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Exemption to the rule

With the approach of the end of the tax year on April 5, clients considering any form of inheritance tax planning would be well advised to make certain that they use their exemptions.

Gifts up to a total of £3,000 in any tax year are exempt. Any part of the exemption not used in one tax year can be carried forward to the next tax year only and used in that year, provided that year’s exemption is used first. A husband and wife/registered civil partners each have this exemption.

Where clients can afford to make such gifts, one possible option is the use of an investment bond written subject to a suitable trust. For example, an investment bond could be effected by a husband and wife on a last survivor basis, in trust, for a single premium of £12,000 and if the exemptions for the current tax year and previous tax year are available, the whole gift of the single premium would be exempt. A further £6,000 could be contributed immediately after April 5, 2009 if further funds are available.

The possible use of the normal expenditure out of income exemption should also be investigated.

To qualify for this exemption, the donor must show that:

  • The transfer was part of his/her normal expenditure.

  • Taking one year with another, it was made out of income.

  • After the gift, the donor was left with sufficient income to maintain his/her usual standard of living.

    A gift is regarded as part of the donor’s normal expenditure if its amount and type are consistent with his or her usual pattern of gifts. Normal is regarded as broadly equivalent to typical or habitual. The first gift in a series can qualify as normal, provided that there is clear evidence that further gifts are intended.

    The normal expenditure out of income exemption can prove to be a valuable tool for IHT planning, whether by simply making regular outright gifts or gifts via a trust or perhaps in the payment of premiums under a life insurance policy written in trust.

    However, it is essential to document such gifts accurately to avoid potential disputes with HM Revenue & Customs on the donor’s death. Form IHT403 is available for download from the HMRC website and it is recommended that gifts using the normal expenditure from income exemption are documented using this form as a basis.

    It should be borne in mind that withdrawals from single- premium life insurance bonds do not qualify as income and therefore the normal expenditure out of income exemption cannot apply. Similarly, the capital element of a purchased life annuity bought after November 12, 1974 is not regarded as part of the transferor’s income for this purpose.

    One final important point. Clients should not leave it too late. Where a gift is made by cheque, it should be borne in mind that the effective gift takes place not when the donor has signed and handed over the cheque but when the cheque is cleared and the funds are debited from the donor’s account and credited to the recipient’s account.

    Brian Murphy is financial planning manager at Axa Life

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