Posted: 19/12/2023
The festive season is traditionally a time when family and friends exchange gifts with one another, and it is not uncommon for the opportunity to be taken for sizeable gifts to be made from one generation to the next. For the reasons explained below, if anyone is considering making gifts either of assets of substantial value or sizable financial gifts, whether at Christmas or otherwise, it would be wise to be aware of potential legal pitfalls, particularly in relation to inheritance tax (IHT) and any claims which could later be made against those gifts.
For example, many fail to realise that, if the donor is UK domiciled, then these gifts are not necessarily absolute and, in the event of the donor’s death, could still be subject to significant IHT and/or be reclaimed back entirely by a person bringing a claim against the donor’s estate. This can be the case even many years after the original gift was made.
So which type of gifts are protected and which may be the subject of potential claims? How can you protect the gifts that you are making from being reclaimed in future?
Where the donor dies more than seven years after giving the gift
Typically, any gifts that were made seven years before the donor’s death are made free from IHT, regardless of their value. So, for example, if a grandfather gifted a property to his grandson, then provided the grandfather lived for more than seven years from the date of the gift it would be completely free from IHT.
Where the donor dies within seven years of giving the gift
Some gifts made within seven years before the donor’s death will still be free from IHT if their value falls within the 'Nil Rate Band' (NRB). The NRB is currently £325,000 for 2023-2024. If the total value of all the gifts comes under that value then there may be no IHT payable. To the extent that the value of the gifts within the seven year period exceed the NRB then that will be subject to IHT.
The rate of tax payable on the value of gifts exceeding the NRB depends on when the gift was made in relation to when the donor died. If the gift was made within three years of the donor’s death then the full rate of 40% IHT applies. If more than three years has passed since the gift was made then the IHT due on that gift decreases by 20% for each full year between the gift and the donor’s death, so that the IHT due is reduced by 80% if the gift was made between six and seven years before the donor’s death. This is known as taper relief.
Where the donor retains an interest in the gift they have given
If the donor does not give away their interest and benefit in a gift entirely then it may be deemed to still be within the donor’s estate and be subject to IHT at the maximum rate of 40% on their death. For example, if a donor gives away their villa in Spain to their child but continues to holiday there whenever they want for several months of the year, its value may still be subject to full IHT. This can be doubly painful because the recipient of the gift will not benefit from a tax-free uplift in value for capital gains tax purposes that would otherwise have been available if the gift was made on death.
Where the gift comprises international assets
An individual who is domiciled in the UK is subject to IHT on their worldwide estate so gifts of international property would also still be considered for IHT purposes. Non-UK-domiciled individuals who gift UK situated property are also subject to the same rules.
Who pays the tax due on the gift?
The IHT which is payable on a gift must be paid, in the first instance, by the donee. This means that if a grandparent made a significant gift to a grandchild, and died within seven years of that gift with no remaining available NRB, then the grandchild will potentially be “on the hook” for paying any IHT due on the asset to HMRC.
If, for whatever reason, the tax cannot be recovered from the donee (for example, they no longer have the gift and have no other resources to pay the tax due) then the deceased’s estate will be accountable for the IHT. This will therefore have implications on the inheritance to be received by the estate’s other beneficiaries.
Gifts using the £3,000 Annual Allowance
Each individual has a yearly allowance, currently set at £3,000 for 2023-2024, which they can gift to another free from IHT. Unused allowance from one previous year may be carried forward, so for example if no gifts were made last year then a donor can gift £6,000 free of IHT this year (being 2 x £3,000). This exemption applies in time order against the first gift in the tax year so, gifts made in the tax year before Christmas will benefit from this exemption first.
'Small' gifts of £250
The small gift exemption can be ideal for Christmas giving in large families. This allows £250 to be given free of IHT every tax year to each individual recipient with no limit on the amount of individual recipients who can receive a gift. So, for example, an individual at a Christmas party could gift £250 to everyone who attends and that would all be free from IHT (nb this exemption cannot be used in conjunction with the annual allowance mentioned above).
Normal expenditure out of income
Regular transfers of value (often cash) can fall into the 'normal expenditure out of income' exemption giving rise to an instant exemption for IHT. These transfers must be made out of the transferor’s excess income (not capital) – after the gift is made it is important that the transferor still has sufficient other income to live on as they usually would. There must be a pattern of regular gifting for this exemption to apply, for instance a monthly or annual gift of excess income to the same recipient. This is a subjective test. If the transferor is very wealthy this means that the gifts could potentially be very large and still not be subject to IHT.
The marriage exemption
Gifts in contemplation of a marriage/civil partnership can also avoid charges for IHT – whether being made at Christmas or any other time of year. The gift must be before the event and not after. The exemption also does not apply if the marriage/civil partnership does not take place. The amount available depends on the relationship between the transferor to the person receiving the gift. Any person can gift £1,000 free of IHT to either party to the marriage, this rises to £2,500 from a grandparent or remoter ancestor and up to £5,000 from a parent.
In the United Kingdom we recognise the concept of individuals being able to leave their assets by will in any manner they see fit. This is known as 'testamentary freedom'. However, there are some key exceptions to this basic principle.
The Inheritance Act is one such exception as it provides a mechanism for certain categories of relatives or people being financially maintained by the deceased to make an application for financial provision where 'objectively [the deceased’s] disposition or lack of disposition produces an unreasonable result in that it does not make any or any greater provision for the applicant' (Ilott v The Blue Cross).
For example, if a father with young children died, but left all of his estate to a charity in a will, then the children would likely have a claim under the Inheritance Act for some financial provision from their father’s estate.
Section 10 of the Inheritance Act gives the court the power to deal with lifetime gifting that had the intention of putting assets out of reach of parties who might try to make an Inheritance Act claim. It provides the court with the ability to set aside any gifts that were made by the deceased within six years before the date of their death if it can be proved that one of the intentions of the gifts was to defeat an Inheritance Act claim.
Under Section 10 of the Inheritance Act, the court can compel the recipient of the lifetime gift to pay a sum of money back to the estate for it to be used to pay the claimant, even if the recipient no longer has the asset or the money from the sale of the asset.
In short, there is nothing a person can do to prevent someone from bringing a claim against their estate. The key question is whether that claim has any chance of success.
The best way to provide a robust defence to any claim for your executors and chosen beneficiaries to run, or to dissuade a potential claimant, is via effective communication during your lifetime. However, this is often not possible or indeed desirable.
One option is that to whomever you are planning on leaving your estate (and it may be that this person has been the subject to gifting), you could make clear to them and your advisors why you have made a gift in this way. Your advisors can then capture and store this data which may prove useful in the future.
A further point of note is that often lifetime gifting occurs with a view to then leaving an estate elsewhere; this can create a dependency or an expectation of a gift on death and so careful consideration is needed around how to communicate these decisions.
In summary, if you are choosing to make significant Christmas gifts (or indeed, gifting at any other time of the year), careful thought, planning and effective communication is required with a view to the longer term and what it is you are ultimately trying to achieve. This is why instructing a solicitor with a comprehensive approach to estate planning is recommended. It is safe to say, giving a gift is not a straightforward transaction much as it might seem that way, especially during the festive season.
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