Top Tip – What happens if the donor pays the IHT on a chargeable transfer? CII R03, J02, AF1, AF5
A question that has come up in both J02 and R03 in particular is the grossing up of chargeable lifetime transfers where the donor (also called the settlor or transferor) pays the tax on transfers over the nil rate band.
As you’ll know, a lifetime chargeable transfer will trigger an immediate charge to IHT if it exceeds the NRB. (Together with any other chargeable transfers in the previous 7 years). The rate of tax is half the death rate – ie 20% – with nothing further to pay if the person lives for the next 7 years.
Let’s look at an example:
Charlie gifts £350,000 into a discretionary trust. He had already used his annual allowances of £3,000 but had made no other gifts.
If the trustees pay the tax on the gift, their liability will be:
£350,000 – £325,000 = £25,000 x 20% = £5,000
If Charlie pays the tax as settlor, then the value has to be grossed up. The easiest way to work this through is by multiplying the net transfer by 1.25 (or divide by 0.8), ie £25,000 x 1.25 = £31,250 and multiplying this by 20% to give £6,250.
The reason we have to gross up is because IHT is based on the loss to the person’s estate. If they make a transfer to the trustees and they pay the tax to the tax man then the loss to the estate is the two added together and tax is worked out on that figure.
In the exam to save time and to easily remember, if the trustees pay the tax multiply the net transfer (in our example £25,000) x 20% and if it’s the settlor paying the tax, multiply by 25% and you’ll get the right answer every time.
So look out for this in R03 in particular as both answers will be in front of you and it’s easy to go for the 20% answer and miss they’ve said the settlor is paying the tax.
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