What are the rules?
Lifetime transfers are exempt from inheritance tax to the extent that:
- They are part of the normal, habitual or typical expenditure of the transferor;
- Taking one year with another, they are made out of income (i.e. not out of capital); and
- The transferor is left with sufficient net income to maintain his or her usual standard of living.
This is an extremely useful exemption. Unlike gifts deriving from capital there is no annual exemption of £3000 to worry about and no requirement for the transferor to outlive the gift by 7 complete years.
When do gifts become habitual?
HMRC will usually consider expenditure to have become normal or habitual or regular when they have been made three times, with the intention of continuing to make further similar payments.
However it is possible to establish the gifts have become part of one’s normal expenditure even if death intervenes after the first gift. What is needed is a clear intention on the part of the transferor that gifts will continue on a regular basis. These do not have to be for the same amount or to the same person, incidentally.
A contractual commitment to make regular payments will usually be accepted as evidence of an intention to make the expenditure part of the transferor’s normal pattern of expenditure. In the absence of such a commitment some other documentary evidence of the transferor’s intentions is advisable.
Record of income & expenditure
It is vital that a clear record of both income and expenditure is maintained on a year by year basis and that your Executors know about it and know where to locate it. When HMRC becomes aware that there have been lifetime gifts he will ask the Executors to complete a complex form requiring all relevant information. This can be a very difficult job for Executors and the transferor can make it a lot simpler by maintaining a year by year record.
Income consists of business profits, salary, pensions, rents, interest (including PEPs and ISAs), annuities, dividends and other investment income.
Deduct income tax payable to arrive at net income.
Expenditure will include such items as mortgage payments, insurance, household bills, council tax, travelling costs, entertainment, holidays, nursing home expenses and any other outgoings.
Net income less expenditure will establish your residual or surplus income.
Not everyone has surplus income of £50,000 to give away each year but the same principles apply to smaller gifts. Remember that income not spent or gifted will be added to capital and may well be charged to inheritance tax @ 40% one day.
You can be quite sure that any significant gifts out of income will be thoroughly scrutinised by HMRC. The examining officer will have to be satisfied that all conditions have been met but a well-kept record will go a long way in support of a claim. C&H Stedman will be pleased to provide you with a template on request.
For more info, give us a call on 01442 202650