The normal expenditure out of income exemption can be a highly effective way to pass on wealth during your lifetime, without triggering inheritance tax (IHT) or waiting seven years.
A recent case heard by the First-tier Tribunal has provided further clarity on how the normal expenditure out of income exemption works in practice, particularly around what qualifies as ‘normal expenditure’.
What is the normal expenditure out of the income exemption?
The normal expenditure out of income exemption allows individuals to make gifts from surplus income that are immediately exempt from IHT.
To qualify, gifts must meet three key conditions:
- They must form part of your normal expenditure
- They must be made out of income
- They must not reduce your ability to maintain your usual standard of living
All three conditions must be met for the normal expenditure out of income exemption to apply.
What counts as ‘income’ for the exemption?
When applying the normal expenditure out of income exemption, income is not always defined in the same way as taxable income.
For example:
- It can include non-taxable income, such as income from ISAs
- There is no strict statutory definition of income for this purpose
- HMRC generally considers income to become capital after it has been accumulated for two years
This makes accurate record keeping essential when relying on the normal expenditure out of income exemption.
Maintaining your standard of living
A key requirement of the normal expenditure out of income exemption is that gifts must not affect your usual standard of living.
In practice:
- This is assessed based on your circumstances at the time the gift is made
- If you had surplus income when committing to regular gifts, the exemption may still apply even if your situation later changes
For example, a later reduction in income, such as redundancy, does not automatically prevent earlier gifts from qualifying.
What does ‘normal expenditure’ mean?
The recent tribunal case focused on whether certain gifts could qualify as normal expenditure under the normal expenditure out of income exemption.
To be considered ‘normal’:
- Gifts should be habitual or follow a regular pattern
- They do not need to be for a fixed amount
In this case:
- The individual had made several substantial charitable donations
- HMRC challenged donations made to campaigns supporting the UK’s leaving the EU
The exemption was denied because:
- The donations were made over just nine months
- This was not long enough to establish a consistent pattern
- There was no clear structure or predictability in the amounts given
What can we take from this?
This case highlights the importance of consistency when using the normal expenditure out of income exemption.
Typically:
- A pattern of gifting over three to four years is more likely to qualify
- A single gift may still qualify, but only if there is clear evidence it was intended to form part of a regular pattern
Why the normal expenditure out of income exemption matters
The normal expenditure out of income exemption remains a valuable tool for inheritance tax planning, particularly for those with surplus income.
However, it is not automatic. It relies on:
- Careful planning
- Clear documentation
- A consistent and structured approach to gifting
If you are considering using the normal expenditure out of income exemption, getting the structure right from the outset can make all the difference.
As part of the SMH Group, you will also benefit from access to a wider range of services to support you through every stage of your financial journey. We are here to give you the confidence to grow and shape your future. We are here to give you the confidence to grow and shape your future. Give us a call at 01142 664 432 or email info@smh.group for more information.
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