The 2011 budget announced that it was the Government’s intention, following the completion of a formal consultation on the issue later that year, to introduce from April 2012 a lower Inheritance Tax charge where a person dies leaving 10% or more of their estate to charity in their Will.
In the 2012 budget, which was delivered on the 21 March by the Chancellor of the Exchequer, George Osborne, it was confirmed that the reduced Inheritance Tax charge is set to apply for deaths which take place on or after 6 April 2012. The change in the law will be included as part of the Finance Act 2012 which is set to be enacted later this year.
What is the change?
If you leave 10% or more of your estate to a charity in your Will, and your estate is subject to inheritance tax upon your death, then a reduced tax rate of 36% (otherwise 40%) will apply on the value of your estate not passing to charity.
Is the change that simple?
As with a number of previous amendments to the tax rules, its practical application is likely to be complicated by the legislation which is introduced to support it.
The proposal is that for the purposes of the ’10% charitable test’, a deceased’s estate will be divided into three separate components which will be known as the ‘survivorship component’, ‘settled property component’ and the ‘general component’.
The general component relates to the deceased’s ‘free estate’. The survivorship and settled property components take into account assets that do not pass by the deceased’s Will but are aggregated with the value of the deceased’s free estate for Inheritance Tax purposes. The Government has decided that the reduced Inheritance Tax rate should not apply to assets in which the deceased had reserved a benefit due to the fact they do not devolve on the deceased’s death.
The lower Inheritance Tax rate applies if the 10% charitable test is satisfied in respect of any component of the deceased’s estate. Unfortunately the proposal is that the lower tax rate will be administered on an ‘all or nothing’ basis. As a result, there will be no sliding scale of relief for estates which fall just short of the requirements.
How will it be calculated?
For each of the three components, the test compares the ‘donated amount’ against the ‘baseline amount’. The baseline amount is the value of the assets in the estate in that component less any available nil rate band, all exemptions (other than charity) and reliefs, such as Agricultural Relief and Business Property Relief.
If the donated amount is equal to, or more than, 10% of the value of the baseline amount of a particular component of the estate then the lower IHT rate applies to that component.
If, when each component of the estate is considered in isolation, the lower IHT rate does not apply there, is the option to merge a component of the estate with one or both of the remaining components to which the 10% test can then be applied. If upon such a merger the 10% test is satisfied the lower tax rate can then be claimed.
Is there an opt out?
Rather interestingly, the Government has included the ability to opt out of the lower tax rate if the decision is taken that the administrative burden, and costs of making such a claim, would be overly onerous on the estate. The beneficiaries of the Will would be required to provide their consent to any opt out if they were to be financially disadvantaged as a result.
What are the views of the charities to the change?
It is clear that the Government’s motive behind the change in the law is to encourage increased charitable donations. However, there is a concern amongst some charities that the lower Inheritance Tax charge, when coupled with the proposed amendments that are set to take effect next year to the income tax relief regime, may actually lead to donors opting to benefit charities on death rather than through their lifetime. If this were to happen then it could cause a serious funding gap for many of the country’s charities.