Topic

The Charity Exemption

As explained above, any transfer of value to a qualifying charity is exempt from IHT. 

To qualify a charity must be registered within the UK or European Economic Area. 

Where at least 10% of the estate has been left to a charity, the IHT rate is reduced on the taxable part of the estate from 40% to 36%. 

However, there are circumstances where amount a charity receives from an estate is reduced due to IHT being payable on other parts of the estate. 

If the Will leaves legacies to non-exempt beneficiaries and states that this legacies are left “free of tax”, this means these legacies use the NRB first before the remainder of the estate (known as the residuary estate). 

It is not possible in tax law for a testator to state that no tax is payable on particular legacies. The only way to ensure that is to only leaves funds to a spouse or charities – or to make use of other reliefs. 

If those legacies, exceed the available NRB then the tax that would otherwise be due on those gifts is instead paid for by the residuary estate. 

This is best explained by an example:

Noah dies leaving a £500,000 legacy specified to be free of tax to his sister Beatrice. The residue of his estate (worth £1m) is to go to Good Dogs UK (a registered UK charity re-homing abandoned and stray canines).  

Noah had never married. 

The legacy exceeds the available NRB and there is no transferable NRB or residential NRB available here. This means the gift is subject to IHT. 

More than 10% of the estate has been left to charity so the 36% rate applies here. 

Unfortunately we cannot simply deduct the available NRB from the value of the legacy and then multiply the remainder by 36%. The reason for this is that to do so would not reflect the true position of the estate. 

In effect, by saying “free of tax” Noah is saying “net of tax” or “after tax”. In other words he wants Beatrice to receive £500,000 and whatever is left after tax, expenses of the estate and such, is payable to Good Dogs Uk.

In order to determine the tax payable we therefore need to gross up the legacy. 

The calculation to do this is as follows: 

£500,000 x 100/64 = £781,250

This is the gross value of the legacy and when multiplied by 36% it tells us that £281,250 is payable in IHT. 

Or another way to do find the tax is to do £500,000 x 36/64 =  £281,250. 

The effect of this is that the estate is divided as follows:

Beatrice: £500,000
HMRC: £281,250
Good Dogs UK: £718,750