There has been considerable discussion lately about the exemption from IHT in respect of gifts out of income under Section 21 IHTA 1984. This is a particularly valuable relief, not least because it is unlimited, being subject only to the requirements that the gifts must be:  

  1. part of normal expenditure;
  2. made out of the individual’s income;
  3. made when there was sufficient income remaining to maintain the normal standard of living.  

The recent discussion has centred around whether the 5% withdrawals from a single premium policy are income for this purpose. HMRC have recently updated their Manuals to confirm their view – which is that such withdrawals are not income for the purposes of the Section 21 exemption. They consider that although income is not defined, it should be determined in accordance with normal accountancy rules.  

Although the 5% withdrawal has always been regarded as a partial repayment of capital, that is just an artificial division made for tax purposes; it could equally well (if one looked at it as a matter of pure accountancy) be regarded as an income return or the yield from the investment. In any event, it is an amount withdrawn by the policyholder in the nature of income and I expect in most cases is disbursed in exactly the same way as their other income. This would certainly seem to satisfy the HMRC test of the money representing income on normal accountancy rules. This used to be the approach adopted by HMRC but they have changed their mind and now take the opposite view.  

Whether we agree with this analysis or not, HMRC are perfectly entitled to their view and where a dispute arises, the proper forum for resolving the dispute is the Tax Tribunal. As long as HMRC do not attempt to impose this new view retrospectively by saying that this was always their view and we must all have misunderstood (ring any bells?), there can be no objection.  

A less satisfactory element in the revised Manuals is the suggestion that if a person receives a payment from an insurance policy which is chargeable to income tax, HMRC will not regard it as income for the purposes of the exemption for gifts out of income. Whilst I can see some technical justification for this conclusion (which is really only the corollary of the point made above on the 5% withdrawals) it is a breathtakingly unattractive argument to claim that something is income for the purpose of charging tax but not for the purpose of giving a tax relief. There could hardly be a better example of how HMRC can bring themselves into disrepute in the mind of the ordinary taxpayer – which is not what they need right now.