Inheritance Tax - Surplus Income Gifts

[Chloe]

I am tracking back through someone's (simple) bank account in order to compile an IHT403 (and minimise IHT liability).
He had been giving gifts out of surplus income (and using his 3000 annual exemption) to his children and grandchildren, and in most years there was clearly sufficient surplus. A couple of years (the 2015-16 and 2016-17 tax years) there are shortfalls of less than 30,000 in total - the expenditure had increased considerably.
I'd assumed the excess gifts would be declared as potentially exempt transfers. However, in 2014-15 he took a tax free lump sum of more than double the 30,000.
Is the lump sum considered income so far as Gifts from Surplus Income are concerned?
If so, can the income be carried over for one year or even two years and cover some/all the excesses?
-Chloe

[supremetwo]

https://www.pruadviser.co.uk/knowledge- ... exemption/

Income is not defined in the IHT legislation but should be determined for each year in accordance with normal accountancy rules.
It is not necessarily the same as income for income tax purposes.
Income is the net income after payment of income tax.

------------------------

For the avoidance of doubt, expenditure will include income tax and all regular expenditure of an income nature (but not capital expenditure such as a home extension).

Where the exemption is used over a number of years, it does not matter if in one of those years there was a deficit so long as ‘taking one year with another’ there was a surplus and gifts were made out of that surplus.

Expenditure need not be fixed and the recipient need not be the same on each occasion. In addition, the amount of the gift may be fixed by a formula, eg a percentage of earnings.

[PinkDalek]

However, in 2014-15 he took a tax free lump sum of more than double the 30,000.
Is the lump sum considered income so far as Gifts from Surplus Income are concerned?

There's plenty to get your teeth into from here https://www.gov.uk/hmrc-internal-manual ... /ihtm14231 onwards and again form https://www.gov.uk/hmrc-internal-manual ... /ihtm14241.

In so far as your specific question is concerned, https://www.gov.uk/hmrc-internal-manual ... /ihtm14250 might suggest that the lump sum you mention is not income for these purposes (at least in HMRC's view). Perhaps you should explain from what this lump sum derived.

... the expenditure had increased considerably.

The background to that increased expenditure may also assist. For example IHTM14250 includes (my emphasis):

If there is a permanent change in the transferor’s level of income or expenditure, for example they start having to pay for care home fees, you should use your judgment in accepting or refusing the exemption in full or in part for continuing regular gifts.

[Chloe]

Thank you supremetwo and Pink Dalek.
The tax free lump sum: I should have said it was the tax free part received on taking a pension - a 'PCLS'.
In one of the years, the increased expenditure was 20,000+ for a brand new car. Not a house extension, but could it be excluded for expenditure calculation purposes'?
-Chloe

[abisgran]

I am not an accountant but my interpretation of HMRC guidance would be that a new car would be a capital expenditure for most and not taken from one years income.This is certainly how I personally have treated it -it is for business purposes not treated as an allowable expense out of one years income(for the self employed businessperson)but a small allowance is claimed each year of its life for a depreciating capital asset.

[abisgran]

Just to clarify-I would exclude the cost of the new car for expenditure calculation and if challenged explain my reasoning as above.

[PinkDalek]

The tax free lump sum: I should have said it was the tax free part received on taking a pension - a 'PCLS'.

My gut feeling is this is capital and not income.

A random internet search finds this, where Tim Good appears to agree, saying it is fairly clear-cut (about half way down - I haven't watched the video):

https://www.accountingweb.co.uk/tax/per ... n-lump-sum

In one of the years, the increased expenditure was 20,000+ for a brand new car. Not a house extension, but could it be excluded for expenditure calculation purposes'?

I would consider that to be a capital outgoing and ignore it.

After all, it doesn't fit within any of the example Expenditure boxes on HMRC's non-compulsory guide on page 8 https://assets.publishing.service.gov.u ... _10_18.pdf (and I'm sure the Other row doesn't apply to such capital expenditure).

I think this was raised back in the days of The Motley Fool (it may even have been on TLF). I can't recall the precise answer the poster got from HMRC but it was something along the lines of a new car being purchased every year or so being considered to be regular expenditure but not a one-off purchase every X years.

[JohnB]

I would argue that pension lump sums are income for this case. https://www.gov.uk/hmrc-internal-manual ... /ihtm14250 says "Common sources of income are employment and self-employment, rents from property, pensions, interest and dividends." The fact that its a lump sum, and free of income tax does not exclude it as " Income is the net income after payment of income tax."

The manuals talk about smearing gifts and income over a few years, and if you smear expenditure in the same way, I think buying a car need be included, as the regular purchase of cars is part of maintaining a standard of living. Similarly household maintenance to keep a property sound is normal expenditure, even if it needs a new roof every 50 years. An extension is different, as its changing the circumstances, and raising the standard of living.

[PinkDalek]

I would argue that pension lump sums are income for this case. https://www.gov.uk/hmrc-internal-manual ... /ihtm14250 says "Common sources of income are employment and self-employment, rents from property, pensions, interest and dividends." The fact that its a lump sum, and free of income tax does not exclude it as " Income is the net income after payment of income tax."

That last part was preceded by It is not necessarily the same as income for income tax purposes.

Did you see the article I reference in my post immediately before yours?

I've now listened to the video where the relevant part starts here https://youtu.be/DgP8lv-SODA?t=215. In it Tim Good references an article in Taxation by Mark McLaughlin CTA (Fellow) ATT (Fellow) TEP from 2012. I've yet to find the article but have read many by Mark McLaughlin over the years on the subject.

I think buying a car need be included, as the regular purchase of cars is part of maintaining a standard of living. Similarly household maintenance to keep a property sound is normal expenditure, even if it needs a new roof every 50 years.

I'd say that maintaining the vehicle is part of maintaining the standard of living. Not the purchase (although one could, of course, knock off any trade in allowance).

I'd also not necessarily agree with your new roof scenario. It has a capital flavour to me, as against patch repairs, given the 50 years. Say an individual cashed in some shares to pay for it. Would you treat the expenditure in such a way, when the monies to pay for it clearly came from capital?

Incidentally, it is not about normal expenditure. It is the gifts themselves that must be part of the normal expenditure of the person making them (along with the other conditions) although certain one-offs may be permitted in certain circumstances https://www.gov.uk/hmrc-internal-manual ... /ihtm14241.

[JohnB]

Surely its that the gifts can be made out of income only and not effect standard of living that would require propping up by spending capital.

Household expenditure must include an element of new for old replacement, as all goods from milk to houses have a finite lifespan. You can't just consider energy and service costs, nor distinguish between buying a car outright or on finance.

I always thought this IHT loophole was badly designed, and its disappointing that HMRC don't cover such obvious questions as pension lump sums in their guidance. They spend so much time on defining gifts, but none on the threshold where they could start.

[PinkDalek]

Household expenditure must include an element of new for old replacement, as all goods from milk to houses have a finite lifespan. You can't just consider energy and service costs, nor distinguish between buying a car outright or on finance.

I categorise replacement white goods and property repairs and maintenance as expenditure, for the purposes of my version of the IHT403. In fact, on my amended version, I have described the rows as follows (which in itself is a work in progress):

General household expenditure
School fees and expenses
University accommodation/maintenance
Household utilities
Motor vehicle costs
Veterinary fees and insurance
Subscriptions and charitable donations
Dental and medical
House and travel insurance
Boiler service & repairs & house painting & repairs
Holidays

[Some other items I shan't list here but I don't include what I would consider capital for accounting purposes. I do have a note below my list to include such items though, for my Executors and their appointed solicitors to consider.]

As I don't buy my vehicle(s) on finance, I treat that irregular expenditure as capital. As it happens our previous vehicle lasted nearly 20 years. I treated the costs of the replacement engine as out of income. The replacement I'm treating as capital. Which is what I would do if I were to draw up a personal Statement of Financial Position (aka Balance Sheet). As I said earlier, someone on TMF received confirmation from HMRC on the new vehicle point, as long as it wasn't something along the lines of every year or so.

It will, of course, be down to My Executors as to what they might claim. I'll be gone by then but at least they'll have some paperwork to consider, should they so wish.

Also bear in mind the comment from HMRC here https://www.gov.uk/hmrc-internal-manual ... /ihtm14255:

For example, the transferor may have taken on a commitment to pay regular insurance premiums, initially affordable out of income, but later on has to pay nursing home fees, that were unforeseen when the policy was first taken out. But, a commitment made at a time when the fall in income could be foreseen would not qualify.

That could conceivably be applied to your complete roof replacement example after 50 years. When the gifts commenced that major capital (?) expenditure might not have been anticipated.

I always thought this IHT loophole was badly designed, and its disappointing that HMRC don't cover such obvious questions as pension lump sums in their guidance.

It isn't a loophole. It is legislation http://www.legislation.gov.uk/ukpga/1984/51/section/21.

I don't think they can possibly hope to cover everything, although it would be good, but both the capital element of purchased Annuities and payments from Insurance policies are mentioned here https://www.gov.uk/hmrc-internal-manual ... /ihtm14250. Those aren't far from the PCLS.

Note the:

If the taxpayer or agent argues that payments of this sort are income in nature, you should obtain all the relevant documents and refer the case to Technical.

[Chloe]

Thank you all, again.
I find myself getting drawn into the discussion on its own account, rather than for my task at hand!
Just in case anybody wishes to see the threads noting that a car is a capital purchase unless you buy a new one each year (my paraphrase)', which PinkDalek identified, PinkDalek's post is on this thread:
viewtopic.php?f=49&t=10855&hilit=gift+out+of+income&start=20
(it's at the top of the second page of replies)
and it refers to a TMF archived entry that is at https://web.archive.org/web/20170412014 ... sort=whole (about the 5th reply down).