The rules for securing a 10% reduction in the IHT rate provided a charitable legacy of at least 10% of the estate is made on death.
Introduction
To encourage people to leave part of their estate on death to charity, rules introduced by Finance Bill 2012/Sch32 (and now contained in Schedule 1A IHT Act 1984) apply for deaths after 5 April 2012. The rate of inheritance tax (IHT) payable on death will be reduced to 36% if the deceased leaves 10% or more of their net estate to charity.
In summary:
Gifts to charity are already exempt from IHT regardless of the size of the gift.
Where a legacy equates to 10% or more of the net estate, the rate of IHT on the rest of the estate is reduced from 40% to 36%.
Result: the charity will receive the same amount, while the non-charitable heirs will be marginally better off because less IHT is paid on what they receive.
The rules in detail
The rules are relatively complex.
Within each of these components, any reliefs or exemptions – such as the available proportion of the nil rate band – will be deducted first to ascertain the chargeable element. The charitable gift is then added back in to give the “baseline amount”. If more than 10% of the baseline amount within one component passes to charity, then the reduced rate of 36% will apply to the rest of the assets within that component.
Basic calculation – the baseline amount
The legislation sets out three steps in arriving at the baseline amount. The baseline amount is determined for each component separately unless an election to merge components has been made:
Step 1
Establish the value transferred by the chargeable transfer (i.e., excluding the charitable legacy) that is attributable to each component.
Step 2
Deduct from this, the appropriate proportion of the available nil-rate band. The available nil-rate band is the nil-rate band that applies at the death, increased as appropriate by any transferable nil-rate band (TNRB) and reduced by the amount used up by any previous lifetime chargeable transfers. The appropriate proportion is the amount of the nil-rate band apportioned to the component concerned in relation to the whole chargeable transfer on death. The residence nil rate band (RNRB) is not taken into account in calculating the baseline amount for the reduced rate of IHT for charitable giving.
Step 3
Add the amount of the charitable legacy that was deducted at Step 1 to the amount determined by Step 2, to arrive at the baseline amount.
Example: Simple estate – one component
Let’s take a case where Jane, a widow, dies after 5 April 2012. All of her husband’s estate passed to her on his death three years ago. She has an estate of £l million, and her Will leaves £50,000 to charity and the rest of the estate to the children.
After the combined nil rate bands of £650,000 are taken into consideration, the baseline amount here would be £350,000.
As the £50,000 charitable gift exceeds 10% of the baseline amount, the reduced 36% rate of IHT will apply to the estate passing to the children.
As a result:
the IHT liability is reduced to £108,000 (36% of £300,000) instead of being £120,000 (40% of £300,000);
the charity receives £50,000; and
the children receive £842,000 – which is £12,000 more than they would have received under the previous rules.
Charitable legacy worded to meet the 10% test
To avoid the need to continually revise charitable legacies in Wills, a clause may be worded so that a specific legacy to charity will always meet the 10% test. The Society of Trust and Estate Practitioners (STEP) have published a draft model clause for use in Wills. The clause has been approved by HMRC and is referred to on their website. Where such wording is used, a specific legacy to charity will always meet the 10% test.
This can be viewed on the below link:
https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm45008
