SearchA light shone on the limits of the IHT gift rule
The normal expenditure out of income exemption allows individuals to make gifts during their lifetime that are immediately exempt from inheritance tax (IHT), without the need to survive seven years. A recent case heard by the First-tier Tribunal (FTT) has provided further clarity on what is meant by ‘normal expenditure’.
The exemption
For gifts to qualify for the exemption, they must:
- Be made as part of the individual’s normal expenditure;
- Be made out of income; and
- Leave the individual with sufficient income to maintain their usual standard of living.
While the income requirement may seem straightforward, this is not always the case. There is no statutory definition of income for these purposes, and it does not necessarily align with taxable income.
For example, income can include non-taxable sources such as returns from individual savings accounts (ISAs). HMRC generally considers income to become capital once it has been accumulated for around two years.
The ‘usual standard of living’ is typically based on the individual’s circumstances at the time the gift is made. This means the exemption may still apply where a person makes regular gifts during a period of surplus income, even if their financial position later changes due to events such as redundancy.
What counts as normal expenditure?
The FTT case focused specifically on whether the gifts made by the taxpayer qualified as normal expenditure.
To meet this condition, gifts must be habitual or regular, although they do not need to be for a fixed amount.
In this case, the taxpayer had made a number of substantial charitable donations. However, HMRC challenged donations made to campaigns supporting the UK leaving the EU.
The exemption was denied for these particular gifts because:
- They were made over a period of just nine months, which was not long enough to establish a settled pattern;
- There was a lack of predictability in the timing and frequency of the donations; and
- There was no clear rationale for the amounts given.
Typically, a settled pattern would involve gifts being made over a period of three to four years. However, a single gift may still qualify if there is clear evidence that it was intended to form part of an ongoing pattern.
Further guidance
Detailed guidance on the normal expenditure out of income exemption can be found in HMRC’s internal manuals (IHTM14231 to IHTM14255).
Need advice on inheritance tax planning?
If you would like to understand how these rules apply to your circumstances, please email us imagine@hurst.co.uk or call 0161 477 2474.