I have a case where the client clearly has surplus annual income in the region of £8,000 per annum.
He has been making gifts to his daughters since the tax year ended 5 April 2019 onwards up to death.
In the first year, he made gifts totaling £22,500 which cannot all be supported by the excess income of that year.
There follows an extract from an article I have read:
“There are no set rules about when accumulated income becomes capital but HMRC normally considers this to happen after two years. This may be a problem where income has been accumulated.”
There is an obvious benefit to being able to claim that these gifts were made out of the surplus income for the tax years ended 5 April 2017, 2018 & 2019.
Does anyone have any experience with making such claims and if there were any queries raised by HMRC.
All thoughts appreciated.
Even if a source is taxed as income it does not mean the source constitutes income for exemption purposes. Classically, withdrawals from an investment bond although taxed as income are treated as capital as is any capital element of a purchased life annuity.
Income is typically treated as accumulated after two years by HMRC and thus payments out of such accumulations may be challenged by HMRC.
The normal expenditure out of income exemption is heavily fact dependent and requires looking at the position of surplus income on a year to year basis in which case income from an earlier year may be used to make a gift which qualifies for exemption.
The s.21 IHTA exemption is mercurial. Others’ experience of a general nature may have its limitations. All I can say of mine is that I have had no adverse feedback from clients over a long period. With PRs as clients one can advance to HMRC any argument that is not specious. Lifetime planning demands more caution and worst case scenario advice seems recommended.
IHTM 14231-14255 are informative as to HMRC’s position for the time being (though as ever not determinative of the law). As the exemption is highly fact- and evidence-based it is doubtful whether the contents could found a legitimate expectation and twice they warn of a need to refer to “Technical” plus one FOI exclusion. 14250 deals with accumulated income under the headings “available” and “fluctuating” and 14521 with the McDowall case (but pointedly).
I have my reservations about the case as an authority and so may HMRC, though you would not expect this to be explicit in the Manual. These are:
1 With due (genuine) respect it is a first level decision;
2 The gifts were held invalid in law so the IHT element was obiter;
3 There seems to have been an over-reliance on identifying the funding source as income in nature (and so conflation with the available annual income calculation formula) whereas no one takes the view that s.21 ordains, not even impliedly, any like for like matching or tracing exercise;
4 “taking one year with another” in s.21 does seem to justify the carry forward of surplus income but it appears strongly arguable that it cannot be bought forward from before the making of the first gift in the relevant series (or, applying Bennett, the only gift made out of a commitment to a series). If it could, where would the line be drawn? Not “indefinitely” argues14251. The Commissioners did not take that point but might have been swayed their by their approach (erroneous in my view) to point 3 above. HMRC do not (in terms) take it either;
5 In the actual case the gifts made in the single year were £60,000 and available income around £45,000. In fact the Commissioners expressly doubted whether that level of giving would be maintained. It might have been that under Bennett only a much smaller sum should have been treated as exempt and thus within the income of the year itself. HMRC refer to just such a general possibility with references to “part” in 14243 and 14255.