Reduced Inheritance Tax Rate For Charitable Gifts

In the UK Inheritance Tax (IHT) may become payable when someone dies leaving an estate worth over £325,000. The amount of tax payable is 40% of the proportion of the estate that is over the £325,000 IHT limit.

HMRC have however legislated to make it possible for you to reduce the amount of tax payable if you leave 10% of your estate to charity. The purpose of this blog post is to outline how it works.

Leaving 10% of net Estate to Charity to Reduce IHT

In order to encourage people to leave a proportion of their estate to charity, IHTM45000 - Reduced rate for charitable giftsIHTA84/Sch1A legislation provides that where at least 10% of a person's net estate is left to charity, the rate of tax charged is reduced to 36%.

In the legislation the word charity has the normal meaning for Inheritance Tax purposes and includes registered community amateur sports clubs and organisations in the European Economic Area that meet the requirements for being a charity.

The reduced rate only applies to charges that arise on deaths occurring on or after 6 April 2012.

The charitable giving condition is set out in IHTA84/Sch1A/Para 2(2). In order to qualify for the lower rate; the donated amount must be at least 10% of the baseline amount.

The donated amount is defined in IHTA84/Sch1A/Para 4 as the amount of the component which is attributable to property that qualifies for charity exemption.

This could be a legacy of a specific amount, a share of the residue, or a share of the estate that is quantified so as to ensure the estate, or a component of the estate, will meet the 10% test.

The calculation for the baseline amount is set out in IHTA84/Sch1A/Para 5 and is, broadly, the value transferred by a chargeable transfer, but after adding back the amount that qualifies for charity exemption.

Components of an Estate

A person's estate for Inheritance Tax (IHT) is made up of all the property to which they are beneficially entitled, so there may be a number of chargeable elements to the estate, which IHTA84/Sch1A describes as components of an estate.

The reduced rate applies separately to each component that makes up an estate, so it is possible that one component may bear tax at 36% whilst others pay tax at the full rate.

For the purposes of applying the reduced rate, IHTA84/Sch1A/Para 3 divides the aggregate estate on death into three components.

General Component

All other property in the estate, other than property included in the survivorship and settled property components.

Survivorship Component

Property held jointly as Beneficial Joint Tenants.

Settled Property Component

Property held in a trust that is treated as part of the estate for IHT purposes.

It is possible for one or more components to be merged so that the combined component qualifies for the reduced rate.