Gifting to charity (Part 2)

Introduction

The Government has, for many years, encouraged charitable gifting by making a variety of tax reliefs available to donors who wish to give to charity.  In Part 1 we reviewed the tax benefits of an individual making lifetime gifts of cash to a charity via the Gift Aid Scheme

• the tax position on non-cash gifts to charity by individuals which benefit from income tax relief; and

• gifts to a charity on death which can reduce the rate of inheritance tax (IHT) payable on an estate or part of an estate to 36%.

 

Non-cash gifts to charity 

• Income tax relief is available on a gift of qualifying investments direct to registered UK charities

A qualifying investment is any of the following:

• Shares or securities listed or dealt in on a recognised stock exchange

• Unlisted shares and securities dealt in with on a recognised stock exchange, such as the Alternative Investment Market (AIM)

• Units in an authorised unit trust or shares in an open-ended investment company

• Holdings in certain foreign collective investment schemes

• UK property

The market value of the investment at the time of the disposal plus costs, or the excess of that value over any consideration given for the disposal, is deductible in computing the donor’s total income for the tax year of disposal. This means relief is available at the donor’s marginal income tax rate(s) up to 45%.  Market value is determined in the same way as for capital gains tax purposes.  The deduction from total income is disregarded for the purposes of computing top-slicing relief on chargeable event gains under life assurance policies.

• Relief from capital gains tax is also available on the basis that a gift of an asset to a charity is treated as being on a no gain/no loss basis – section 257 Taxation of Chargeable Gains Act 1992.

• Gifts to charities are exempt from inheritance tax under section 23 Inheritance Tax Act 1984.

 

Gifting to a charity on death  

Leaving part of an estate or the whole of an estate on death to a charity can reduce and, in some situations, eliminate an IHT liability on the estate.  This is because when something is left to a ‘qualifying charity’ on death in a Will, it will not count towards the total taxable value of the estate for IHT purposes.  This is often referred to as ‘leaving a charitable legacy.’ For IHT purposes, a ‘qualifying charity’ is broadly one established for charitable purposes only which satisfies jurisdiction, registration and management conditions; and is established in the EU or other specified countries. 

In addition, the IHT on the remainder of an estate can be reduced from 40% to 36% if, as generally stated, at least 10% of the ‘net estate’ is left to a charity. However, to ascertain whether the 36% reduced rate is applicable the ‘net estate’ is subject to a special calculation to find the ‘baseline amount’ – see next section. 

 

Charitable legacies and IHT  

The reduction in the rate of IHT is to encourage people to leave part of their estate on death to charity. As stated above, to ensure that the rate of IHT payable on death on the whole or part of an estate is reduced to 36%, the deceased must leave 10% or more of the baseline amount on death to charity. 

The IHT rules to secure the reduction can be relatively complex depending upon the nature of the assets in the estate.   

On death, an estate is divided into three separate components for IHT purposes - each of which needs to be looked at individually to establish whether the 36% reduced rate of tax applies to the estate.  The components are:

Component	Description
survivorship	property held jointly as joint tenants
settled property	property held in a trust that is treated as part of the estate for IHT purposes
general	essentially everything else

 
If more than 10% of the baseline amount within any one component is left to charity, then the reduced IHT rate of 36% will apply to the rest of the assets within that component. 

Also, if an election is made, it is possible for one or more components to be merged so that the combined component qualifies for the reduced rate. We will look at this in more detail later.

 

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 – see later.

 

Step 1

Establish the value transferred by the chargeable transfer (i.e. excluding the charitable legacy which is exempt from IHT) that is attributable to each component.

Step 2

Deduct from the value transferred under each component the appropriate proportion of the available nil rate band including any transferable nil rate band. The available nil rate band is the nil-rate band that applies at the death. 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 1 - estate with one component

Let’s take a case where Julia, a widow, dies in September 2020. All of her husband’s estate passed to her on his death three years ago. She has a free estate of £l million, and in her Will leaves £50,000 to charity and the rest of the estate to her children. The whole estate is categorised as being a general component.

To establish whether the reduced rate of 36% applies to Jane’s estate it is necessary to calculate the baseline amount as follows:-

Step 1                                                                                   £

                                                                                           

Estate on death (general component)                         1,000,000

Less: Charitable legacy                                                   50,000

                                                                                 ________

Chargeable transfer                                                       950,000

 

Step 2

 

Deduct the nil rate band                                                 (650,000)

                                                                                    ________

                                                                                       300,000

Step 3

 

Add back the charitable legacy                                      50,000

                                                                                 ________

Baseline amount                                                           350,000

 

The legacy of £50,000 exceeds 10% of £350,000 so the 36% reduced rate of tax applies to the whole of the taxable estate as it is a general component out of which the charitable legacy has been made.

 

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 (£950,000 less £108,000).

Without the £50,000 charitable legacy, the children would receive £860,000 (£1 million - £140,000) so they are £18,000 worse off.

 

Example 2 – estate with two components

The calculation is more complicated where there is more than one component of the aggregate estate. This is because the 10% test is applied to each component separately. The value of the assets passing to charity from a particular component will be compared to the baseline amount for that component. If the 10% test for a component is passed, IHT will be charged on that particular component at 36%.

Taking the facts of Example 1 above but, rather than being owned by Julia outright, some of the assets of her estate for IHT purposes, say £400,000, were held in an immediate post-death interest trust (created by her husband when he died three years ago) which counts as settled property.  Her estate would therefore be made up of two components – the settled property component of £400,000 and the remaining general component, which is £600,000. In addition, in this example, Julia’s charitable gift is not £50,000 but £22,000.

 

Tax calculation

Julia’s estate is made up of 2 components:

• the general component valued at £600,000
• the settled property component valued at £400,000

The reduced rate will not be due in respect of the settled property component as none of it is passing to a charity.

 

• The general component

The legacy of £22,000 would be made out of the general component so the baseline amount of this component will need to be calculated for the ‘10% test’ as follows:

 

Step 1                                                                                £

                                                                                         

General component on death                                      600,000

Less: Charitable legacy                                                22,000

                                                                                ________

Chargeable transfer                                                     578,000

 

Step 2

 

The appropriate proportion of the nil rate band is

 

       578,000               x         650,000                      (384,151)

 ______________

578,000 + 400,000                                                   193,849                                  

 

Step 3

 

Add back charitable legacy                                          22,000

                                                                                ______

Baseline amount                                                         215,849

 

The legacy of £22,000 exceeds 10% of £215,849 so the general component qualifies for the lower 36% rate.

 

• The settled property component

 

As no part of the settled property is used to satisfy the £22,000 legacy then the amount of the nil rate band applicable to this component is:

                                                                                                     £

          £400,000

       ___________

£578,000 + £400,000  x         650,000                       =          265,843           

 

Deduct from chargeable transfer of £400,000            =          134,157

 

(iii)      Total tax liability

 

General component £193,849 @ 36%                        =             69,786

Settled property component £134,157 @ 40%           =             53,663

                                                                                             _______

                                                                                              £123,449

 

As a result, the IHT liability is reduced to £123,449 from £131,200 a reduction of £7,751 so the loss to the children is only £14,249 out of the £22,000 that passes to the charity.

However, even though this reduced amount of £22,000 exceeds 10% of £215,849 and so the reduced rate would apply to the chargeable assets passing under her Will (her free estate), the full 40% rate will still apply to the assets passing under the trust because none of this is subject to a charitable gift.

 

The option to merge 

If the assets passing to charity from one component are 10% or more of the baseline amount of that component, other components may be merged with it to give an aggregate baseline amount. For example, if Julia did not reduce her gift to £22,000 (above) but kept it at £50,000 this would be more than 10% of the baseline amount of both components added together. In such a case an election should be made to “merge” the two components as follows:

 

                                                                                                         £

Merged estate                                                                          1,000,000

Less: charitable legacy                                                              50,000

                                                                                                ________

Chargeable transfer                                                                   950,000

Less: nil rate band                                                                     650,000

                                                                                                ________

                                                                                               300,000                       

Add back charitable legacy                                                         50,000

                                                                                                ________

Baseline amount                                                                        350,000

 

By doing this, the reduced IHT rate would apply to both her free estate and the trust assets. Without such an election only her free estate would enjoy the reduced rate of 36%, the 40% rate then applying to the trust.

 

Redirecting a legacy to charity  

If an individual receives a legacy and chooses to pass it on to a charity it may be appropriate to give effect to the transfer by means of a deed of variation within the two-year period following the date of death of the testator (donor).

Under a deed of variation, a gift is treated for IHT purposes as if it had been made by the deceased person and can therefore benefit from the general charity exemption.

There is a requirement to provide evidence as to the payment and the charity to HMRC to prevent abuse.

 

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. HMRC has published a draft model clause for use in Wills. The clause can be found in the HMRC Inheritance Tax Manual under reference IHTM 45008.

HMRC has produced a reduced rate calculator which can be used to work out how much an individual would need to leave to charity to qualify for the reduced rate. Please see:

https://www.gov.uk/inheritance-tax-reduced-rate-calculator [gov.uk]