Giving Away Income
One of the least understood and, therefore, least used reliefs available under Inheritance Tax legislation is giving away what, in effect, amounts to surplus income. The Inheritance Taxes Act provides that such a gift is exempt from Inheritance Tax, provided that it can be shown that (1) the transfer was made as part of the transferor’s normal expenditure; and (2) the transfer was (taking one year with another) made out of the transferor’s income; and (3) the transferor, after allowing for all transfers of value forming part of his normal expenditure, was then left with a sufficient income to maintain his usual standard of living.
Thus, there are three basic requirements to ensure that the gift is within the legislation.
The first of these is that the expenditure must be normal. What this means is there must be a settled pattern of giving, so that for example a one off gift, never to be repeated, will fall outside of the relief. In effect there must be a commitment, which does not have to be legally binding, provided that there is evidence of an intention to make regular payments over a period of time. An example of such an intention would be the payment of annual premiums on a life insurance policy, the proceeds of which are designed ultimately to be paid to a third party. It is not necessary for the Act to work that the gifts are made to the same person, or indeed that the gifts are of the same amount, because of course the gift is one made from surplus income and that is likely to vary from year to year.
The gift must be made from income, and the word “income” is to be construed according to its ordinary meaning. It must be net income after tax has been paid on it, and it must be income of the current year, that is the year in which the gift is made. Years in relation to tax of course mean the tax year which runs from the 6th April to the 5th April. If income is accumulated and gifted a year or so later the Revenue will consider that to be a gift out of capital and the relief will not apply. “Taking one year with another” is very important. There must be a regular pattern of gifts, and so a gift made, perhaps in a very good year, after there has been some sort of windfall, will not be made out of income for the purposes of the Act if the gift does not adhere generally to the pattern of gifts in normal years.
The third requirement is of course that the transferor, having made the gift of surplus income, must be left with sufficient income to maintain his or her usual standard of living, after allowing for all transfers of value forming part of his normal expenditure, but ignoring other gifts that he may have made, perhaps out of capital. In other words it must genuinely be a gift of surplus income, the giving away of which does not detract from the transferor’s usual standard of living. Historically the law has looked to the ordinary man in the street and described him as “the man on the Clapham Omnibus”. In this instance that does not apply, the standard of living that applies is that of the individual who makes the gift. Thus, an extremely wealthy person who has a large income will benefit from this relief even if he or she gives away vast sums of surplus income in each year.
One of the problems with surplus income, itself a luxury I suppose, is that having paid income tax on it it can then be added to the estate and if it is not given away then Inheritance Tax is also paid on it.
Provided that the requirements of the Inheritance Taxes Act as outlined above are met then there is no limit and the gift can be as high as can be afforded without liability to tax. It is important to note too that the receiver of the gift does not pay tax, either capital tax or income tax.
It is also worth noting that if, from the beginning, it is established that there is a settled commitment to make gifts each year then it is quite probable that the relief would be granted by the Revenue if only one payment has been made before the donor dies.
August 2005
