The Office of Tax Simplification (OTS) recently released a report on simplifying the design of UK inheritance tax (IHT). This article highlights areas where taxpayers might take advantage of existing opportunities to make tax-efficient gifts and summarises the OTS’s recommended changes.
Lifetime gifting opportunities under the UK’s IHT regime remain somewhat misunderstood and underutilised. One of the main reasons for the introduction of IHT in 1986 was to promote lifetime gifting, but according to recent HM Revenue & Customs research, only 13% of the UK population are identified as “gifters”. For the purposes of the research, a “gifter” was recognised as “having given a single gift of £1,000 or more in the two years prior . . . or multiple gifts of at least £250 totalling £3,000 or more”. Of that 13%, approximately half admitted a genuine lack of knowledge of the IHT gifting rules.
The OTS recently published its Inheritance Tax Review – second report: simplifying the design of Inheritance Tax, in which it made a number of recommendations and identified areas of the current regime that are not well understood or which give rise to significant uncertainty. A key area identified as needing reform is that of lifetime gifts. Of the 3,000 people who undertook the OTS Inheritance Tax Survey, the majority were familiar with the “seven-year rule” (detailed below) and availability of the nil rate band, but were much less acquainted with the various other exemptions available. The report also identified areas of uncertainty around lifetime gifting, especially in relation to liability for payment of IHT on such gifts and the apportionment of the nil rate band (currently £325,000) between the lifetime gifts and the estate on death.
This article summarises the current IHT gifting regime in the United Kingdom to highlight where individuals might take advantage of existing opportunities to make tax-efficient gifts, and to point out where the OTS has recommended changes. The status of the OTS recommendations is unclear, as there is no requirement for these to lead to any legislative change; this is a topic that we are keeping under close review.
Annual Exemption and Small Gifts
Each UK taxpayer is entitled to a £3,000 annual gift exemption for IHT. Under this threshold, no IHT is payable and any unused portion can be rolled over for one year, meaning that if the entire annual exemption is unutilised in the current tax year, it is possible to have a £6,000 annual exemption the following year. This is a cumulative total, so any combination of multiple gifts totalling less than £3,000 is permissible. Any gifts made in excess of this exemption become potentially taxable and subject to the “seven-year rule”, depending upon whether the donor of the gift lives for seven years after the point of transfer and also the availability of his or her nil rate band in relation to the lifetime gifts.
In addition to the annual gift exemption, each UK taxpayer is entitled to the small gifts exemption. This separate exemption allows the donor to give £250 (or less) to as many different people as he or she chooses, but cannot be used in conjunction with the annual gift exemption or to reduce large gifts made to an individual.
The report stressed that the interaction of these two exemptions is somewhat confusing to taxpayers and suggested that the level of the small gifts exemption be reconsidered, which would be welcomed given that the small gift exemption has been frozen since 1980.
Gifts on Consideration of Marriage or Civil Partnership
This exemption allows UK taxpayers to give a couple a certain sum in celebration of their marriage or civil partnership, depending on the donor’s relationship to the individuals. Parents are permitted to give up to £5,000 IHT-free and grandparents can gift up to £2,500, while anyone else can gift £1,000 without any IHT consequences.
The report recommends eliminating the annual exemption and the gifts on consideration of marriage or civil partnership exemption in favour of a combined “personal gifts allowance”, which would undoubtedly simplify matters.
Spouse/Civil Partner Exemption
In general, all gifts to a spouse or civil partner are IHT-free, provided the spouses or civil partners have matching domiciles from a UK IHT perspective (i.e., both are UK domiciled or both are non-UK domiciled). In the event where one spouse or civil partner is UK domiciled and the other is not, the spouse/civil partner exemption is limited to £325,000, in addition to the nil rate band, for the UK domiciled spouse/civil partner on gifts to his or her non-domiciled spouse/civil partner. This is a cumulative total for lifetime gifts and on death, and does not renew every seven years. The exemption is still unlimited for gifts from the non-domiciled spouse/civil partner to that which is domiciled.
Normal Expenditure out of Income
This exemption can be extremely useful and permits regular gifts made out of surplus income (not capital) during a person’s lifetime to be considered IHT free on death, regardless of the seven-year rule. Arguments with HM Revenue & Customs have arisen in the past because there are no statutory definitions of “normal expenditure” or “income”. It is important for the donor’s personal representatives to be able to show that the gifts have a degree of regularity and are consistent in nature, and that the donor could maintain his or her standard of living, through bank statements, bills, tax returns, etc. The administrative burden required by this exemption confirms that thought must be given during the donor’s lifetime to prevent the reconstruction of records being necessary once the donor has died. As surplus income may vary each tax year, so too does the exempt amount, which can also make the precise value of this exemption difficult to ascertain.
The OTS has recommended that this exemption be reformed or replaced with the larger personal gifts allowance, discussed above.
When asked, only a quarter of the respondents who undertook the OTS Inheritance Tax Survey were aware of this exemption. The family maintenance exemption allows individuals to make IHT-exempt payments for a spouse’s or civil partner’s maintenance and also for the maintenance, education or training of children under the age of 18. There is no limit on this exemption.
Other Exemptions for Lifetime Giving
The following categories of gifts are also exempt from IHT and have no limit:
Gifts to qualifying political parties
Gifts to charities
Gifts for national purposes (to namedbodies)
Gifts of land to housing associations and registered social landlords
Assets of foreign armed forces, by virtue of their military service
More general recommendations in relation to gifting proposed by the report include reducing the seven-year rule to five years and removing the necessity to “look back” over fourteen years in certain circumstances, together with abolishing Taper Relief.
Some of the exemptions discussed in this article can be difficult to use and may raise additional considerations, such as other potential tax charges, including capital gains tax. Taxpayers may wish to seek expert advice before undertaking lifetime gifting.
If you would like advice on how to utilise the current lifetime gifting exemptions, before any legislative changes, please contact McDermott’s private wealth lawyers, Simon Goldring and Elysa Jacobs, for further details.