers forming part of normal expenditure the donor was left    

          with sufficient income to maintain his standard of living.

Some commentary is required on these conditions; the criteria are subjective in nature.  The question of whether a gift constitutes “normal expenditure” must be answered according to all the facts and circumstances of each particular case.

Two examples may highlight the subjective nature of this test:

A widow with children grown up, frugal tastes, no mortgage and regular pension income (from late husband’s pension provision), will probably save a high proportion of this income; it appears she could give away this proportion (to her family) and it be treated as part of her normal expenditure.

Compare to:

Another individual - albeit with higher income, but with relatively large family commitments and outgoings (including mortgage) and no history of savings - may find it difficult to establish any gifts (out of income) as normal expenditure, as such gifts would reduce his standard of living.  

A pattern of gifting must be established, but the payments need not necessarily be repetitive.  Regularity is an essential character of any payment under these rules; HMRC acknowledge there is no set time limit for the purpose of demonstrating a habit of giving but a span of “three to four years” would be reasonable. 

How do you determine “normal” expenditure? HMRC regard normal as “habitual” (i.e. according to the “norm” of giving which the donor has established). It was held by the Court (Bennett v IRC) that “normal expenditure” accorded with a settled pattern of expenditure.  This could be either:

·         Reference to a sequence of payments by the donor out of past expenditure; or

·         Proof of a prior commitment adopted by the donor regarding future expenditure (e.g. regular premiums to be paid under a pension or insurance contract or instalments for the benefit of another individual).

“Out of Income”

There is no specific requirement for such gifts to be made after tax is deducted from income.  However, in practice PAYE is deducted from employment income and, for those individuals with investment income (which is usually received net of tax at source), any additional tax liability invariably is paid out of income.  Thus, taking income after tax merely reflects theavailable income.

However, if an individual is based abroad, for say three or four years, suffering reduced tax deducted; then he does not have to take tax into account.

Between spouses, it can be advantageous to transfer income producing assets for income tax purposes (say from husband to wife).  This practice could enhance the wife’s ability to make normal income gifts.

Are there any snags?  The capital element of a purchased life annuity and withdrawals within the 5% allowance of an investment bond are not treated as income for IHT purposes.

Record keeping: no requirement for such (income expenditure) gifts to be returned to HMRC; nevertheless it is eminently sensible to keep a record of such gifts, in case the donor’s personal representatives are required to provide evidence on the donor’s demise.

Donors would be wise to maintain careful records (of income/ expenditure) not only for the year in which such income gifts are made, but in several years before and after to ensure a pattern can be proved.  If the income tax year is adopted (6th April to following 5th April), this will make it relatively straightforward to match available income against expenditure.

It is perfectly acceptable to resolve to establish a pattern of gifts (say quarterly) – provided the donor will live long enough for such regularity to be established. A specific written declaration of intention would assist and an individual’s own financial plan would be a good starting point.

For further assistance please contact Gareth Hughes, Head of our Private Client Department on  0207 611 4848 or by e-mail at ghughes@rollingsons.co.uk to arrange a consultation.