Inheritance Tax Briefing Note
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1 Inheritance Tax Briefing Note September The new 36% rate September Introduction To encourage charitable giving through Wills the Government has announced a reduced rate of inheritance tax where a specific percentage of an estate is bequeathed to charity. The measures are effective from the commencement of the tax year 2012/13, but were finalised in the Finance Act Key facts 2.1. Effective in respect of all deaths occurring on or after 6 April Detailed provisions were introduced by Schedule 33 of the Finance Act 2012, which received Royal Assent on 17 July The new law is now embodied in Schedule 1A of the Inheritance Tax Act 1984, (the Act ). 3. Outline of the provisions 3.1. Simply put, where a minimum of 10% of an estate is given to charity, the taxable part of the estate qualifies for a reduced rate of inheritance tax (IHT) of 36%. The foregoing statement is an over simplification and attention has to be paid to the detailed provisions of Schedule 1A of the Act More precisely put, the reduced rate of IHT applies where 10% or more of the baseline amount is bequeathed to charity Different elements of a person s estate are subject to IHT on death and a baseline amount calculation needs to be carried out in respect of each separate element The separate elements of the estate for which baseline amount calculations need to be carried out are referred to in the legislation as components. 4. Learning the new definitions 4.1. The components: There are four components that can be taxable on a person s death and they are: The survivorship component This is property passing by survivorship on the death of a taxpayer The settled property component This is property in which, perhaps, the taxpayer had a life interest before dying and which is taxable as a result of the taxpayer s death The reservation of benefit component Rarely a taxpayer will have made a lifetime gift that remains in their estate due to the reservation of benefit provisions contained in the Finance Act When a taxpayer dies a tax charge can arise as a result of the reservation of benefit.
2 (Strictly speaking is not described as a component in the legislation for a good reason but it is convenient to treat it as one in this article.) The general component 4.2. The value transferred This is the component that will be encountered most frequently in practice. It is the estate passing on the death of a taxpayer and, most importantly, it EXCLUDES the preceding three components. In any estate the value transferred is the amount of an estate that is actually charged to IHT. It is arrived at by deducting from the component the following items: Any reliefs from IHT (such as APR or BPR) Any exemptions from IHT (such as charity or spouse exemption) The amount of any unused nil rate band (NRB) The amount of any unused transferrable NRB (TNRB) The donated amount In the new legislation this term is used to refer to the value of any charitable gift or gifts that qualify the component for a reduced rate of IHT The baseline amount This is a crucial definition to learn in understanding whether or not a component qualifies for a reduced rate of IHT. The baseline amount is arrived at by adding together the value transferred and the donated amount. 5. The new rule to learn If the donated amount is 10% or more of the baseline amount the IHT rate drops to 36% on the taxable element of a component. 6. A simple example 6.1. Veronica dies having made no lifetime gifts leaving an estate of 1,000, which passes entirely under her Will she is not a beneficiary of any trust she is married In her Will Veronica leaves:- 50,000 to charity (5%) 450,000 to her children subject to tax (45%) Residue of 500,000 to her husband (50%) 6.2. Analysing the example using the new definitions, we need to work out what are Veronica s component value transferred donated amount baseline amount The firm is not authorised under the Financial Services & Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services to clients because we are members of the Solicitors Regulation Authority. We can provide these investment services if they are a part of the professional services we are engaged to provide. Professional advice should always be sought for assistance in specific areas of the law, and we cannot accept any responsibility for any action based on these articles.
3 Veronica s general component is From that we deduct: Spouse gift Donated amount (charity gift) Nil rate band To arrive at the value transferred Add back donated amount (charity gift) Which gives us the baseline amount 500,000 50, ,000 1,000, , ,000 50, , Then apply the new test in paragraph 5 above Is the donated amount 10% or more of the baseline amount? Put another way, is 50,000 10% or more of 175,000? As 10% of 175,000 is 17,500, the answer to these two questions is an emphatic yes and the reduced rate of IHT applies to the gift of 450,000 to the children So out of an estate of 1,000,000 in this example, a charity gift of only 17,500 is required to qualify the taxable estate for the reduced rate of IHT of 36% 7. Merging components 7.1. It might be that when a taxpayer dies that taxpayer has more than one component that is subject to IHT For example, perhaps the taxpayer has a free estate (general component) that contains a mix of charitable and non charitable gifts and a trust of which the taxpayer was the life tenant (settled property component) that passes to taxable beneficiaries If the donated amount in the free estate is more than 10% of the baseline amount of the free estate, the personal representatives of the free estate can elect to transfer the excess of the donated amount to the trustees of the life interest trust (settled property component) to see if the IHT rate on the life interest trust can be reduced also to 36% The personal representatives cannot be compelled to make an election and, where there are more than two components, the personal representatives have freedom to choose which component should benefit from the excess of the donated amount The election can be made by the appropriate person in any component and therefore might apply to the trustees of a life interest trust (where the remainder is passing to charity), where an election by the trustees could conversely reduce the rate of IHT on the free estate Note, the representatives of the non-qualifying component cannot compel the representatives of a qualifying component to make an election, nor can they make an election themselves at any time. 8. Important duties 8.1. Wherever there is a component that is being charged to IHT on a death, and that component is shared in some proportion between a charity and a taxable beneficiary, or
4 is wholly passing to charity, the person(s) in charge of that component will be responsible for carrying out a baseline amount calculation to see whether or not: a reduced rate of IHT can apply to the taxable part of that component and/or there is any excess donated amount that might be shared with another component in order to reduce the IHT bill of that other component 8.2. Legal representatives administering estates should also make sure this test is carried out 8.3. Charitable beneficiaries will want to be sure that this job is done properly in every case for the reason set out in paragraph As the reduced rate claim is the subject of a formal assessment, it will not be possible to carry it out with estimated valuations. 9. A peculiar twist 9.1. There will be cases where the donated amount is less than 10% of the baseline amount so the reduced rate of IHT does not apply The fact that the IHT rate is reduced automatically where the donated amount is 10% or more of the baseline amount means that sometimes it will be worth seeking to try to increase the donated amount to 10% in order to qualify the taxable part of the component for the reduced rate of IHT Consider the position where there is a gift in a Will of a baseline amount of 100 with a percentage (donated amount) passing to charity. The same principles apply to baseline amounts of 1,000, 10,000, etc. The following table sets out who receives what if the charity takes 3 out of 100 that will amount to 3% of the baseline amount IHT of 40% is charged on the remaining 97, leaving passing to the taxable beneficiary Who receives what? % % % % Charity Inheritance tax rate Beneficiaries receive If the donated amount rises to 4 (or 4%) out of the baseline amount the taxable beneficiary receives But look along the table to where the donated amount rises to 10% of the baseline amount. Here you can see that the taxable beneficiary receives exactly the same as when the donated amount was only 4% Therefore, for a testator, increasing the donated amount from 4% to 10% will not result in any loss to the taxable beneficiaries. The increase is borne entirely by HMRC The question for charity beneficiaries is whether they will want, in circumstances where the donated amount is less than 10%, to suggest a Deed of Variation of a Will to increase the donated amount to 10% (or more even!). Apart from some small administrative costs, this cost of the increased legacy to charity will be borne entirely by HMRC Although the figures in the above table are based on a baseline amount of 100, if the baseline amount were 100,000, the taxable beneficiary could contemplate a deed of variation resulting in an increase of a charitable gift from 4,000 to 10,000 at no cost at all to the residuary beneficiary. The firm is not authorised under the Financial Services & Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services to clients because we are members of the Solicitors Regulation Authority. We can provide these investment services if they are a part of the professional services we are engaged to provide. Professional advice should always be sought for assistance in specific areas of the law, and we cannot accept any responsibility for any action based on these articles.
5 10. Action steps On every estate where there is a mix of Charitable beneficiaries non charitable beneficiaries and IHT payable The following are key points to bear in mind, whether the charity receives a pecuniary legacy or a share of residue Accurate valuations should be obtained of all relevant assets Accurate calculations should be carried out to establish the values and comparative values of: Each component Each donated amount Each baseline amount. Failure to carry out these steps properly at the outset of each administration could result in too much IHT being paid and a lost opportunity to increase a charitable legacy where it was originally less than 10% of a baseline amount Post death revaluations and elections to substitute lower sale prices for probate values might cause the relative proportionality of donated amounts and baseline amounts to change so that recalculations will be necessary further on in the administration Special rules apply where grossing up is necessary (due to the application of sections IHTA 1984). Where grossing up applies, it should first be carried out at 36% to see if the reduced rate of IHT applies. If it does not then a recalculation should be carried out at 40%. 11. Resources As well as carefully reading the legislation and commentaries on it, the HMRC manual provides useful guidance and further examples at paragraphs IHTM IHTM The comments in this note are for general information only and professional advice should always be sought for assistance in specific areas of law. Henmans LLP cannot accept any responsibility for any action taken based on the contents of this briefing note. For further information please contact, partner and head of charities, on: Tel: Date: September 2012 Prepared by Henmans LLP for ILM
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