Giving to charity
In 2011, the government announced two new forms of tax relief to encourage philanthropy.
One is a tax incentive for lifetime gifts of important works of art to the nation (to be introduced from a date yet to be announced). The other is a reduced rate of inheritance tax for certain charitable donations on death. The inheritance tax relief is now in force and presents some interesting planning opportunities, which this article explores.
Inheritance tax relief
A reduced rate of inheritance tax (36% instead of the usual 40%) is available to estates of people who die on or after 6 April 2012 leaving 10% or more of their net estate to charity.
There is no tax benefit to be gained from the reduced rate unless the estate is actually taxable. Only around 3% of estates in the UK pay inheritance tax each year. In most cases, the value of the estate does not exceed the 0% band (currently £325,000 or up to £650,000 if there is a transferable nil band from a former deceased spouse), or else is covered by the spouse exemption or other reliefs. In short, the reduced rate is really only relevant to people whose estates will be subject to inheritance tax and who want to leave something to charity on their death.
Nevertheless, while few estates will prove to be taxable in the end, people may want to include qualifying gifts to charity in their Wills as a fall-back, in the event that the gifts to their primary beneficiaries fail (e.g. if their spouse dies first) and the relief may therefore be helpful.
There will be cases where increasing an existing charitable legacy to meet the 10% threshold may be particularly beneficial. Donors who already intend to leave 4% of their net chargeable estate to charity can increase the gift to 10% without any reduction in the value passing to the other beneficiaries – the cost of the increased charitable gift is effectively borne by HM Revenue and Customs.
Assume a gross estate of £1 million. There is no tax to pay on the first £325,000 and so the net taxable estate is £675,000. Compare the following charitable donations:
|IHT (40% / 36%)||£259,200||£218,700|
|Non-charity beneficiaries receive||£713,800||£713,800|
By increasing the legacy from 4% to 10%, the charity receives an additional £40,500. This is paid for by a corresponding reduction in IHT as a result of the lower rate and without any loss to the rest of the estate.
Similarly, donors intending to leave a charitable legacy of somewhere between 4% and 10% can increase this to 10% and both the charity and the other beneficiaries will be better off. This is because the tax saving which flows from the reduced IHT rate is more than enough to meet the increased charity gift, so the benefit is effectively shared between the charity and the other beneficiaries.
|IHT (40% / 36%)||£251,100||£218,700|
|Non-charity beneficiaries receive||£701,650||£713,800|
At the other ends of the spectrum, it follows that a donation of less than 4% which is increased to meet the 10% threshold will be paid for principally by a reduction in tax but partly also at the cost of the other beneficiaries. Clearly any gift to charity will come at the expense of other beneficiaries, compared to no charitable gift at all.
There is no added tax benefit to non-charity beneficiaries if more than 10% of an estate is given to charity, because the tax savings decrease as a proportion of the donation(s).
Ultimately, the right approach for any individual will depend on their circumstances and their priorities.
Although the idea behind this relief is simple enough, the way in which it is calculated and applied is less straight-forward. There are several different ways in which a Will can provide for a qualifying gift to be made and the options need careful consideration. There may also be additional complexity for executors of estates since assets passing on the death outside the Will may also obtain the relief. These include trust assets in which the deceased had a qualifying life interest and jointly owned property passing by survivorship as well as property in which the deceased had reserved a benefit.
Despite the complexities, many people may prefer to leave more to charity and pay less inheritance tax, especially if they can do so without affecting or possibly benefitting their other beneficiaries.
U-turn on gift aid relief cap
It was announced in the Budget this year that a cap would be introduced from April 2013 on income tax reliefs which are currently unlimited, such as gift aid. This was at odds with other measures to encourage more philanthropy. Thankfully the government listened to the charity world which was very concerned about the impact on large donations. It announced on 31 May that there will be no cap on income tax relief for lifetime charitable giving. The cap on other types of relief (e.g. loss relief) will go ahead as planned.
Giving to EU charities
From 1 April 2012 donors are able to claim all available UK tax reliefs on donations to qualifying charities located in another EU member state or in Iceland or Norway. This extended relief has applied to gift aid donations since 1 April 2010 but now applies to tax reliefs for any donation, including those made on death.
In order to qualify, the recipient charity must be registered by the relevant body equivalent to the Charity Commission if required by the domestic law of the country concerned and the managers of the charity must be “fit and proper persons.”
In some EU countries, the charity registration standards may not be quite as stringent as those in the UK. Donors should carry out thorough inquiries before making substantial donations to ensure tax relief is not lost.
UK tax relief is not available for gifts to charities outside the EU even if the recipient organisation would be “charitable” under English law. Potential donors must therefore look at alternative methods for donating to those charities.