I have a client with a decent income who is understandably intent on making the most of his surplus income by lifetime gifts. I was always taught that the increase in value of a national savings certificate is a capital accretion or addition, rather than income or capital gain in the traditional sense. The problem with ‘I was always taught’ is when you’re asked to justify why this is so. I’ve had a look at the public facing National savings certificates websites, but understandably given that they are tax-free, how the return is classified for accountancy purposes is not clear. The inheritance tax manual does not specifically comment on this point.
I would be happy to have my view seconded, the client would obviously prefer that I have to admit I was wrong, for financial reasons! Any ideas?
Interest on NSCs is specifically exempted from Income Tax by ITTOIA 2005 s692. Otherwise, it would be subject to Income Tax. Whether this translates across to IHT…………?
I guess the problem will be proving the income as the interest is only paid on encashment and, until paid, cannot be available for use for making gifts.
Graeme Lindop Probate Consultant Coles Miller Solicitors LLP
ITTOIA 2005 s370(1) subjects to income tax “the full amount of the interest arising in the tax year”.
ITTOIA 2005 s692 provides that “No liability to income tax arises in respect of income [interest] from authorised savings certificates” (see s692(3) for definitions).
If the interest was paid each year directly to the holder then such would undoubtedly constitute “income” and be available to satisfy the IHT “normal expenditure out of income exemption”.
If, however, as Graeme states the interest is only received (in its normal sense) on encashment of the certificate (ie not annually) and is automatically reinvested in further certificates each year what is the position? There is case law support that at least for income tax such interest arises each tax year and is taxable in that year ie the interest has “arisen” even though the taxpayer cannot actually get at the interest.
On this basis, arguably, the interest thus arises each year (for both income tax and normal accountancy principles) and is income and thus counts towards the taxpayer’s total income for the year and thus available to satisfy the IHT exemption.
HMRC may seek to argue that the interest income has become capital after possibly two years. However, in McDowall v CIR [2004] the IHT exemption
was found to apply to gifts that were made from income that was accumulated for three years before the gifts were made.
I agree with Terry, that the “small print” of NSCs back in the day clearly stated that the return was calculated as interest but capitalised when ascertained, so was always applied as capital.
I believe that this was specifically confirmed at one time by CTO [as was], for purposes of annual expenditure but am not sure if there was ever a court decision on the point.
I don’t suppose that the client has kept all the “bumph” when he/she invested, as this may contain details no longer available online …?
Kevin
I recall having to look at NSCs many years ago, where there was a large holding in an estate where residue was left on life interest trusts.
I was referred to a case (Re Shepherd?) in which an argument had arisen as the will included a non-apportionment clause and the life tenant was claiming the significant uplift in value of the NSC’s on the basis that it was income received post death (when he NSCs were encashed).
The matter went to court and the judge reviewed the prospectuses for the issues of NSC in question and identified a provision to the effect that interest earned during any month was automatically capitalised at the end of the month. Accordingly, the life tenant was only entitled to the interest/accretion in value arising on the holdings since the start of the month in which the deceased had died.
The judge also made the point that it was necessary to carefully consider the prospectus of each issue of NSCs in question to identify the position, as they might not be consistent.
I suggest that the position is probably much the same now and that it will be necessary to look at the prospectus for each issue of NSCs in question to identify if the accretion to value retains the status of “income” when the units are repaid or has been irredeemably converted into capital.
Paul Saunders FCIB TEP
Independent Trust Consultant
Providing support and advice to fellow professionals
