Writing for Taxation magazine’s Readers’ Forum, BKL tax consultant Terry Jordan answers a reader’s query about the rate of inheritance tax (IHT) applying to a ‘free of tax’ legacy. Terry explains how IHTA 1984, Sch 1A confirms that the lower rate is used for ‘grossing-up’.
‘A client has requested some inheritance tax advice regarding their proposed will. One proposal is that the client, as testator, will leave residential property to named beneficiaries ‘free of inheritance tax’. The residue of their estate will be left to registered charities.
My question is whether ‘grossing up’ of the specific legacies is required by reference to IHTA 1984, s 38? If so, is 40% the appropriate grossing-up rate that has to be used here, even though if no grossing up were required the correct rate of inheritance tax charged on the estate would be 36%?
I hope Taxation readers can advise.’ Query 19,525 – Masky.
Terry Jordan’s reply: IHTA 1984, Sch 1A confirms that the lower rate is used for grossing-up
‘Masky’s client has sought advice about the terms of his will leaving residential property to named beneficiaries ‘free of inheritance tax’ with the residue being left to charities. As has been identified, the gifts to the named individuals will be ‘specific legacies’. If their value does not exceed the nil rate band of £325,000 (perhaps together with the residence nil rate band of £175,000 from 6 April this year if part or all of a residence is left to a direct descendant and the value of the estate does not exceed £2m) there will be no inheritance tax liability and no question of grossing-up.
On the premise that the value of the specific gifts exceeds the available nil rate bands, then grossing-up will be in point. As Tolley’s Inheritance Tax explains at section 1.7: ‘Although inheritance tax is essentially a tax based on the loss to the person giving rather than on the benefit to the person receiving, the tax itself may be paid either by the transferor or the transferee. Where the tax is paid by the transferor, it is part of the diminution in value of his estate and is itself included in the transfer of value. A “net” transfer has to be grossed-up to arrive at the amount of the chargeable transfer.’
Transfers to charity have long been exempt from inheritance tax, regardless of whether made during lifetime or on death and, since 6 April 2012, if at least 10% of the net value of a component part of a deceased’s estate is left to charity the rate on the remainder is reduced from the normal 40% to 36% (see IHTA 1984, Sch 1A). In the case of Masky’s client it appears that the only component is his free estate (the ‘general component’). Schedule 1A, para 6.1 confirms that the rate to be used for grossing-up purposes is, currently, 36% and see HMRC’s Inheritance Tax Manual at IHTM45030.’
For more information about inheritance tax and legacies, please get in touch with your usual BKL contact or use our enquiry form.