The normal expenditure out of income exemption enables individuals to give gifts during their lifetime that are instantly free from inheritance tax (IHT)—eliminating the typical seven-year wait. A recent ruling by the First-tier Tribunal (FTT) has provided some clarity on what qualifies as ‘normal expenditure.’
Exemption
To fall under this exemption, gifts must meet three conditions:
- They should be part of the individual’s regular expenditure.
- They need to be made from income.
- They must allow the individual to retain enough income to uphold their typical standard of living.
While the income requirement may seem straightforward, it can be more complex. There is no official definition of income, and it doesn’t always align with taxable income. For example, it can include non-taxable income like that from individual savings accounts (ISAs). Additionally, HMRC considers income to transition into capital once it has been saved for two years.
The term ‘usual standard of living’ typically reflects what was considered normal for the individual at the time the gift was given. Thus, the exemption may still apply even if the giver later has to reduce their standard of living due to circumstances like job loss, despite having made regular gifts when surplus income was available.
Normal expenditure
The FTT case focused solely on whether the taxpayer’s gifts qualified as normal expenditure. For gifts to be deemed normal, they should be made on a habitual or regular basis, but they don’t need to be for a set amount.
The taxpayer had made numerous significant donations to charitable causes, but HMRC questioned his contributions to campaigns advocating for the UK’s exit from the EU. The exemption for these donations was denied because they occurred over just nine months, a timeframe considered too short to establish a consistent pattern; the donations lacked predictability and specific reasoning behind their amounts.
Typically, a consistent pattern implies gifts being given over three to four years, although a single gift could qualify if there is clear evidence that it was intended to be the start of a pattern.
Detailed guidance on the normal expenditure out of income exemption is available in HMRC’s internal manuals: IHTM14231 to IHTM14255.