Reduced rate for gifts to charity: the charitable giving condition or 10% test: interaction
Where an estate component contains relievable property and the estate is also partially exempt because assets are passing to charity, it is necessary to apply the provisions of IHTA84/S39A to allocate the relief and exemptions correctly. Whilst this will often work in the taxpayer’s favour by reducing - for IHT purposes - the amount of any chargeable specific legacies, it will also reduce the value of specific gifts left to charity. Without specific provision, this may mean that a component would fail the 10% test, because the value of the donated amount is reduced to a value that is less than 10% of the baseline.
To avoid this happening, IHTA84/Sch1A/Para 6(2) disapplies IHTA/S39A so that, for the purposes of the 10% test, the value of a specific gift to charity shall be taken at its unreduced value. This restriction only applies to specific gifts to charity; all other specific gifts are reduced or relieved in the normal way. As with grossing up, (IHTM45030) it is important to recognise that there are two distinct stages:
- firstly, working out whether or not the 10% test is met, and
- secondly, calculating the chargeable estate and applying the appropriate rate of tax.
If a specific legacy is worded in such a way that the amount of the charitable legacy must meet the 10% test (IHTM45003), the estate will qualify for the reduced rate. Once you have worked out what the figure for the legacy is, you can apply the interaction calculations for the purposes of calculating the chargeable estate in the normal way.
Joanna died on 15 June 2012, leaving an estate valued at £1m after deduction of liabilities. Her Will leaves pecuniary legacies of £250,000 to her son, bearing its own tax, and £20,000 to the RNLI. The residue is left as to 5% to the Salvation Army and the remainder to her two daughters equally. It includes land qualifying for 100% agricultural relief valued at £200,000.
The effect of interaction will normally be to reduce the value of the legacies and calculate the residue after deduction of the agricultural relief. However, in establishing the donated amount, but not the baseline amount, the legacy to the RNLI remains at £20,000.
The interaction calculation for the purposes of the 10% test follows the normal process (IHTM26101).
The value transferred is £800,000; being the value of the estate less agricultural relief.
There are no specific gifts of relievable property
There is other relievable property that is not specifically given. There are specific gifts to charity and to the son which must be reduced by the IHTA84/S39(4) fraction which is
(£800,000 - nil) ÷ (£1,000,000 - nil) = 0.80 or 80%.
The value of the gifts are reduced to:
Charity: £20,000 × 80% = £16,000
Son: £250,000 × 80% = £200,000
No grossing up is required
Calculate the residue using the reduced values
|Less reduced value of gifts||-£216,000|
|Exempt share of residue (5%)||£29,200|
The donated amount, after interaction, is revised to £29,200 + £20,000 = £49,200
The calculation of the baseline would then be
|Estate on death||£1,000,000|
|Less agricultural relief||-£200,000|
|Chargeable transfer||£750,800||(step 1)|
|Less nil-rate band||-£325,000|
|Add back donated amount||£49,200|
|Baseline amount||£475,000||(step 3)|
The charitable giving condition (IHTM45002) or 10% test requires that the donated amount is at least 10% of the baseline amount or £47,500. At £49,200, the donated amount meets this test, so the estate qualifies for the reduced rate of 36%.
If the estate had failed to meet the 10% test, the chargeable estate will be same, but tax is charged at 40%.