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Where There's a Will There's a Way (To Calculate Inheritance Tax)

on Thursday, 17 December 2020.

Charitable legacies are exempt from Inheritance Tax charges (IHT) in estates where IHT charges apply.

However, charitable legacies can still suffer unnecessary reductions in some cases due to opaque problems which can arise when a Will includes legacies to non-exempt beneficiaries too.

This article illustrates these issues.

Two Approaches to Calculating Inheritance Tax

Mr John Doe is a wealthy individual who is a keen supporter of his local cancer research charity, (the Charity), for the support it gave his wife. Mr Doe has four children: Simon, Frederick, Elizabeth and Louise.

Mr Doe always intended that his children and the Charity should benefit from his estate.

His Will splits his £3 million estate equally between his children, who, as individuals are not exempt from IHT charges and the Charity, who are exempt. So far so good. However, there is no direction in Mr Doe's Will as to whether he wanted the gifts to the Charity to be made before or after the deduction of the IHT charges which are due on the non-exempt share of the residuary estate.

To resolve this situation, two approaches have been decided in the courts in the cases of Re Benham and Re Ratcliffe. However, each one produces markedly different results for the beneficiaries.

Re Benham:

  • states that the gifts should be calculated after the deduction of IHT (this is now known as the 'net division approach')
  • is more beneficial for non-exempt beneficiaries, like Mr Doe's children as they will receive a larger gift
  • this results in a larger payment of IHT and a smaller gift to the exempt beneficiaries, like the Charity

Whereas Re Ratcliffe:

  • states that the gifts should be calculated before the deduction of IHT (this is now known as the 'gross division approach')
  • is more beneficial for exempt beneficiaries as they will receive a larger gift
  • this results in a smaller payment of IHT, but also a smaller gift to the non-exempt beneficiaries.

Why Does it Matter Which Approach is Used?

The two approaches produce markedly different results for each set of beneficiaries.

As a starting point, and in any event, because more than 10% of Mr Doe's estate passes to a charity, the estate benefits from a reduced IHT rate of 36% (as opposed to 40%), which is welcome news.

However, if the approach in Re Ratcliffe was used to calculate the gifts in Mr Doe's estate, it would have the following effect:

Re Ratcliffe approach:

       
   

Payment / gift

 

% share of estate

         

IHT payment

 

£747,000.00

 

24.90%

The Charity

 

£600,000.00

 

20.00%

Simon Doe

 

£413,250.00

 

13.78%

Frederick Doe

 

£413,250.00

 

13.78%

Elizabeth Doe

 

£413,250.00

 

13.78%

Louise Doe

 

£413,250.00

 

13.78%

         

Totals

 

£3,000,000.00

 

100.00%

 

In contrast, if the approach in Re Benham was used it would have the following effect:

 

Re Benham approach:

       
   

Payment / gift

 

% share of estate

         

IHT payment

 

£804,956.90

 

26.83%

The Charity

 

£439,008.62

 

14.63%

Simon Doe

 

£439,008.62

 

14.63%

Frederick Doe

 

£439,008.62

 

14.63%

Elizabeth Doe

 

£439,008.62

 

14.63%

Louise Doe

 

£439,008.62

 

14.63%

         

Totals

 

£3,000,000.00

 

100.00%

 

The decision in Re Ratcliffe is therefore beneficial to charities and accords with the principle that gifts to charities are exempt from IHT - so a charity should not have to bear the burden of IHT unless the testator specifically states in the Will that the ultimate net gifts should be equal with non-exempt beneficiaries.

However, the Re Benham approach benefits non-exempt beneficiaries, and puts them on a level footing with the Charity in terms of the percentage of the net estate that they inherit.

In the example above, no one can be sure which result of the above two Mr Doe really wanted, as he did not specify this in his Will.

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Careful Will Drafting to Avoid Uncertainty or Dispute

When deciding which approach to adopt, the wording of the Will is the crucial starting point.

Therefore, it is important that this point is raised and considered through expert legal advice and questioning when a Will is prepared. A failure to identify or explain the implications of splitting an estate between exempt and non-exempt beneficiaries could lead to uncertainty and even a dispute between the two types of beneficiary.

In such cases, it will fall to the executors named in the Will to decide which approach to take. Whilst the Re Ratcliffe approach tends to be the default position (being the most recent decision), which benefits charities as exempt beneficiaries, there may be additional evidence which suggests the person making their Will would have chosen otherwise.

In cases where it is difficult for the executors to decide, an application to HMRC or to the Court (if no agreement can be reached) may be required, causing costs and delay to the estate, further reducing the ultimate gifts and causing uncertainty for the charity and the non-exempt beneficiaries until a solution is reached.

How Can Our Legacy Protection Team Help You?

Our legacy protection team advises charities who are beneficiaries in estates where such complications arise. Whilst it is clearly in a charity's best financial interests to seek a distribution following the Re Ratcliffe approach, we understand that other factors, such as reputational management come into play and must be weighed carefully in the balance before decisions are made.


For specialist advice in relation to your charity's entitlement under a Will or how to manage your legacy entitlements, please contact Leila Goodarzi in our Private Client team on 07909 682 364 or complete the form below.

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