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Charitable gifts and trusts

Last month we looked at a case involving a charity, who was the beneficiary in remainder under a trust, taking the trustees to Court to obtain information about the trust. In fact, there have been many cases reported recently where charities have been involved in litigation, for which many have been roundly criticised.

We previously reported the cases involving RSPCA Gill v RSPCA [2009 and 2010] and RSPCA v Sharp [2010], as well as the Illot v The Blue Cross and others [2017] case which involved a number of animal charities.

One cannot help but wonder whether the donors to the charities, and indeed the testators, in each case would have left the legacies to those charities knowing that substantial sums are being spent on aggressive litigation as opposed to being expended for charitable purposes. This month we consider the best ways of leaving a legacy to a charity

IHT-efficient charitable legacies

According to HMRC statistics IHT charity relief has nearly doubled since 2012, presumably reflecting the special reduced IHT rate introduced in that year for gifts on death. The relief amounted to £470m in 2011/12 and to £880m in 2015/16. In 2013/14 9.3% of all deaths resulting in an IHT charge benefited from the reduced 36% rate (at a cost to the Exchequer of £328m).

Let’s briefly remind ourselves the rules to reduce the IHT rate payable on an estate on death from 40% to 36%.

For deaths occurring on or after 6 April 2012, where an estate includes a qualifying charitable legacy of more that 10% of the net estate, the taxable estate will benefit from a 36% rate of IHT, rather than the normal 40% rate. For these purposes the ‘net estate’ is the value of the estate after taking into account the available nil rate band (NRB) (including any transferable NRB), IHT exemptions (such as the spouse exemption) and IHT reliefs (such as business property relief) but includes the value of the charitable legacy itself.

To qualify for the relief, the legacy would need to be left to one of the following:

  1. A charity for UK tax purposes that is a charity or other organisation in the UK, European Union Member State, Iceland or Norway that would be a charity under the law of England and Wales (if it were located in England and Wales); or
  2. Settled into trust to be used for charitable purposes only; or
  3. A Community Amateur Sports Club.

As stated above, the reduced rate of IHT applies to estates where 10% or more of the deceased’s taxable estate is left to charity. The value of the estate on which the 10% threshold is calculated (the ‘baseline’) will be the value of the net estate charged to IHT after deducting all available reliefs, exemptions and available nil rate band, but excluding the charitable legacy itself.

The reduced rate does not have to just apply to assets transferred under the deceased’s will and can also apply to other assets on which IHT is payable on death.

When calculating the availability of the reduced rate the estate is divided into three ‘component’ elements:

  • Jointly owned assets which pass by survivorship or similar provision (the ‘survivorship component’). These would be assets such as bank accounts or property owned as joint tenants (as opposed to property owned jointly as tenants in common which will pass under the terms of a Will).
  • Trust assets in which the deceased had a life interest or right to income immediately before death (the ‘settled property component’). These would be arrangements such as pre-Finance Act 2006 interest in possession trusts and immediate post-death interest trusts.
  • All other assets in the estate, including the free estate, but not including property which the deceased gave away but reserved a benefit in it for IHT purposes (the ‘general component’).

The total value of charitable legacies will be compared with the baseline amount to determine whether the ‘component’ of the estate qualifies for the reduced IHT rate. The reduced rate can apply to either individual components or they can be merged and the reduced rate applied across the merged components (if the charitable legacy is 10% or greater of the value of the merged components).

Some people will simply want to use the charitable legacy route to reduce the IHT rate on the remainder of the estate, i.e. to limit the charitable legacy to the required 10%. In such a case special wording may be included in the Will to ensure that this happens. In many cases, however, in particular where the testator has no children and no spouse, they may want to leave a larger portion of their estate to a charity. If you are an adviser and are looking at a client’s Will, or advising them on how to structure their Will, while it may be apparent that the reduced rate will apply, for example where they intend to leave a third of their estate to charities and the rest to nephews and nieces, when it comes to work out the potential IHT liability on the estate things may not be quite so straightforward.

A legacy of a fixed sum or a legacy of residue?

In most cases recently before the Courts the charities involved were the beneficiaries of the residue. It is indeed a frequently found Will provision which, say, leaves a right to income for a named beneficiary with the capital on that person’s death passing to a charity. 

Following the adverse publicity earned by the charities involved in the litigation, some legal advisers have started advising people making Wills not to leave a share of residue to a charity but instead to leave a fixed sum legacy. Whilst that would mean that there would be less litigation of the kind mentioned above it is not necessarily a solution suitable to all.

However, there is another, very valid, argument against leaving a share of the residue of one’s estate to a charity. The problem is in calculating the IHT due on gifts that are partly exempt. If a part of the residue is left to a charity and part to an individual, we have the task of calculating tax on ‘partly exempt transfers’ and legend has it there are only two people in this country who know how to do this. This is because there are very complex rules in the legislation and, indeed, case law on how the tax should be borne where the Will provisions are not clear enough. What is essential is that the Will should state whether the intended beneficiaries should receive their specified shares or amounts of the residue "before" or "after" tax, and this frequently does not happen. Needless to say things will get even more complicated where the estate includes trust interests and / or property qualifying for business or agricultural property relief. Professional assistance should always be obtained in such a case.  The easier alternative would, of course, be to leave a fixed sum to a charity/ies or to a charitable trust.

An outright legacy or a charitable trust?

If the testator knows exactly which charities they want to benefit, that would be the easier way to leave a legacy. In such a case all that would be required is to verify that the intended beneficiaries are indeed qualifying charities. Often legacies are left to schools or clubs or foreign institutions and not all of them will qualify as a charity for the purpose of the 10% IHT reduction.

If the client is not totally certain about which particular charities should benefit outright, the option would be to include a charitable trust in the Will. We will look at the requirements for such a trust to qualify as a charitable trust in another article.

Including charities as beneficiaries of a discretionary will trust

An "ordinary" discretionary trust, which includes, say, family members as well as charities as potential beneficiaries, will not qualify as a charitable legacy for the purposes of the 10% IHT rate reduction. However, it should be remembered that any appointments made by the trustees within 2 years after the death of the testator are "read back" into the Will, so as long as there are advancements to qualifying charities made by the trustees within those 2 years the same result will be achieved as if there were outright charitable legacies included in the Will. 

Comment

Especially in cases where a testator is not able to benefit from the various reliefs and exemptions reserved for married people with children (namely the spouse exemption and the transferable nil rate band) the benefit of a reduced IHT rate on charitable legacies is probably even more important. It may even be that people in this category are more likely to make charitable legacies. Advisers therefore need to be aware of this tax planning opportunity as well as being aware of the best methods of ensuring that not only the lower tax rate is achieved but that the testator's practical aims are achieved.