Overlooked inheritance tax exemption
QUESTION: I am considering making regular gifts to my adult children. Do I have to survive each of these gifts by seven years in order for them to fall outside my estate for inheritance tax purposes?
ANSWER: A gift by one UK tax payer to another (other than a spouse which is exempt) is normally categorised as a Potentially Exempt Transfer (PET) whereby, once the donor survives the gift by seven years, the gift falls out of their estate for inheritance tax.
However, there are a number of small gift exemptions which can be relied upon to enable the gifts not to be considered as PETs. The minor gift allowances are £250 per annum per person, there is also the annual exemption of £3,000 per annum and if the previous year's exemption is unused it can be carried forward to enable you to make £6,000 of gifts in one year and there is also the ability to make a gift of up to £1,000 per person on the occasion of marriage which increases to £2,500 for a grandchild or great grandchild and up to £5,000 for a child.
An often overlooked exemption however is the “Normal Expenditure Out of Income” exemption (NEOOI). This is a very valuable exemption which can be used to mitigate inheritance tax because the gift or to give it its technical term “disposition”, is exempt and therefore it is irrelevant whether or not the donor survives the gift by seven years.
However, for the NEOOI exemption to apply, it is essential to show that the disposition meets three conditions. Firstly, the gift forms part of the donor's normal expenditure, secondly the gift was made out of income after taking one year with another and finally the gift leaves the donor with enough income to maintain their normal standard of living.
“Normal” does not normally mean regular or annual however gifts made on a regular basis are more likely to pass the normality test. There is no set timespan to establish a pattern of giving however HMRC normally look over a four-year period as a reasonable period when considering gifting patterns.
It is also advisable that the gifts made are of a similar size however it can be argued that gifts may vary in size if the donor has a fluctuating income. If the donor has to resort to their capital to meet their normal living expenses then the gifts will not qualify for exemption.
In summary, HMRC will typically consider five factors when considering whether a gift is normal and qualifies for the exemption those factors being the frequency of the gift, nature of the gift, amount of the gift, who the recipients are and what is the reason for the gift.
In order to claim this exemption, it is important to keep detailed records of gifts and of the income and expenditure of the donor. There is a very useful form on HMRC's website (IHT 403) which provides a schedule which can be kept over a number of years to prove that the gifts were made as part of normal expenditure out of income.
Following death when an estate is being submitted to HMRC by a solicitor, this form IHT 403 will be populated and submitted as part of the overall IHT400 return.
:: Paddy Harty (firstname.lastname@example.org) is a senior tax director at PKF-FPM (www.pkffpm. com). The advice in this column is specific to the facts surrounding the question posed. Neither the Irish News nor contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.