Gifts out of Surplus Income

Most people will know that they are entitled to give £3,000 in any one year (or £6,000 if they have not made a gift in the previous year) without there being any inheritance tax implications.  If you make gifts over this amount and you die within 7 years of making that gift then the value of that gift is added to your estate at death for inheritance tax purposes.

This 7 year rule often deters many elderly or people who have serious illness from making lifetime gifts.

However, there is a further useful (and much underutilised) exemption that allows gifts over and above the value of £3,000 to be made without these gifts forming part of your estate if you die within 7 years of making them.

The exemption comes under the heading of “Gifts of normal expenditure out of surplus income”.  It is a particularly valuable way of gifting part of your estate to future generations on a regular basis.

The main requirements of this exemption are as follows:-

1.   Gifts must form part of a pattern of normal expenditure

  • There must be a regular pattern of giving.   HMRC have suggested that a pattern of giving over a period of 3 to 4 years should be sufficient;

or

  • The person making the gift has shown a commitment to make future gifts on a regular basis (e.g. by covenant).

2.  Gifts must be made out of income

  • Income can include salary, dividend income, deposit interest, pension income or rental income etc.
  • However it does not include capital sums arising from the sale of investment, lottery winnings, inheritances or maturity proceeds from endowment policies etc.

3.  The normal standard of living must be maintained

  • The person making the gift (the donor) must, after payment of the gift, have retained sufficient income to maintain their usual standard of living.  This standard of living is based on the habits of the donor himself and is not objective.
  • Generally, this means that after all living and other expenses have been deducted from a person’s annual income, the balance can be treated as surplus income and be gifted.

The exemption is not given automatically and on death requires the personal representatives of the deceased donor to claim this exemption.  The HMRC Account Form which is filed by the personal representatives when applying for probate, has a separate page for claiming this exemption and a detailed breakdown of the deceased’s annual income, living expenses and pattern of gift making must be set out.

Accordingly, in order to increase the chances of this exemption applying to your estate, it is important to make and retain sufficient record of gifts made during your lifetime which indicate an established pattern of giving.  This will assist your personal representatives upon your death.  In particular it would be useful to prepare a letter to accompany each gift (addressed to the recipient of the gift) stating that it is a gift made from surplus income.

Given that HMRC assess the application for the exemption on a case by case basis and have the authority to contest whether the qualifying criteria has been met, it is advisable to seek legal advice that is tailored to your needs so that the benefit of this exemption is maximised.

This article was written by Stephanie Brobbey, Solicitor, with assistance from Amantha Seneviratne.

This guide is for general information and interest only and should not be relied upon as providing specific legal advice. If you require any further information about the issues raised in this article please contact the author or call 020 7404 0606 and ask for your usual Goodman Derrick contact.