Reduced rate Inheritance Tax: Knowing your charities 10% from your 10% baseline amounts

We have seen a number of cases recently which involve issues around when and how lower rate Inheritance Tax (IHT) charity relief can apply and the difference in the calculations on 10% of the residue and 10% of the baseline amount.

A lower rate of IHT for testators who leave 10% or more of their net estate to charity was introduced in 2012 and applies to the estate of a testator who dies on or after 6 April 2012. The provision reduces the IHT applicable to the estate to 36% from the standard 40%.

The amount gifted to charity must be at least 10% of the baseline amount to meet the criteria pursuant to Inheritance Tax Act 1984, Sch 1A, Para 2(2)(IHTA 1984).

Lower rate IHT and 10% baseline amounts

One could be forgiven in thinking that the 10% baseline amount is the same as 10% of the residuary estate but, unfortunately, it is not that simple. In fact, it can be quite complicated. The wording of baseline amount allows for Wills drafted today to benefit from the lower rate of IHT should the required calculation from HMRC change in the future.

A specific gift, a pecuniary gift or a share of the residue could all amount to 10% of baseline amount and thus qualify the estate for the lower rate of IHT.

IHTA 1984, Sch 1A, Para 3 divides the estate on death into three components for the purposes of applying the reduced rate.

• The survivorship component
• The settled property component
• The general component
• Or a mixture of all three

Most assets of an estate will fall into the general component and for this calculation you will need to know whether any nil-rate band and/or transferable nil-rate band is applicable to the estate. Please see the HMRC web page on calculating baseline amounts with a single component.

Retrospective application

It is possible to obtain the lower rate of IHT with retrospective treatment unders.142 IHTA 1984, where a beneficiary under the will makes a gift to charity by an after-death variation. The Deed of Variation must, however, be executed within two years from the date of death to benefit from this provision.

Importance to charities – our recent experience

Although in theory the rate of IHT applicable to the estate does not impact the gift to charities (as IHT is not applicable to any gifts to charities), understanding the provisions can be vital for ensuring your charity receives the gift the deceased intended.

Foot Anstey helped a charity client recently who had an issue with an executor who had an error in the calculation of the estate account. The will was prepared as a Statutory Will, which included a clause gifting '10% of the baseline amount' to our charity client. The deceased left the residue to lay beneficiaries.

On receiving final estate accounts, the amount due to be distributed to our client was far lower than expected. The calculations in the estate accounts were challenged, however, the executors still made a final distribution. The client was informed that the will included a drafting error and the property (the main asset in the estate) was in fact intended to be gifted specifically to lay beneficiaries.

We requested the will file and the IHT400 (the form to HMRC which shows how much IHT has been paid). The IHT400 showed the lower rate of IHT was paid to HMRC. We were able to highlight to the executors that pursuant to Inheritance Tax Act 1984, Sch 1A, Para 2(2) (IHTA 1984) the estate would not be eligible for the of lower rate of IHT had the property been specifically gifted as 10% of the baseline amount would not have been gifted to charity.

The executors realised the error that had been made and agreed that it was not in fact a drafting error but an error in the calculations in the estate accounts. The result was the charity received over £80k in addition to the previous distribution.

Top tips

1. Make sure you ask for detailed Estate Accounts and identify whether IHT has been correctly applied to the estate (i.e., not applied to the gifts to charities)
2. Always read the will and make sure you identify whether the gift to your charity is 10% of the net estate or 10% of the baseline amount.
3. Make sure you are checking the IHT400 and see if the amounts gifted to charity on the form match the estate accounts.
4. If you are unsure or something does not look right always ask the executors for an explanation.

Whether your charity is looking for some assistance with your legacy income management or with advice where matters have got contentious, we can help. Elizabeth Ware or Chloe Phare would be more than happy to review a matter to give their advice on contentious matters. Emma Facey can discuss with you bespoke needs with legacy income management.