Giving To Charity In Your Will - Tax Traps For The Unwary
Many individuals want charitable organisations to benefit on their death. Charitable legacies are exempt from Inheritance Tax (IHT) and, if more than 10% of the net estate is left to charity, the rate of IHT charged is reduced from 40% to 36%.
Problems can arise where the residue of an estate is left to a mixture of beneficiaries that are exempt from IHT, such as charities, and those who are not exempt, such as the testator's children.
Using these examples, testators must consider whether they want the charity and their children to receive equal net amounts of their estate, or whether they want the estate to be divided before IHT is deducted (i.e. the beneficiaries each receive the same gross amount).
A well-drafted Will should include a clause stating whether IHT is to be calculated before or after the estate is divided between the beneficiaries.
Poorly drafted Wills mean that this subject has reached the Courts on more than one occasion.
Two key cases have considered this point.
In Re Benham (1995) STC 210, the Court found that, on the specific construction of the Will in question, the testator wanted the charitable and the non-charitable beneficiaries to receive the same net amount.
Re Ratcliffe (1999) STC 262 established the principle that the exempt (ie charitable) and non-exempt beneficiaries should receive the same gross amounts (ie that they should receive different net amounts), unless there is specific wording in the Will that would support a Re Benham-style interpretation.
This means that if the Will is silent on this point and does not address the subject of how IHT should be paid (ie there is no specific wording to support a Re Benham interpretation), the full charitable exemption should apply and the charity beneficiaries will receive a larger proportion of residue than the non-exempt beneficiaries.
Why Does it Matter Which Approach Is Used?
The two approaches produce markedly different results for each set of beneficiaries, and, in some cases it can mean the difference between the estate qualifying for the 36% or 40% rate of IHT.
Calculating the Tax Due
When the division is made using a Re Ratcliffe interpretation, the calculation is straightforward, as the division is made before the tax is calculated and deducted from the non-exempt shares.
Re Benham cases involve a more complicated calculation, where a 'grossing up' exercise is required, which effectively increases the (pre-tax) share of the estate due to the non-exempt beneficiaries.
Summary
Re Benham method:
- the shares should be calculated after the deduction of IHT (now known as the 'net division approach');
- is more beneficial for non-exempt beneficiaries;
- results in a larger payment of IHT and a smaller gift to the exempt beneficiaries.
Re Ratcliffe method:
- the shares should be calculated before the deduction of IHT (now known as the 'gross division approach');
- is more beneficial for exempt beneficiaries as they will receive a larger gift;
- results in a lower payment of IHT, but also a smaller gift to the non-exempt beneficiaries.