The Office of Tax Simplification ("OTS") has issued its second report on inheritance tax. Our sister Personal Law blog will cover the report more generally. Here we look at thoughts for charities. Importantly, and perhaps most interestingly, a key charities message from the OTS is less about tax and more about effective fundraising. The power of talking about legacies.

What is the Office of Tax Simplification?

A very brief overview. Rather than tax policy, the OTS is interested in making recommendations about improving the administration of the UK tax system for those engaging with it. Consequently, the OTS will research and then make recommendations on rule changes which will help facilitate a smooth tax system.

What did the Office of Tax Simplification say about charities and inheritance tax?

The OTS looked at three main points about charities:

  • the calculation of inheritance tax and the rule of 'grossing up' (basically a rule to make sure the right inheritance tax is paid and 'suffered' by the right beneficiaries);
  • the reduced rate of inheritance tax where 10% of an estate is passed to charity; and
  • the general appetite for giving to charity on death.

Grossing up

'Grossing up' applies where some of an estate passes to a beneficiary who is liable to suffer inheritance tax (non-exempt beneficiaries such as children, nephews or nieces, a trust) and some passes to a beneficiary that should not suffer inheritance tax (e.g. a charity). The idea is that the entitlement of non-exempt beneficiary is notionally made bigger or grossed up by the tax to make sure the right amount of tax is paid, suffered by the right beneficiary, the right amounts are paid out of the estate and there is no manipulation to artificially reduce the inheritance tax payable. The OTS research found the rules are complex, mis-understood, mis-applied or not applied at all. There is also the potential that charities are accidentally suffering inheritance tax but are not wishing to correct executors for fear of the reputational impact of doing so.

To cut a long story short, while the rules are complex, the OTS recommends not proposing to remove grossing up.

As a technical aside, the OTS notes that one option for reform (to require the tax to be paid out of the legacy to the non-exempt beneficiary) would go against the presumption that specific legacies are free of tax unless the deceased determines otherwise in their wills. There is, of course, the example of Scottish legal rights which are treated as legacies that suffer their own tax.

The reduced rate of inheritance tax where 10% of an estate is passed to charity

The OTS noted that the while the policy intent of the reduced rate of inheritance tax was to encourage more giving, there are still only a small proportion of estates (2.1.%) where 10% of more goes to charity. The OTS also noted there is no data to show what impact the reduced rate has on giving. The result is that, despite some complications with the reduced rates rules and their application, it is still too early to decide if the reduced rate should be changed at all. Positively, the OTS highlighted the number of estates in which beneficiaries were making deeds of variation (the ability within two years of a death to 're-write' a will) to benefit (in some cases by a greater amount) charities: a potential mix of generosity/philanthropy and utilising the reduced rate.

It's good to talk: the general charitable exemption and the power of discussing giving on death

The first two were quite technical topics. On wider giving to charity on death, it was found that the public does have strong awareness of the inheritance tax benefits of giving to charity. And that awareness leads to the opportunity for charitable giving to be discussed. For the OTS it seems that the very discussion can lead to legacies and support for charities. So, out of a report about tax simplification, it appears that a key message is that legacy income can be driven by charities and others appropriately talking about giving on death. An interesting and perhaps encouraging message for charities and fundraising teams to consider.