This week, Alex Hatfield, a partner with The Private Office, our sister company, provides valuable information about an important aspect of estate planning.
The Private Office comes across many questions when speaking to clients about estate planning. One of the most common areas of misunderstanding surrounds the valuable ‘normal expenditure out of income’ exemption.
Gifting as normal expenditure out of income is a valuable exemption for you to claim, because if a gift, or ‘disposition’, is exempt, then for Inheritance Tax purposes, it is irrelevant whether or not the donor survives for seven years.
The exemption is set out under Section 21 of the Inheritance Tax Act 1984 and for the exemption to apply, the transfer of value must meet three conditions:
- It formed part of the transferor’s normal expenditure
- the transfers were made out of income (taking one year with another)
- after the gift, the transferor has sufficient net income to maintain their normal standard of living.
With this in mind, it is worthwhile understanding the rules, which were also considered in Bennett and Others v Inland Revenue Commissioners 1995, when claiming the exemption.
What does ‘normal’ mean?
The rules can be summarised as follows:
- ‘Normal expenditure’ is what is normal for the transferor, not necessarily the average person
- There should be a ‘settled pattern’
- There is no fixed minimum period
- There is no formal commitment
- There can be some variation
- The amount of the transfer does not need to be fixed
What are gifts made out of income?
- Generally, a gift of capital assets such as shares or jewellery does not qualify unless it was specifically purchased with income with the intention of making the gift
- Income should be determined each year in line with normal accountancy rules.
- Income is net income after the deduction of tax
- Income sources include earnings, rent, pension income, dividends and interest.
- Income sources do not include those which are capital in nature, such as withdrawals from investment bonds
- Generally HMRC will look at the income of the year in which gifts were made first. Income from previous years does not retain its character as income indefinitely. At some point it becomes capital but there are no hard and fast rules about this. Generally speaking the longer the income accumulates the more likely it has become capital.
What is maintaining a normal standard of living?
- The exemption will fail if the transferor is reliant on capital to meet normal living expenses.
The exemption is claimed by your executors on your death and is not claimed each tax year. As such it is important that:
- Your executors are made aware that you wish to claim this exemption and
- Your records are comprehensive and clear to reduce the possibility of the exemption being restricted or lost.
A pro forma document is available from HMRC which will assist:
It is important to consider this valuable exemption as it is often overlooked or misunderstood.
Along with other exemptions and reliefs it forms part of the various ‘house-keeping’ steps that we consider for clients when thinking about estate and succession planning.
As is often the case, record keeping is important and you should make your executors aware.
Alex advises on all aspects of financial, investment and retirement planning for a range of private clients. Historically, a large proportion of his client work has been dedicated to working with vulnerable persons and those who have suffered from a catastrophic personal injury or clinical negligence.
The Private Office is a trading name of The Partners of The Private Office Limited Liability Partnership, authorised and regulated by the Financial Conduct Authority. The Financial Conduct Authority does not regulate Trusts, Tax Advice or Wills.
For more information on Inheritance Tax planning or for a copy of our free guide, call us on 0800 321 3581