Editor's note: The following comments, by Sophie Dover, associate, at law firm Stevens & Bolton, examines recent changes to inheritance tax changes as they relate to charitable contributions, an important wealth planning issue. 

New legislation introduced by the [UK] Finance Act 2012 provides for a reduction in inheritance tax where a person leaves a minimum percentage of his estate on death to charity. 

The new rules apply to deaths occurring on or after 6 April 2012 and reduce the rate of inheritance tax by ten per cent, from the usual 40 per cent to 36 per cent.  To qualify for the relief, a minimum of ten per cent of a person’s chargeable estate must pass to charity beneficiaries. 

Unveiling the relief in his 2011 budget, George Osborne [finance minister] stressed that the government was keen to support philanthropy, encourage charitable giving and reduce the administrative burden on charities, and signalled that the new measures would generate an additional £300 million (around $481.9 million) worth of funding for charities in coming years. Yet the scheme is not without its critics, who have raised a number of concerns about the likely success of the new measures.

One of the criticisms commonly levelled against the new legislation is that it is likely to be of limited application. After applying the inheritance tax threshold and various other exemptions and reliefs, most estates are not liable to inheritance tax in any event. 

Where the legislation does apply, critics fear that it may discourage lifetime giving in favour of giving on death, at a time when many charities are already struggling for funding. Charities are increasingly relying on the older generation for donations – a recent report indicates that more than half of all donations come from the over-sixties.  Yet, it is these persons who are most likely to put in place a will and who may, therefore, shun lifetime donations in favour of post-mortem giving. This could deprive charities of an important source of funding, and impede cash flow in the short to medium term.   

On the other hand, it has been argued that the new legislation is too complex a way of encouraging charitable giving.  This is partly because of the need to include a lengthy formula clause in the will, to ensure that a sufficient proportion of the estate is passed to charity to allow the relief to apply. Previously, persons wanting to leave a share of their estate to charity would often do so by way of a legacy of a fixed amount, rather than as a share in the residue of the estate. This had a number of advantages, often simplifying the administration. However, a person wishing to ensure that a minimum of ten per cent passes to charity is less likely to be able to frame such a gift in terms of a specific sum, and either a formula clause or a flexible trust may therefore need to be included. This is likely to increase costs of drafting the Will, and may act as a deterrent in some cases. 

Available relief

Furthermore, the relief is not only available against the estate as a whole, but may also be available against part of the estate. For example, relief may be available on the value of the estate passing by will but not on the value of joint property passing to a surviving joint owner. In order to establish the position, it is necessary to divide the estate into its constituent parts and to carry out a series of calculations. The legislation sets out the basis of these calculations, and in certain cases it may be necessary to see whether a more favourable outcome can be achieved by combining one or more of the constituent elements. This will require negotiation amongst the different beneficiaries of the estate, and may also necessitate putting in place a deed of variation to redirect further assets to charity. All of this is likely to drive up the costs of administering the estate, reducing the end value available for beneficiaries.

Prior to the introduction of the new legislation, valuation of specific assets passing to charity was of less importance, as any charitable gift would be inheritance tax free irrespective of the value or nature of the property in question.  Now, however, the personal representatives of the deceased will need to obtain an accurate valuation of any asset passing to charity, as the value may influence the inheritance tax payable upon the estate at large. This will again serve to increase the costs of administering the estate, potentially reducing the amount available for charity at the end of the process. Moreover, as the relief is automatic, personal representatives will need to ensure that they opt out if they believe that the costs of obtaining the relief are likely to outweigh the potential inheritance tax saving.

Clients wishing to take advantage of the new provisions should take advice on the drafting of their Wills, and on the assets comprised in their taxable estates, so as to avoid post-death costs and complications over the availability of the relief.