IHT and when "income becomes capital"

pysifr

HMRC suggest two years, but this is not defined and the  McDowall case accepted 3 years. However, all the "case law"  relates to giving "gifts out of income". HMRC gives some guidance about explaining why the "income" should retain its meaning for longer than two years and not become capital in relation to "gifts out of income". But if I keep my excess money at the end of each year in one or more current accounts, as we are saving for a big expenditure for ourselves (eg two business class airfares - Australia and USA west coast) does this allow me to use "savings" older than two years to fund these, and thus continue to make the usual gifts out of income to my daughters and grandchildren

Keep_pedalling

You say you are saving for these trips which would suggest you don’t have access to much in the way liquid assets at the moment is that correct? 

The rules around gifting from excess income are a little vague at best so I am not sure there is a definitive answer to your question. 

pysifr

The question is does FIFO work. The rules are contradictory.

On the one hand HMRC state under Available income:

"You should initially look at the income of the year in which gifts were made to see if there was enough income available to make the gifts, before considering earlier years"

This "rule" would seem to rule out FIFO in that it appears that you cannot use "surplus" income from the previous two years, unless you cannot afford the gifts out of the current year's income.

But, on the other hand, HMRC also seem to accept that income/outgoings fluctuate and refer to "taking one year with another" This seems to suggest that you can "Front load" the savings from the previous one or two years?

Linton

[Deleted User] said:

The comment about "You should" is an instruction to the HMRC officer reading the manual.  If they see £100,000 of income, £60,000 of expenses and £10,000 of regular gifts, they don't need to do anything more complicated 

So that is not a "rule" but a practical way for HMRC to look at a completed IHT403 form.

The taking one year with another point is part of the legislation and (without checking Hansard) I think it is designed to help people with variable income (eg normal expenditure is £60,000 per year but in some years income is £50,000 and in other years £100,000 - for example they have less income in a recession or because on maternity leave).

The question then is how you apply it?  No idea. You could apply it by eye and say you are fine because you clearly have a net surplus by looking at two consecutive years. But if you want to maximize this exemption then some methodology would be helpful.  

If you find that a consistent FIFO basis allows you to maximize gifts that fall within this exemptions then contemporaneously document it (spreadsheet showing numbers and how FIFO applies) and make sure your executors have the evidence. While a tribunal might or might not agree with the basis, having contemporaneous evidence of what you wanted to do, how you did it and why you did it (ie maximise the use of s21) must be helpful.

Agreed. The principle of Gifts From Income is simple, but the details are not and cannot be tightly defined otherwise it would be too constricted or leave wide open loop holes for clever advisors to use for tax avoidance.

Ultimately it will be up to a tax inspector to make a decision based on the circumstances.  This  could be challenged in the courts, but I can’t see this being viable for anyone other than the seriously rich..

So I suggest you just use GFI for simple obvious cases where your income is well above your needs and make life easier for yourself, your executor, and HMRC. Don’t try to be too clever to possibly save a few £s in IHT.

pysifr

In the "taking one year with a other" you could use savings that are not more than two years old. Is there any guidance/rule about the order of using such savings. For the £3000 exemption you can only use a previous year's unused exemption if your have used the current year's exemption - so you cannot use last year's unused exemption in the current year, and allow the current year's exemption to be used next year. is there anything similar about savings. Do I have to use up savings from last year before I can dip into the older savings, or can I use the older savings first thus allowing the more recent savings to be carried forward?   I can find nothing about this.