The inheritance tax gift rules can be more generous than many people realise, but they are not always straightforward. One useful exemption allows gifts made during a person’s lifetime to fall immediately outside inheritance tax, without the usual seven-year wait. However, a recent First-tier Tribunal case has highlighted that the conditions still need to be met, especially when it comes to what counts as normal expenditure.
The exemption for gifts out of income
The normal expenditure out of income exemption allows certain lifetime gifts to be treated as immediately exempt from inheritance tax. To qualify, three conditions must be met.
The gifts must:
- be made as part of the individual’s normal expenditure
- be made out of income
- leave the individual with enough income to maintain their usual standard of living
What counts as income is not always obvious
At first glance, the income test may seem straightforward. In practice, it is not always that simple. There is no statutory definition, and income does not necessarily mean income for tax purposes.
For example, non-taxable income can still count. That includes income from individual savings accounts, or ISAs. HMRC also takes the view that income becomes capital after it has been accumulated for two years.
Usual standard of living still matters
Another condition is that the gifts must leave the individual with enough income to maintain their usual standard of living. In most cases, that means the standard of living that was normal for them when the gift was made.
That matters because the exemption may still apply even if circumstances later change. For example, someone may have made a regular commitment when surplus income was available, but later had to reduce their standard of living for another reason, such as redundancy.
Why normal expenditure can be harder to prove
The recent tribunal case focused on one part of the inheritance tax gift rules: whether the gifts counted as normal expenditure. For gifts to qualify as normal, they must be habitual or regular. They do not need to be for a fixed amount.
In that case, the taxpayer had made a number of substantial charitable donations. However, HMRC challenged donations made to campaigns supporting the UK leaving the EU. Those donations were not accepted as exempt.
The reason was that the gifts had only been made over a period of nine months. That was not considered long enough to show a settled pattern. There was also no predictability in the donations and no particular reason for the amount of each gift.
What a settled pattern may look like
A settled pattern will usually mean gifts being made over three to four years. However, a single gift might still qualify if there is evidence that it was intended to be the first in a pattern.
That distinction is important. The exemption is not just about giving money away. It is about showing that the giving formed part of a normal and established pattern of spending.
A useful reminder for anyone making regular gifts
This case is a useful reminder that the inheritance tax gift rules do allow some lifetime gifts to fall outside inheritance tax immediately, but the detail matters. The source of the funds, the regularity of the gifts, and the effect on the giver’s standard of living all need to be considered. Detailed HMRC guidance on the normal expenditure out of income exemption is available in the internal manuals at IHTM14231 to IHTM14255.