Inheritance tax: reduced rate for estates leaving 10 percent or more to charity

Peninsula Team

June 08 2012

At Budget 2011, the Government announced that Finance Bill 2012 would include legislation at Sch. 1A IHTA 1984 introducing a lower rate of inheritance tax of 36% (from the normal 40 %) where a deceased leaves a charitable legacy of 10% or more of their net estate (after deducting inheritance tax reliefs, exemptions and the nil-rate band) when they die on or after 6th April 2012. Following consultation, draft legislation was published on 6th December 2011 to be included in Finance Bill 2012.

In March 2012, it was estimated that the relief will cost the Exchequer around £60m per year in reduced IHT liabilities. Donations made in accordance with of deeds of variation will also be counted in determining whether the relief applies to the estate.

This measure will primarily affect people who are considering leaving, or who have already left a charitable legacy in their will. The personal representatives of people who have died and the beneficiaries of their estates may also be affected. Solicitors, estate practitioners, accountants and other professional advisers who deal with or advise on wills, estates and inheritance tax (IHT) will also be affected.

This policy supports the Government's aim to encourage charitable giving, promote greater philanthropy, and links into the Government's objective of fairness in the tax system. The aim of the policy is to act as an incentive for people to make charitable legacies, or to increase existing legacies, and so increase the amount charities receive from estates.

The measure will have effect for deaths on or after 6th April 2012.

Currently on death, IHT is charged on estates where the net value is more than the IHT threshold or ‘nil-rate band’ (currently £325,000).
A person's estate for IHT purposes includes not only the assets that they directly owned immediately before their death and which they are able to dispose of under the terms of their will (their ‘free estate’) but also certain other assets and property. These include jointly owned assets which pass automatically to the surviving joint owner, interests in certain types of trust (settled property), and some other assets which the individual gave away during their lifetime whilst continuing to derive a benefit (gifts with reservation of benefit). All these different categories of asset combine to form an aggregate estate that is subject to IHT.

This aggregate estate is reduced by a number of reliefs and exemptions. For example, assets passing to a spouse or civil partner are exempt, and certain business assets may qualify for business property relief. Gifts made to qualifying charities are exempt from IHT. After deducting the various reliefs and exemptions most estates are below the available nil-rate band and so are not liable to IHT.
IHT is charged at a single rate of 40 % on the net chargeable value of an estate (after reliefs and exemptions have been deducted) over the available nil-rate band. 

The distribution of a deceased's estate can be altered after death by executing an Instrument of Variation if the relevant beneficiaries agree. Where beneficiaries redirect all or part of their inheritance to charity, they can elect for those charitable gifts to be treated for IHT purposes as if they were made from the deceased's estate. This applies not only to assets passing under the deceased's will, but also to assets passing under the intestacy rules and to jointly owned assets passing to the surviving joint owner.

Where the estate comprises only the deceased's ‘free estate’, the value of the estate on which the 10 % threshold will be based (the ‘baseline’) will be the value of the net estate charged to IHT after deducting all available reliefs, exemptions and available nil-rate band, but excluding the charitable legacy itself. The total amount of charitable legacies will be compared with the baseline amount to see if the estate qualifies for the reduced IHT rate (the ‘10 % test’). 

In cases in which the IHT estate includes assets additional to those in the ‘free estate’, the 10 % test will be applied to each category of assets (or component) that makes up the aggregate estate such as the ‘free estate’, jointly owned assets and settled property. If the assets passing to charity from one component exceed 10 % of the baseline, other components may be merged with it to give an aggregate baseline. The value of the assets passing to charity from a particular component will be compared to the baseline amount for that component. If the 10 % test for a component is passed, IHT will be charged on that particular component at 36 %. 

The reduced rate of IHT will apply automatically if the estate or component passes the 10 % test. If it does not, IHT will be charged at the full rate. However, personal representatives and other relevant persons will be able to elect for the reduced rate not to apply if, for example, the benefit obtained from applying the reduced rate is likely to be minimal and they do not wish to incur additional costs of valuing items left to charity. 

The new provisions will apply equally to charitable legacies made by will or by an Instrument of Variation. The conditions for an Instrument of Variation to be taken into account for IHT purposes will be amended so that the reduced rate will only apply if it is shown that the charity has been notified that the devolution of the estate has been varied in its favour.

HMRC has published guidance on the reduced rate of Inheritance Tax payable and there is a new calculator which will work out the charity donation required to qualify for the reduced rate in addition to this the Inheritance Tax manual will soon be updated to reflect the changes.

For any further information on any of the issues outlined in this piece, please call the Advice Service on 01455 852555.

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