Chapter: 2 - Inheritance Tax Mitigation: The Basics

The annual exemption

2.2.4

Gifts of £3,000 in a tax year are exempt (IHTA 1984 s19).  To the extent that the allowance in one year is unused, it can be carried forward for one year (only).  This exemption is ‘per donor’ (whereas the £250 exemption is ‘per donee’).  While it might not seem very much (and was raised from £2,000 as long ago as 1981), regular use can get £30,000 IHT-free out of the chargeable estate over a ten-year period – or £60,000 per married couple/ civil partnership.

HMRC Trusts & Estates interpret the statute (specifically, IHTA 1984 s19(3A) in circumstances where more than one transfer of value is made in a particular tax year as follows: the annual exemption should be deducted from the first gift (not otherwise exempt), whether a PET or not: see IHTM 14143 http://www.hmrc.gov.uk/manuals/ihtmanual/IHTM14143.htm.  This is disadvantageous to taxpayers where the donor survives seven years and the annual exemption may be wasted on a gift which subsequently proves to be wholly exempt. The practical advice is in any tax year to make a chargeable transfer before a PET. Where more than £3,000 is given in any tax year, any unused balance from the preceding year may be used.

The annual exemption might be used to pay premiums on a life assurance policy written in trust for others or to make gifts in kind – a painting worth up to £3,000, for example.  Alternatively, consider setting up a stakeholder pension for a child or grandchild: a payment of £2,880 (net of 20% basic rate tax in 2011/12, ie £3,600 gross) can be made for a minor beneficiary, although of course the benefits cannot be taken until (currently) age 55 (which many might consider an advantage).

In the case of a parental gift, there is no income to be caught by ITOIA 2005 s624. However, somewhat strangely, s624 will apply to the income from a £3,000 cash ISA set up from 6.4.01 for a 16 or 17 year old unmarried child of the donor (though not to income from the new Junior ISA to be established following Budget 2011).

TAX TIP:  It is axiomatic that regular (and recorded) use should be made of the annual exemption.  In the absence of other contenders for the gifts, stakeholder pensions might be thought quite a sensible thing to set up, within the annual exemption and/or the normal expenditure out of income exemption (see 2.2.6).