10%: a real gain?

With the passing of the Finance Bill 2012, new rules relating to charitable legacies will come into force. For deaths on or after 6 April 2012, estates that include charitable legacies of at least 10% of the net estate will benefit from a 36% rate of inheritance tax (IHT) compared with the standard rate of 40%.

Several of the issues surrounding the proposed incentives were highlighted in an article at Journal, October 2011, 24, but with the new legislation now in force, have those issues been resolved?

Problem points

In its consultation document, A New Incentive for Charitable Legacies, the Government invited feedback on a number of points, including whether the value of the estate should comprise both “free estate” and “aggregate estate”. In terms of the new legislation, both “free estate” and “aggregate estate” will be relevant. Whether or not the 10% threshold has been met will be determined by splitting a deceased’s estate into three components: “the general component”; the “survivorship component”; and “the settled property component”. The reduced rate of IHT may then apply against the tax charge in respect of any one or more of these components.

The valuation of assets was seen as another grey area. Under the new rules, there is no restriction as to the type of asset which can qualify for relief. The degree to which HMRC will scrutinise valuations of assets remains to be seen, but the additional costs to be incurred in obtaining valuations may, in some cases, negate any potential IHT saving. Fortunately the new legislation enables executors to elect for the reduced rate not to apply if, for example, the benefit to be obtained is likely to be minimal.

Meeting the threshold

Predicting with any precision what the value of an individual’s estate will be at date of death is impossible, with many reliefs (such as APR and BPR) not being determinable until after death. It would therefore seem inevitable that standard “formula” clauses will start to appear in wills. However a more straightforward alternative may be to make use of deeds of variation, discretionary trusts and precatory trusts as a means of ensuring that the 10% test is met, post-death.

Alterations in the devolution of property after death under s 142(1) IHTA 1984 (instruments of variation), s 143 (precatory trusts), and s 144 (two-year discretionary trusts), may be effected in order to obtain the benefit of the reduced IHT rate. Deeds of variation will only benefit from the reduced rate if the charity is notified of the deed. No such requirement applies for precatory or two-year discretionary trusts.

A disincentive?

One of the main criticisms of the new measures is that they might act as a disincentive to lifetime giving. Where exactly 10% of the net estate is given to charity, each £100 of charitable legacy reduces the IHT on the estate by £76. When this 76% relief on death is compared with, at best, 50% relief under Gift Aid, it is easy to see why taxpayers might decide to postpone their charitable giving. The Chancellor’s announcement in this year’s Budget of a proposed cap on income tax reliefs (including Gift Aid) will certainly not help. Fortunately, many of those who give to charity during their lifetime do so for reasons other than tax mitigation, but the potential impact on lifetime giving is nevertheless a legitimate concern for charities who cannot afford to lose vital income.

In its consultation, HMRC admitted that the take-up by those wishing to donate will depend on the extent to which the reduced rate is promoted by charities and professional advisers. Those charities who already promote active tax-efficient giving will no doubt actively promote the charitable legacy incentive, yet trying to promote something so complex may be challenging. The key to effective marketing is simplicity, but the new measures are anything but straightforward. Would something more akin to Gift Aid (as proposed by the Chartered Institute of Taxation) not have been much simpler and therefore easier to promote?

Tax incentives are becoming increasingly important for charities. However, to what extent the new legislation will be a stimulus for charitable giving remains to be seen. While it may encourage those already intending to leave a charitable legacy to increase that legacy, it seems unlikely that it will be enough to persuade others to donate through their will. Some might say that this is a missed opportunity, both for charities and testators.