IHT - using Normal Expenditure from Income. What is income?

JBW_athome

I have been searching the forums for some answers but I sill have some uncertainties.

Having recently put together a spreadsheet to calculate any potential IHT payable I was horrified at the result.

I have been supporting our children for some years with monthly standing orders.

My question is clarifying what counts as income. I know for instance that interest from my ISA that is held within the ISA account and compounded does not count as income. (iirc)

In particular does income from a NS&I Income bond, paid directly into my current account count as income or is it seen as return of capital?

Similarly, do prizes from Earnie count towards income, again paid directly into my current account? It's paid tax free of course, but I am not sure if it is included.

Thanks for reading.

eskbanker

https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm14250 is where HMRC addresses the issue of what counts as income, but doesn't go to the level of detail of your questions.

My interpretation is that there isn't any distinction between the income being taxable or not, so PB winnings and ISA interest aren't excluded simply because they're tax-free…

poseidon1

The premium bond winnings question came up in the thread below and worth reviewing, in particular @Jeremy535897 's observations . The position with regard to NSI bond income also cropped up -

https://forums.moneysavingexpert.com/discussion/6644760/inheritance-tax-section-21-ihta-meaning-of-income

The general view within the tax advisory profession is that PB winnings are not income in this context- see below

https://www.rodgerstaxation.co.uk/the-iht-gifts-out-of-income-exemption-what-counts

ISA income may qualify, but only if regularly paid out to the investor rather than accumulated in the ISA.

You may find the following general guidance from Aberdeen Group useful , on both the identifcation of expenditure as well as what constitutes income in arriving at your surplus income available for gifting each tax year -

https://techzone.aberdeenadviser.com/public/iht-est-plan/gifts-out-of-surplus-income

Albermarle

One issue is that how the rules are exactly applied is at HMRC's discretion. Your executor will have to prove what was eligible income that was gifted, so make sure you leave lots of detailed info.

As it is a kind of loophole anyway, there is always the chance it will get changed at some point anyway.

JBW_athome

My thanks to eskbanker, poseidon1, Albermarle, for your quick and detailed responses.

I have another IHT question up my sleeve, but I will digest this info first, before asking my next question.

Riedel

I wouldn't necessarily leave out ISA interest just because you have chosen to have it credited to the ISA. It is still income which is at your disposal even if, in the case of a fixed-rate ISA bond, you may suffer a penalty to access it. Of course, you cannot show that such income was used to pay the gifts but I believe it should still be included when considering whether you were still left with sufficient income to meet your normal standard of living. You may find HMRC's guidance at IHTM14255 helpful where it states: "Although the normal expenditure gifts must have left the transferor with ‘sufficient income’ to maintain their usual standard of living, they do not need to have actually used this for living expenses. The transferor may in fact choose to use capital to meet their living expenses and use the income remaining, after making the gifts, for some other purpose. It is enough, for the exemption to apply, that the income was enough to meet both the normal expenditure gifts and the usual living expenses."

Interest on income bonds is clearly 'income' in nature. It is a return on capital rather than a return of capital. It's paid into your current account so is clearly available to fund your standing orders. Another bit of HMRC guidance that may interest you is at IHTM14250, which includes the following statement: "If a gift is made out of a current account you only need to check that the gift could have been made out of income. You do not need to match the gift to specific money in the account."

Dead_keen

https://forums.moneysavingexpert.com/discussion/comment/82123630#Comment_82123630

I agree - "income" is a concept, not cash. And there is nothing to say you need to identify the cash from which the "income" came from and spend that particular bit of cash. But equally there is another concept that income does not stay income for ever.

One issue is that how the rules are exactly applied is at HMRC's discretion.

No, that is not right. The legislation is not something that HMRC has discretion about. Some of the concepts (e.g. "income", "normal", "taking one year with another", etc) are not defined with hard boundaries and will depend on a particular set of facts. If, for example, I disagree with @poseidon1's view on premium bond prize that are used as part of a normal investment strategy (which I do) and HMRC disagree, then it is up to the courts to decide, not HMRC.

As it is a kind of loophole anyway

It is explicitly set out in legislation so it is a "loophole" in the same way that getting tax relief on pension contributions, or ISAs, are "loopholes" (which they are not).

there is always the chance it will get changed at some point anyway.

That's right. And the pension tax rules can change too but the risk of a future change does not stop many people making pension contributions now.

dales1

Thanks, Riedel.

Here is a relevant thread with the views of Tom99 (an accountancy type, as a change from the two legal bods mentioned above). He is another who believes that reinvested dividends can constitute Income for IHT403 (as long as the donor has sufficient other monies from which to fund the gifts themselves).

Also, there is nothing to be lost by including (as Income on IHT403) these reinvested dividends and PB prizes (if you are among those who believe they ought to qualify). All that HMRC can do is to deny the claim. And the IHT403 form itself does not draw out the presence of such items, as these amounts will be subsumed in the row headings which are specified on the form.

DRS1

Premium bond prizes are an interesting one. I suspect that if I won £1million on a premium bond I would find it hard to convince myself that it was income.

dales1

Yes DRS1, I agree.

But you wouldn't be making your regular gifts out of income, out of a one-off £1m prize; and so you would not claim an IHT403 exemption on such a sum. So I would certainly ignore that sum.

However a regular monthly stream of small prizes (out of a healthy PB balance, and at an official prize fund interest rate of 4.35%) does feel like income to me (and to the man on the Clapham omnibus). So I would (and I do) confidently include them in my IHT403.

DRS1

https://forums.moneysavingexpert.com/discussion/comment/82123845#Comment_82123845

Point taken though if one prize doesn't count you may find all prizes don't count - at what point could you say the regularity aspect ceases - £100, £1,000 or £100,000?

On the other hand I believe there was a case where someone totalled up their surplus income for a year and gave all that surplus away. They did that for more than one year and had documented the fact that that was how they were doing it. It was held that this fell within the exemption even though the amounts given away were variable. If you did that maybe you could use the £1million prize in the calculation and give most of it away as surplus. It would be a brave thing to do.