Britain's most valuable inheritance tax loophole: your questions answered

Telegraph

2 days ago

Mike will be answering your questions in the comments below at 5pm.
Inheritance tax revenue is predicted to almost double over the next five years to £14.3bn, according to the Office for Budget Responsibility (OBR) – thanks to the freezing of the inheritance tax threshold and changes announced by Chancellor Rachel Reeves.
It is therefore all the more important that we take full advantage of any savings legally available.
One of the most valuable, but possibly misunderstood, ways of saving inheritance tax is through making regular gifts out of income.
I would ideally like to quantify this for you, but although the individual amounts of tax saved are obviously known to HMRC, it does not release the total amount because the cost of gathering the information for statistical purposes would be disproportionate.
The legislation involved is relatively brief, as you can see in the box below.
Fortunately, it is supplemented by guidance in the HMRC manuals between IHTM14241 and IHTM14255, although this still leaves various issues unclear.
This was apparent from the responses from readers after I wrote about it two months ago – and, here, I'll answer some of your most common questions.
How can we document regular gifts as a couple?
The following question received from one concerned Telegraph reader was typical:
'My wife and I have shared finances. Our incomes are very different, and are reported each year to HMRC under self-assessment. We don't make any attempt to separate expenditure, simply splitting the total 50:50.
'In these circumstances, how can we handle the question of making gifts to our children from surplus income? Because of my higher income, I have a permanent income surplus, yet my wife has a deficit.
HMRC's form IHT403 can presumably only be completed and used for an individual, and not for a couple? Any advice you can give in this tricky area will be greatly appreciated.'
Form IHT403 used by executors contains a spreadsheet on page eight for income and expenditure to be completed following each death to obtain this saving. Completing this page is not mandatory, but it does provide a summary of the information HMRC expects to receive.
One of the advantages of writing for The Telegraph is that we have access through the HMRC press office to the technical experts there, which I find very useful.
Based on the guidance that a representative sent me on this issue, I can confirm that, where a couple are involved, HMRC is required to consider each individual's income and expenditure separately.
The IHT403 form should therefore reflect the income each of them has received. I do not see this as particularly onerous because it should be relatively straightforward to keep records of income as long as you know this may be needed, particularly for those in self-assessment.
Expenditure is more difficult. HMRC expects the IHT403 document to reflect, as far as possible, how this was dealt with by the couple. In general, where household expenditure is paid for out of a joint account that the couple both contribute to, the approach of splitting the expenses 50:50 will be regarded by HMRC as reasonable and appropriate.
If, however, there is a situation where one party to the marriage pays all the household bills, HMRC would expect that to be reflected in the IHT403 form.
My experience is that HMRC will take a relatively flexible and common-sense approach on expenditure, as long as taxpayers are open, honest and sensible. Nevertheless, the better records you can keep, the easier it will be for the executors to make a claim.
What if my income, and spending, fluctuates?
Another question often raised is about the treatment of investment income where the interest is rolled up. The guidance in the manual at IHTM14250 says that income should be determined for each year in accordance with normal accountancy rules.
However, I have received confirmation that for NS&I, or similar investments, HMRC looks at the income in the year that the interest or other amount was paid, and therefore, available to make the gift out of income.
I am grateful to those readers who offered their own experience in dealing with HMRC, particularly on the treatment of abnormal expenditure. Several supported my view that abnormal expenditure, such as building works or expenditure moving house, should not be counted.
Likewise, one reader received confirmation from HMRC that regular nursing homes fees would have reduced excess income, and one was told that a one-off heart operation would not.
The manual at IHTM14250 confirms this point, and also gives guidance on lifetime nursing or residential care plans arranged through a single upfront payment. In this case, payments from the provider to the care home are regarded as capital rather than income.
Nevertheless, there is helpful guidance on this in the HMRC manual at IHTM14255 which includes:
'If the transferor has had to lower their standard of living for some other reason, such as losing their job or a drop in income on retirement, the exemption may not be completely lost if they had made a regular commitment at an earlier date when surplus income was available.
'For example, the transferor may have taken on a commitment to pay regular insurance premiums, initially affordable out of income, but later on has to pay nursing home fees, that were unforeseen when the policy was first taken out.'
My view is that you should keep a record of any such expenditure. If you believe that it is genuinely abnormal, you should provide the information to HMRC, but claim it as such. I found HMRC reasonable to deal with when claiming the exemption, and I note that this experience was generally supported by other readers.
Incidentally, normal expenditure out of income is strictly an exemption rather than a relief. As explained in the HMRC manuals at IHTM14132, you first apply the normal expenditure out of income exemption on a purely factual basis, and without regard to any other exemption.
You then apply any other other exemptions with the annual £3,000 exemption last. Remember that the annual exemption can be carried forward for one year only if not already used.
For an exemption that is so important, we have relatively little detailed guidance available. In particular, the supporting notes to form IHT400 are far too brief to be of practical use.
It is the role of HMRC to collect the correct amount of tax prescribed by law, which should take into account of any tax exemptions available and claimed where appropriate. Under the HMRC charter, there is an undertaking that it will help taxpayers to do so.
My personal view is that the publicly available guidance should be expanded to benefit both HMRC and taxpayers alike. As always, I welcome any comments.