Mark McLaughlin
CTA (Fellow) ATT TEP, General Editor of TaxationWeb, selects a 'question of the month' from TaxationWeb's Forum

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June 2006

Introduction

This month's TaxationWeb 'Tax Clinic' topic concerns inheritance tax (IHT) planning involving an important, and often under-used, exemption from IHT for 'normal expenditure out of income' (IHTA 1984, s 21). This exemption is important because, unlike some of the other exemptions (e.g. the annual exemption), the normal expenditure out of income exemption is not subject to an upper maximum, i.e. it is only restricted to the extent that gifts made satisfy certain conditions. Such expenditure is exempt where it can be shown that:

1. the income was part of the transferor's normal pattern of expenditure;
2. it was made out of his or her income (taking one year with another); and
3. the transferor was left with sufficient income to maintain a normal standard of living.

Q:

I do hope you are able to help shed some more light on the 'gifts that are part of your normal expenditure' stated in most IHT Gift Exemption Guides. I am assuming that 'after tax yearly income" includes, yearly interest on capital (i.e. interest on savings accounts, investments etc), as well as pension received. My mother wishes to gift some of her income to us on a regular basis which will not impact upon her normal standard of living. By gifting some or all of the yearly interest on her accounts she will also not increase her capital any further. Is there any more information available on this rather 'woolly' guidance.

A:

Editor's Comments

HMRC's view (see below) suggests that a habit of making gifts should be considered over a period of three to four years. However, they also accept that a single gift may be accepted as 'normal' if there is a commitment to making a series of gifts. HMRC may also look for a pattern of giving. Whilst not expressly stated in its guidance, a monthly standing order should establish such a pattern.

As the above rules and the responses from contributors below indicate, gifts must be made 'out of income'. HMRC regard this to mean 'current income'. In other words, if income is accumulated in a savings account over time, this may assume the identity of capital and therefore fail the test. To reduce this possibility, consider making gifts out of a current account.

Perhaps the most difficult condition to satisfy is the third, i.e. after allowing for gifts forming part of normal expenditure, the donor's usual standard of living must be maintained when the gifts were made. This is mainly because it can be difficult to prove to HMRC that this condition has been satisfied without sufficient records of income and outgoings.

The questioner asks about further guidance on the exemption. For HMRC's current thinking on the annual expenditure out of income exemption and how it is applied, reference should be made to their Inheritance Tax Manual (paragraph 14231 onwards).

Selection of responses from contributors

'Sherlock' commented:

From the information that you have supplied your mother would seem to meet the two main conditions of proposed gifts out of income exempted by section 21, IHTA 1984, - (1) that they are regular, and (2) that they are made out of net income.

'Lambs' commented:

You are clearly conscious of the underlying principle that your mother's capital base must not be diminished by these gifts.

Aside from that, she merely has to establish a pattern of giving - this does not mean regular fixed amounts to the same people but that she does indeed make gifts over a period of time.

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