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Inheritance Tax incentives for charitable giving

The Government wishes to encourage higher levels of charitable giving.

In the post-credit-crunch era levels of individual donations have declined, and with charities seen as having a key role in the Conservatives Big Society, and with reduced public services, funding of charities is being encouraged by the tax system.

Gifts to charities attract relief against both income and capital gains tax for lifetime gifts, through the Gift Aid system, and have full relief from Inheritance Tax for gifts on death.  A further incentive is being introduced from 6 April, with a reduced rate of Inheritance Tax of 36 per cent on estates where 10 per cent is passing to charity. 

It is hard to judge how effective this will be in encouraging higher levels of charitable legacies.  Where charitable gifts are not part of a testator’s plan, adding a 10 per cent gift to charity will actually reduce the net benefit to the individual beneficiaries.  With an estate of £1million passing to two children, where the nil rate band has already been used, a 40 per cent charge will leave them with £600,000.  If 10 per cent passes to charity, the remaining £900,000 would be taxed at the reduced rate of 36 per cent; after tax of £324,000 they will be left with a net benefit of £576,000. 

Nonetheless, paying less tax is a strong attraction for many taxpayers, and some may be encouraged along this course.  It should certainly be of interest to those already considering leaving a portion of their estate to charity and with the tax incentive they may be encouraged to increase the amount to secure the reduced rate of tax.

Unfortunately, the application of the new tax rules is going to be complicated.  The estate is actually divided into three elements. 

  • The survivorship element - assets owned by the deceased jointly which pass to the surviving owner.
  • Settled property - a trust where the deceased was the life tenant with a qualifying interest in possession. 
  • The general component - assets within the actual estate passing under the will.

The lower rate of IHT applies if the charitable giving condition of 10 per cent is met for any of these components.  However the test is ‘cliff edge’, so there is no tapering of the rate if the legacy is just below the 10 per cent figure.

The test is applied by comparing the donated amount with what is called the baseline amount.  This is the net value of the assets in that particular component, after deducting:

  • Any available nil rate band.
  • Exemptions, other than the charity exemption, such as the spouse exemption.
  • Reliefs such as agricultural or business property relief. 

There is a further complication with the ability to elect to merge some of these components.  For example, if the donated amount for one component was 15 per cent and for another component was 8 per cent, the merged component might then qualify as exceeding 10 per cent overall.  There are other complications for the professional adviser in less straightforward situations, for example where agricultural and business property relief is involved. 

It is not unusual for beneficiaries to want to make charitable gifts out of an inheritance, and this can most effectively be done using a deed of variation.  The new relief can be captured by this means, and indeed it may be easier to make the necessary calculations after the event, when the circumstances of the estate and all the values are known.  At present a Will which secures the relief, and achieves the necessary 10 per cent level, is going to require skilful drafting, whereas with a deed of variation the position should be more straightforward. 

An alternative approach to estimating the right level of provision would be to have discretionary arrangements, with appropriate guidance via letter of wishes to executors, to try to achieve a given result, in the light of the values applying at the time of death.

It is to be hoped that, notwithstanding the fact that individual beneficiaries are likely to receive a lesser amount where this relief is sought, and the considerable complications involved in planning and drafting the will, the attraction of a lower rate of Inheritance Tax will be sufficient to increase the level of charitable giving.

By:

Jeremy Passmore, Partner at Thomson Snell & Passmore.

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