Gifts out of surplus income

By Tolley in association with Emma Haley at Boodle Hatfield LLP
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The following Trusts and Inheritance Tax guidance note by Tolley in association with Emma Haley at Boodle Hatfield LLP provides comprehensive and up to date tax information covering:

  • Gifts out of surplus income
  • When does the exemption apply?
  • Order in which exemptions apply
  • A trap ― reservation of benefit
  • Claiming the exemption

A valuable exemption from inheritance tax (IHT) applies to gifts out of surplus income. This exemption applies only to lifetime gifts and is therefore a key part of lifetime planning. The exemption applies to both outright gifts and gifts into trust.

IHTA 1984, s 21

Gifts which meet the qualifying conditions (see below) are immediately exempt from IHT so it is not necessary to survive seven years to obtain the exemption. Exempt gifts are not aggregated with later gifts and do not eat into the IHT nil rate band. Clients should make use of basic exemptions such as this before embarking on more complex lifetime planning.

There is no set limit on the amount that can be given away, provided the gift does not exceed the donor’s surplus income.

When does the exemption apply?

The qualifying conditions in order for this exemption to apply are as follows.

The gift must be made from income

Gifts made from capital will not be covered by the exemption and it will ultimately be necessary to demonstrate that the gifts were made from net (post-tax) income (see ‘Claiming the exemption’ below).

Income normally takes the form of cash and so cash gifts are the most obvious format for this exemption.

However, HMRC accepts that a gift of other assets can qualify, provided the item in question was purchased specifically from surplus income with the intention of making the gift.

IHTM14250

HMRC considers income to be current income, which is generally taken to mean income from a particular tax year, although some carrying over of income from year to year is permitted.

However, the exemption will not apply to gifts made from income which has been accumulated over several years and has therefore acquired the nature of capital.

For example, where retained income has

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