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Changes to UK Inheritance Tax rules

New amendments to the excepted estates rules for UK Inheritance Tax (IHT) means that normal expenditure out of income could be taken into account when valuing estates.

Amendments have been made to the excepted estates rules for UK Inheritance Tax (UK IHT) which could place an unwelcome burden on the estates of individuals who have undertaken planning to protect against a UK IHT liability. One amendment, effective from 1 March 2011, classifies all transfers above the £3,000 annual threshold as potentially chargeable.

Generally, an individual can give away up to £3,000 annually, either as a single gift or as several gifts totalling that amount. There are other exemptions such as the small gift exemption, gifts in respect of weddings or to charities, but where the amount gifted is not covered by one of these exemptions, it is potentially chargeable to UK IHT.

However, where it can be demonstrated that gifts not covered by the various UK IHT exemptions are part of a regular pattern of giving made out of surplus income (as opposed to eroding capital), these gifts are also exempt. Unfortunately, HMRC are now of the view that the exemption can be used inappropriately and, as a consequence, UK IHT is not being paid.

Case Study

Mr Smith has given £12,000 to his grandchildren over the last seven years. He dies with net assets of £300,000.

On death, the value of his estate (£300,000) is under the £325,000 nil-rate band.

For deaths prior to 1 March 2011, the additional £9,000 p/a that he gave away would be covered by the ‘normal expenditure out of the income’ rules and, as such, would have been ignored. As a result, only a short UK IHT return would have been necessary. The short UK IHT return does not require details to be provided for amounts considered covered by this exemption and, as a result, HMRC would not have been aware of the £84,000 given away over the previous seven years.

However, from 1 March 2011 onwards, £9,000 of the £12,000 given annually will be treated as ‘chargeable transfers’, increasing Mr Smith’s estate to £363,000, with the result that a full IHT return would have to be delivered. The full return will show the total amount gifted and the exemption being applied. HMRC are then in a position to check that the exemption is being applied correctly.

It’s very important to stress that the exemption itself is not being attacked or being capped at £3,000 per annum – it’s simply the case that HMRC want the amounts to be taken into account when ascertaining the value of a deceased’s estate. This will ensure that the correct UK IHT return is submitted to HMRC and, more importantly for HMRC, allow them to ask for further information which may or may not lead to UK IHT being payable.

Therefore, from 1 March 2011, where a person has transferred over £3,000 p.a. in the seven years prior to their death and they have considered that amount to be exempt as ‘normal expenditure out of their income’, the amount transferred must be included in the value of that person’s estate to determine what UK IHT return must be made to HMRC. This is despite the fact that the transfers may actually qualify for the exemption.

What impact will this change have?

There are a number of possible scenarios. However, if a UK domiciled client has purchased a product which is then placed in, for example, a Gift Trust and they are expecting the premiums they pay to be exempt transfers of value under the ‘normal expenditure out of income’ rules, they may need to be aware that premiums paid in the seven years prior to death may have to be disclosed by their personal representatives. Of course, all of this does depend on the size of the deceased’s estate.