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HMRC internal manual

Inheritance Tax Manual

Lifetime transfers: conditions for normal out of income exemption: Case Law - MacDowell

The case of McDowall and others (executors of McDowall, deceased) v Commissioners of Inland Revenue and related appeal [2004] STC(SCD) 22 is the only case to date that has considered the second condition that a gift is made out of income. The gifts in question were made under a power of attorney and the first set of appeals was unsuccessful because it was held that the attorney had no power to make the gifts. The Special Commissioners though made a decision in principle on the second set of appeals that the gifts, if validly made, would have been normal expenditure out of income.

The deceased’s Attorney had made five payments of £12,000 to each of the deceased’s five children from the deceased’s current account. It would appear that the money had been accumulated in a deposit account over a period of about 3 years before its transfer into the current account. The Special Commissioners concluded that the gifts were made out of income and that they were exempt under IHTA84/S21. This turned on their view that ‘it was identifiably money which was essentially unspent income and not invested in any more formal sense’. It was also important that the Attorney had considered the matter and had taken the view that the payments were being made out of income. Other gifts had also been made but were not regarded as gifts out of income.

The Special Commissioners did not consider the meaning of the words ‘taking one year with another’ in IHTA84/S21(1)(b); nor did they offer any general guidance on when accumulated income becomes capital. It is significant though that they did not consider that the duration of accumulation was, by itself, a decisive consideration. They considered it more important to look at how and for what purpose the income had been accumulated.

You may see the argument that McDowall provides authority that all income that has not been formally invested retains its character as income indefinitely but that is not what the case established and you should resist any such argument.

Evidence was available in this case from the Attorney himself but, in most cases, the gifts in question will have been made by a deceased person and you will need to look for evidence of intention from other sources. You should not accept the taxpayer stating that income was being accumulated with the intention of making a gift out of that income without supporting evidence.

Although this case primarily involved the condition for exemption in IHTA84/S21(1)(b), the Special Commissioners also followed the principles established by Lightman J in the Bennett case (IHTM14244) regarding normal expenditure.

“In our view, the pattern of payments of small gifts at birthdays and Christmas is readily distinguishable from the larger payments of £12,000 and can provide no support for establishing a pattern of payment of larger sums; nor do we consider that the deceased’s habit of making gifts, including those disguised as loans, on sporadic occasions of need can help the appellants. However, we consider that the evidence is just sufficient to enable us to conclude that Mr McNeill, as attorney, made a commitment regarding future expenditure, namely to distribute a substantial part of the excess of WCM’s income over the amount required for his maintenance (making due allowance for unforeseen circumstances) equally among WCM’s five children. The payments of £12,000 to each of the five children in 1997 demonstrated that the commitment was being implemented, and we are satisfied from his evidence that, but for WCM’s death, Mr McNeill would have continued to make similar, even if much smaller, payments”