Mark McLaughlin highlights a selection of circumstances in which letters from individuals making gifts or legacies might be useful.
The reason why an individual (e.g. a family member) makes a gift to another is ultimately a matter of fact. However, it will often be necessary to provide evidence in support of the reason for the gift because the tax treatment might depend on it, particularly if there is more than one possible reason and the transaction is capable of being treated in alternative ways for tax purposes.
Documentary evidence supporting the reason for the gift may, therefore, be important. For example, a letter from the donor to the donee sometimes precedes or accompanies a gift. The letter can be instructive if there is a later dispute with HM Revenue and Customs (HMRC) about the reason for the gift, although HMRC may not necessarily accept that the letter of itself provides conclusive evidence, and might even seek to challenge it. This article outlines some situations when a letter might provide persuasive (albeit inconclusive) evidence.
1. Share and share alike
It is relatively common in family-owned companies for shares to be passed down from one generation to another. For example, shares may be gifted from father to son. If the son works for the company, it needs to be established whether he is receiving the shares as a family member, or in his capacity as an employee. In the latter case, shares received by reason of the son’s employment will have potential tax (and possibly National Insurance contributions) implications as employment income.
On the other hand, shares received solely by reason of the family relationship between father and son should not count as the son’s general earnings. HMRC’s Employment Income manual (at EIM01460) states that a gift does not count as general earnings (under ITEPA 2003, s 62) if made on personal grounds. If shares are being transferred for family reasons, an accompanying letter (or a deed) stating the reason for the gift may provide persuasive evidence of that fact.
2. Is that ‘normal’?
The inheritance tax exemption for normal expenditure out of income is potentially generous if a donor’s gift satisfies certain conditions (in IHTA 1984, s 21). These are broadly that the gift must: (a) be part of the donor’s normal expenditure; (b) be made out of income (taking one year with another); and (c) leave the donor with sufficient income to maintain his or her usual standard of living.
HMRC offers no firm guidance on the ‘normal’ test in (a) above in terms of what evidence is considered to be acceptable for this purpose. However, a letter (or declaration) from the donor stating the intention and circumstances of such normal gifts to the recipient out of income (and possibly also the setting up of a standing order) before the first of a number of proposed gifts may be helpful evidence.
3. Make a wish…
Some individuals have wills dealing with their estates that include discretionary trusts. The potential beneficiaries of such trusts commonly include the surviving spouse (or civil partner) and other family members (e.g. children, grandchildren, etc.). As the name suggests, a discretionary trust deed generally gives the trustees discretionary powers over which beneficiaries are to benefit from the trust’s income and capital, and when they are to benefit. However, the testator may wish one or more specific individuals (e.g. their surviving spouse) to be a principal beneficiary.
In such circumstances, the will (incorporating the discretionary trust) might be accompanied by a ‘letter of wishes’ addressed to the trustees, expressing the hope that the trustees will exercise their discretion in favour of the particular beneficiary, in keeping with the testator’s wishes. It is important that the letter is not legally binding and is not a constraint on the trustees’ discretionary powers.
However, a letter of wishes can offer the testator some degree of comfort that the specified beneficiary might at least be taken into consideration when the trustees consider exercising their discretion.
The letter accompanying a gift in (1) above may be persuasive evidence that the family relationship is the reason for making the gift, but HMRC may still seek to argue otherwise, particularly if there is contrary evidence. Similarly, a letter in (2) above prior to the first of an intended pattern of gifts may be a helpful indicator of that intention if there was a realistic expectation that those further gifts would be made. However, a letter is likely to be only one of a number of factors and evidence that HMRC might take into account depending on the circumstances, and of itself is, therefore, unlikely to prove the taxpayer’s case. The letter of wishes in (3) does not of itself have tax consequences, but the trustees’ actions are likely to have tax implications. The letter must not be binding on the trustees, but in practice trustees generally take reasonable requests into consideration when exercising their discretion.
This article was first printed in Tax Insider in November 2017.