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Catching HMRC in a charitable mood?!
Article date: 22/08/2012
As Jeremy Bentham, the early 19th century English author, jurist, philosopher and legal reformer so aptly stated, "the power of the lawyer is in the uncertainty of the law" and in the case of the reduced inheritance tax rate (from 40% to 36% for testators who leave 10% or more of their net estates to charity) he may well have hit the proverbial nail on the head.
Such is the idiosyncrasy of the law that the reduced rate took effect for all deaths on or after 6th April 2012, despite the fact that the Finance Act 2012 which introduced the legislation only received Royal Assent on 17th July 2012.
The intention behind the legislation is to incentivise people to make charitable legacies, or to increase existing legacies, and so increase the amount charities receive from estates. Whether the legislation will meet the government's objective to encourage charitable giving and promote greater philanthropy remains to be seen.
It is estimated that the cost to the Exchequer in terms of decreased inheritance tax receipts will be approximately £60millon per annum.
In terms of the impact on individuals and households, it is highly uncertain how many estates will be affected. The assumption is that the number of estates where a person will increase the amount they leave to charity to 10% will be about 50 in 2012/2013, increasing to about 1,000 in 2015/2016 and eventually to about 5,000.
It is anticipated, although one would have to ask how accurate such an estimate can possibly be, that charities will benefit from this change to the tune of an average of approximately £40million per annum by 2016/2017, with the average increase in the amount left to charity being around £60,000.
So how does the legislation work?
Broadly, if a testator dies on or after 6 April 2012 and he has left 10% or more of his estate to charity, inheritance tax will be charged on the net value at 36%. For the purposes of the 10% test, the testator's estate will be divided into three components, the survivorship component, the settled property component and the general component. If the test is met for any of the three components, that component is taxed at the reduced rate. It is also possible to merge one or more components to take advantage of the maximum benefit from the reduced rate. The test is an "all or nothing" or "cliff edge" approach. There is no tapering of the rate for legacies that are just below the 10%.
The same result may be achieved if the beneficiaries (or the trustees of a relevant property trust in a will) enter into a post death variation within two years from the date of death.
Notably, personal representatives (provided the beneficiaries agree) may opt out of the reduced rate of inheritance tax, if for example the costs of valuing certain assets, outweigh any benefit from the reduced rate.
Practically, the reduced rate will only be relevant to a testator (or his personal representatives or beneficiaries after his death) if he wants to make gifts to charity on his death and his estate will be subject to inheritance tax. That said, if a testator intends to give 4% of his net estate to charity, the gift can be increased to 10% without the chargeable beneficiaries suffering any reduction in the value of the benefits they received, since the cost of the increase is wholly borne by HMRC!
The legislation is complex and requires that specialist advice is taken at the appropriate time.
For the testator, should he wish to take advantage of the reduced rate he will undoubtedly be required to revisit his will.
Similarly, personal representatives (and this would be key where solicitors or other professional advisers are appointed) and beneficiaries need to take advice at the earliest opportunity if they are to take advantage of the reduced rate in the event of the testator's death.
In both situations, detailed consideration will need to be given to the calculation itself to ensure the 10% qualification is met, and of course an understanding of the interaction of the reduced rate with other estate planning opportunities is vital to ensure the testator is correctly advised.
In either case, flexibility in terms of the drafting of the will (or deed of variation after death) is key, as is ensuring that the 'charities' it is intended to benefit qualify under the charities legislation and satisfy the requirements of HMRC for registration as a charity for tax purposes.
One can see how easy it might be to get this wrong, and if this results in a disadvantage for either charity or other beneficiaries, the potential for a claim against the draftsmen or professional advisers would undoubtedly follow.