How to Gross Up Chargeable Lifetime Transfers When the Donor Pays the Inheritance Tax
A question that has come up in J02, R03 and AF1 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. In this article, we share with you a couple of examples that will help with your CII exam revision.
THIS ARTICLE IS RELEVANT TO EXAMINABLE TAX YEAR 2018/19.
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.
Look at this 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.
Why gross it up?
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.
Save time in the exam
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%. 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.Here are a couple of examples that will help CII R03 and AF1 exam takers save precious time on exam day. Click To Tweet
How It’s Been Tested in AF1
The way it has been tested before in AF1 is as follows – this has been adapted from a past paper:
In May 2018, James, having made no previous lifetime gifts, settled £650,000 into a discretionary trust, with his children as potential beneficiaries.
The question is, calculate the initial IHT liability on the transfer of the gift into the trust – assuming that James pays any tax due.
The information has been given that the settlor is paying the tax on the transfer. The answer, as given in the exam guide, is:
£650,000 ‐ £6,000 ‐ £325,000 = £319,000
£319,000 x 25% = £79, 750
As you can see, the exam guide just shows the 25% – they should also have given credit for candidates showing the correct grossing up of the gift, ie:
£319,000 grossed up by 20% (divide by 0.8) = £398,750 x 20% = £79,750
So remember, if the trustees pay the tax, multiply the net transfer by 20% and if it’s the settlor paying the tax multiply by 25%.
Grab the resources you need!
If you’re studying for your CII AF1 exam, and you’re wanting to feel prepared on exam day, you’ll need to practise as much as possible. Grab our free taster to try out one of Brand Financial Training’s resources for yourself. Click the link to download the AF1 calculation workbook taster now!