Hitting a moving target

He may be an unlikely culprit but Napoléon Bonaparte is partly to blame for inheritance tax (IHT). The first type of death duty dates all the way back to 1694, but later, in 1796, a further tax on estates was used to help fund the war against Napoleon’s France.

This brief history lesson could make IHT seem like a quaint relic from a long-forgotten age, but more than 200 years later it is still a great earner for HM Treasury. The government looks set to collect around £30bn from estates over the next six years alone.

Napoleon was unlikely to be thinking of estate planning when he said, “Victory belongs to the most persevering”, but regular reviews are the only way to ensure plans that are in place today meet tax planning objectives tomorrow.

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It is rare that an estate plan will involve just one solution. The impact of IHT on an estate can be reduced today, but plans also need to deal with rising asset values. Excess income also needs to be taken into account to avoid accumulation and exacerbation of the IHT problem.

This is where the gifts from surplus income exemption – which is widely underused – come in.

Gifts from surplus income

A gift will benefit from a full and immediate IHT exemption if, or to the extent that, it complies with certain conditions, namely:

– The gift was part of the normal expenditure of the transferor;

– That, taking one year with another, it was made out of his or her income;

– That the transferor was left with sufficient income to maintain his or her standard of living.

Normal expenditure

The question of whether a gift forms part of an individual’s normal expenditure will depend on the facts and circumstances of each case. For example, someone with a modest income, but low expenditure and frugal tastes may be able to give a fairly high percentage of their income away.

A person with a substantially higher income, but larger commitments may be unable to make any gifts out of their income without reducing their standard of living.

A single payment may qualify where a pattern of continuity is established. For example, the first contribution under an insurance policy, or any payment made under a contractual obligation would indicate an intention of regularity. If there is no such evidence, but further similar gifts are made, the first gift of the series can qualify retrospectively for exemption.

You should note that normal does not mean regular or annual.

In Bennett and others v Inland Revenue Commissioners (1995) it was held that the term ‘normal expenditure’ denotes expenditure which, at the time it took place, was in accordance with the settled pattern of expenditure adopted by the transferor. The existence of such a settled pattern might be established in one of two ways: either by reference to a sequence of payments by the transferor out of past expenditure, or by proof of a prior commitment or resolution adopted by the transferor regarding their future expenditure.