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Inheritance tax and the Big Society

Fundraising | 31 Mar 2011

The change to Inheritance Tax Relief announced in last week’s Budget may not be the panacea for charities that it appears, says Richard Fairbairn.

The inheritance tax relief (IHT) for charities announced in the Budget was certainly good news but if not too little, it may be too late to assist charities with the current funding crisis.  

The premise of the relief is laudable and sits squarely with the idea of a ‘Big Society’.   However, charitable donors will have been left in no doubt that this measure is aimed at benefitting charities and not a testator’s relatives or any other non-charitable beneficiaries who may hope that they will benefit from the reduced rate of IHT applying to the rest of the estate.  Osborne told the Commons: "If you leave 10 per cent or more of your estate to charity, then the government will take 10 per cent off your IHT rate.  Let's be clear: no beneficiaries will be better off, just the charities to the tune of £300m.  I want to make giving 10 per cent of your legacy to charity the new norm in our country."  

So what does this mean in practice?  At present, an IHT rate of 40 per cent is applied to the balance of an individual's death estate after deduction of any available exemptions or reliefs and the nil rate band, which is presently fixed at £325,000 and set to remain at this level until 2015.

The new rate will apply to the estates of individuals dying on or after 6 April 2012.  In those cases, the IHT rate will be reduced from 40 per cent to 36 per cent where the deceased has left 10 per cent or more of his net estate (after deduction of exemptions, reliefs and the nil rate band) to charity.

In the last year, IHT was paid on 15,000-16,000 estates in the UK – 3 per cent of the total – and the Treasury hopes some wealthy individuals might even leave much more than 10 per cent to good causes under the new scheme. 

If we take a simple example of a testator with an estate worth £1m, it will be noted that non-charitable beneficiaries will in fact ultimately receive less from the testator’s estate as a result of the measures:

Death after 6 April 2012 with 10 per cent of estate passing to charity:
Gross estate                                          £1,000,000
Charitable legacy                                    (£100,000)
Nil – rate band                                        (£325,000)
Net estate – taxed @ 36 per cent            £ 575,000
IHT                                                             £207,000
Balance for non-charitable beneficiaries   £693,000

Death after 6 April 2012 with no charitable legacies:
Gross estate                                           £1,000,000
Nil – rate band                                        (£325,000)
Net estate – taxed @ 40 per cent           £ 675,000
IHT                                                           £270,000
Balance for non-charitable beneficiaries   £730,000

For individuals there is no evidence to show that this will of itself encourage philanthropy.   As will be seen from the example above, depending on the value of the estate, this measure could mean that non-charitable beneficiaries are then left worse off, with testators striving to make charitable donations in order that their estate should then benefit from the reduced rate.  This effect is likely to be particularly applicable to the more modest estates which are subject to inheritance tax.  Testators will therefore want to balance their charitable giving against benefitting non-charitable beneficiaries.  Charities will need to be mindful of this when contacting their potential donors and be mindful of the global effect for the estate as a whole.

It may encourage legacy giving but this will not be a quick fix, as the average time between making a will and the charity receiving the legacy is estimated to be five years.  The reduction in income faced by most charities is happening now but the effect of the new relief is unlikely to be felt for some time.  In terms of charity cashflow it would be much more efficient for individuals to be encouraged to continue to donate under the gift aid scheme during their lifetime with the corresponding tax reclaim then being made by the charity.  The charity then has the certainty of an income stream as after all, a will may be changed many times before death.

There will be a consultation on the detail of this new measure, before the summer.  In the meantime we wonder in reality how many testators will rush to change their wills.  The devil will be in the detail, but at first sight this may not be the panacea for charities that it appears.

Richard Fairbairn is head of the tax & trust team at Lester Aldridge LLP

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