An inheritance tax (IHT) relief was introduced in 2012 to encourage charitable giving. The relief applies a lower rate of IHT to an individual's estate where he leaves a certain proportion of his assets to charity and therefore may provide planning opportunities for individuals who intend to make charitable donations on their death. A summary of the way the relief works is set out below.
When does the relief apply?
The IHT rate is reduced from 40% to 36% for estates of individuals who die on or after 6 April 2012, leaving at least 10% of their taxable estate to charity. For the purpose of the relief, taxable estate means the value of the deceased's net assets after deducting the available nil-rate band, and any reliefs or exemptions other than the value of the charitable legacy itself.
- Anna's net assets at death are worth £1m.
- Her will leaves £70,000 to charity and the rest of her net assets to her son.
- Anna's estate qualifies for the full nil-rate band (£325,000) but no reliefs or exemptions, apart from the charity exemption, apply.
Anna's taxable estate is £1m − £325,000 = £675,00010% of the taxable estate is £67,500As Anna left £70,000 to charity her estate qualifies for the new 36% IHT rate.
IHT is charged on: £1m − £325,000 (nil-rate band) − £70,000 (charity exemption) = £605,000
Therefore, IHT on Anna's estate is: £605,000 × 36% = £217,800 (compared with £242,000 at an IHT rate of 40%).
What about assets that don't pass under my will?
The property which is chargeable to IHT on an individual's death may include more than one component. In addition to the free estate which passes under the individual's will, the following components are also chargeable to IHT (subject to the usual exemptions and reliefs):
- joint property that on death passes automatically to the surviving joint owner(s); and
- trust property where the individual has a right to the trust income (eg certain life interests in the trust).
It is important to note that merely ensuring that 10% of the individual's free estate is left to charity will not, of itself, mean that the other components also qualify for the lower rate of IHT on his death. Instead, the 10% test is applied individually to each component to ascertain whether the lower rate is applicable to that particular component.
What happens if one component qualifies for the lower rate and another doesn't?
If any property component qualifies for the lower rate, an election may be made to merge it with one or more non-qualifying components and the 10% test will then be applied to the merged components. Therefore, when deciding on the value of the charitable legacy in a will, the potential impact of the legacy on all relevant components should be taken into account.
If an individual continues to benefit from property that he has given away previously, this property may also be charged to IHT on his death. If so, it is also possible to take such property into account in a merger election.
Will gifts to foreign charities qualify?
Yes, provided that the charity is in the European Union, Iceland or Norway and would qualify as a charity under the law of England and Wales if it were based here.
Must the relief be claimed?
No, the lower rate of IHT will apply automatically if the 10% test is met. However, in some cases the administrative cost of valuing the assets may exceed the benefit of the relief. In such circumstances it is possible to opt out of the lower rate.
What factors should I consider when deciding whether to take advantage of the relief?
- The lower rate of IHT is only relevant for individuals who make gifts to charity on their death. Even if the lower rate applies, non-charity beneficiaries will always receive less compared with the position if no charitable legacy had been made and the estate was charged to IHT at 40%.
- The relief will not be relevant if the balance of the net estate over and above the charitable legacy is spouse exempt. Therefore, if married couples wish to make a charitable legacy with a view to obtaining the lower rate of IHT, they should ensure that their wills are drafted so that the legacy only takes effect on the survivor's death.
- For individuals who intend to leave at least 10% of their taxable estate to charity, then the lower rate will benefit both charity and non-charity beneficiaries.
- Individuals who intend to leave at least 4% of their taxable estate to charity can increase the amount left to charity to 10% without affecting the amount received by non-charity beneficiaries. This is because the cost of the increased charitable legacy is met through the tax saving produced by the lower rate of IHT.
This relief is advantageous for individuals who intend to leave charitable legacies. It is important that such persons review their wills, in particular if they are contemplating leaving between 4% and 10% of their taxable estate to charity, to ensure that (where appropriate) they obtain the full benefit of the lower rate of IHT.
If you require further information on anything covered in this briefing please contact a member of our Private Client Team on 020 3375 7000 or your usual contact at the firm. Further information can also be found on the Private Wealth page on our website.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, June 2016