One of the most valuable exemptions available for gifts to individuals from an Inheritance Tax (IHT), is sometimes overlooked – that of “normal expenditure out of income”
S21 IHTA 1984 sets out that a transfer of value is an exempt transfer if it can be shown that:
- It represented part of the transferor’s normal expenditure
- Taking one year with another, it was made out of income
- The transferor was left with sufficient income to maintain his usual standard of living
Normal expenditure
“Normal” is taken to mean habitual and therefore requires a pattern of giving to be demonstrated. HMRC are usually prepared to accept that expenditure becomes normal after 3 occasions, with all the payments (including the first 2) becoming eligible for the relief. Intention is also sometimes good enough to establish the pattern.
There is no fixed minimum period during which the expenditure shall have occurred – what is necessary, is to show on the evidence available that a pattern of actual or intended regular payments shall have been established.
The amount of the expenditure does not need to be fixed in amount however, what is necessary is that evidence can show the conformity of each payment with an established pattern of expenditure by the individual concerned.
Made out of Income
Income is generally referred to as an individual’s disposable income after tax and after all living expenses.
Income also refers to current income and therefore the relief will generally not apply if the source that may have originally been income has become capital in nature. HMRC’s view is usually that “income” becomes “capital” after a period of 2 years.
The key to this valuable relief is keeping sufficient evidence to prove that gifts were made out if income.
One way to do this is to use something like the table below to record the position:
| Income | £ |
| Salary / pensions / dividends / rents | X |
| Less: income tax paid | (X) |
| Net income | X |
| Expenditure | |
| Mortgage / rent | X |
| Insurance | X |
| Household bills – utilities / council tax etc | X |
| Travel and holidays | X |
| Entertainment | X |
| Other | X |
| Total expenditure | X |
| Surplus of income over expenditure (available for gifts) | X |
Planning
If gifts qualify for this relief, the amount gifted is immediately outside of the estate for IHT purposes – there is no seven-year survivorship period that applies and therefore you can see how valuable this can be especially for individuals with high surplus income levels.
It is important to keep good records and important to move surplus income as it arises, to stop any surplus becoming capital in nature. So, when looking at your IHT planning, be sure to utilise this valuable relief alongside the annual exemption, to increase the value of any gift where possible.
Written by Paul Dell
For more information on any of the above information, please email paul.dell@raffingers.co.uk