Explanation of S.21 IHTA 1984 and Bennett v IRC

A very useful gifting exemption is the exemption which applies to gifts which can be characterised as “normal expenditure out of income”. To comply with this exemption certain principles must be strictly adhered to. I set out these basic principles for your future reference in the paragraphs below.

Basically, Section 21(1) Inheritance Tax Act 1984 allows an individual to make Inheritance Tax exempt gifts provided the gifts can be characterised as being:

  • part of the donor’s normal expenditure;
  • made out of the donor’s income, taking one year with another; and

provided that, when one takes out these normal expenditure gifts from normal income, the donor is left with sufficient income to maintain his/her usual standard of living.

Case law, particularly the case of Bennett v IRC, has provided us an interpretation of what the above test really means.

The first point to note about the test is that the Revenue applies a subjective test and therefore it is the normal expenditure of the particular donor and not the normal expenditure of an average man that is analysed. This naturally helps the income rich taxpayer.

The second important point to note is that the normal expenditure must be part of a “settled pattern of expenditure”. This means that whilst there is no fixed minimum period during which the gifting must have occurred there must be evidence that an intended pattern of payment had been established and there was an intention for that pattern to remain in place for more than a nominal period. This, of course, is designed to frustrate “death bed” resolutions to make periodic payments for life. Generally, the Revenue consider a period of at least three or four years is the minimum to reasonably assess whether a settled pattern has emerged although this is not exclusive and a single gift can be exempt if, for instance, it is the first payment under a Deed of Covenant or the first of an intended series of premiums on a life policy.

The third important element of the test is that the gift must come out of “income” and this strictly means income arising in the year in which the gift is made. Therefore, if one invests income year on year with a view to making large lump sum payments of rolled up income every few years and then using that rolled up income to make gifts then this will not qualify for exemption.

A fourth and final consideration that must be borne in mind is that the donor must be able to still maintain their usual standard of living. This means that it is not permissible to make gifts from normal income which would lower one’s standard of living but then maintain it by recourse to capital. It is therefore a good idea to keep a record of total annual income and total annual expenditure so one can easily show there was excess income available.

In conclusion, therefore, the sort of gifts that may be made are regular payments of premiums on life policies, payments made in accordance with a covenant or regular payments of a fixed amount of cash annually. A classic example is paying grandchildren’s school fees. Ideally payments should be made annually at about the same time of the year to make the “pattern” obvious. Finally, you must bear in mind that it is a subjective test that the Revenue will apply and the Revenue will only give a ruling once you are dead (unless you do a pilot settlement) so there is always something of an inherent gamble in any arrangement you come to but this exemption should not be refused if one adopts the above principles.