I have a married couple who are in receipt of pension income (annuities and state pensions), bank interest and dividends. They also have stocks & shares ISAs invested managed by a discretionary fund manager and the underlying assets also generate interest and dividends.
They have been making regular gifts using their annual £3,000 exemption and have also made additional gifts using surplus income over the years (& thus relying on the normal expenditure out of income exemption).
They have kept extensive records of income and expenditure year on year and each year there has been sufficient income to cover the gifts when relying on the normal expenditure exemption. Fortunately, they have been able to do this without relying on interest/dividends from the stocks & shares ISAs.
As their expenditure has increased in the last year due to inflation, if they want to continue funding regular gifts out of surplus income they will likely need to rely on the interest/dividends generated from their stock & shares ISAs for there to be a ‘surplus’ and for the gifts to fall within the normal expenditure out of income exemption.
However, there has been doubt raised (from an external party) whether the interest/dividends generated from their stocks & shares ISAs can be treated as income for this purpose. This is because the clients currently opt for any income to be retained within the stocks & shares ISAs (so not paid into a personal bank account), as the income is not needed.
The ISAs are managed under a bespoke service with a discretionary fund manager, and the clients can choose what happens with the interest/dividends generated. Any interest/dividends are currently paid into a bank account in the ISA and the investment manager has discretion if/when these funds are ultimately invested (as currently instructed by the clients). However, if the clients requested the income to be paid out or simply retained in cash then this can be done.
Taking the above into account, and that income is not ‘automatically reinvested into a capital product’, my view is that the income generated within the ISAs can be included for the normal expenditure exemption. I do not believe it matters whether the income is paid out of the ISA to a personal bank account. Reading IHTM14255 I believe the key is to determine whether the clients could use the ISA income to fund the gifts. As they can do this, then I believe any interest/dividends generated within the ISAs, even if retained within the ISAs, can be used when calculating whether there is surplus income.
I would appreciate if anyone can offer a view on this.