Any legacies that are free of tax are normally paid in full and any Inheritance tax (IHT) that is due on the legacies is paid out of the share of the residuary beneficiaries. This is not a problem if the residue passes to chargeable beneficiaries. If, however, the whole, or a portion, of the residue passes to exempt beneficiaries, there is a problem, as the amount the residuary beneficiaries receive would be reduced by the tax payable on the legacies.
The statutory remedy (Sections 36 to 40 IHTA 1984) provides that the value of a free of tax legacy is to be taken to be its grossed up value (i.e. the amount which, after deduction of tax, leaves the legatee with the amount actually given by the Will). After deducting the grossed up value of the legacies, the actual amount to be paid to the exempt and non-exempt residuary beneficiaries can be calculated.
Grossing up applies when all or part of the residue passes to one or more exempt beneficiaries and there are chargeable, specific legacies free of tax. Remember that, legacies that are said to come from the residue, may in fact be specific legacies that should be grossed up.
Example: T died June 2002 leaving an estate valued at £500,000, of which £300,000 left to daughter free of tax and the residue to spouse. If the legacy had not been free of tax, the tax would have been £20,000 and the daughter and spouse would have received £280,000 and £200,000 respectively. The necessary grossing calculation is as follows:
|Less nil rate band||250,000|
|Gross up at 40% (i.e. multiply by 5/3)||83,333|
|Add back the nil rate band||250,000|
|Grossed up value of legacy||333,333|
The exempt residue is thus reduced to £500,000 - £333,333 = £166,667. (Remember that you can check the result by calculating the tax on the grossed legacy and then deducting it. The difference should equate to the nominal amount of the legacy (i.e. £333,333 less tax of £33,333 = £300,000).)
For most, more complex situations, the Grossing Calculator will calculate the value of the chargeable estate.
Where the aggregate estate comprises 'different funds'e.g.:
any necessary grossing should be calculated separately in respect of the legacies taking effect from each fund. If the estate also includes a previous lifetime cumulative total, that total is a component of the rate for grossing purposes for each fund.
Details of the circumstances when the calculator should not be used are included at section 1) on page 1 of the Grossing Calculator.
This, and a later, High Court Judgement (Ratcliffe), addressed the question of the meaning of a Will by which the residuary estate was to be divided between exempt and chargeable beneficiaries. Were its terms designed to ensure that all the residuary beneficiaries received specified proportions of the estate after all IHT had been paid, or should the exempt residuary beneficiaries receive their share of the residue with the IHT being paid out of the share of the chargeable residuary beneficiaries?
Following the Ratcliffe Judgement, the expectation is that the majority of cases will fall within the latter situation.
This occurs when the amount of exemption depends upon the amount of IHT due on the estate, but the amount of IHT due on the estate depends on the amount of the exemption.
The interaction provisions (Section 39A, IHTA 1984) can be an additional
factor in particular circumstances. Where there is relievable property
in the residue and specific legacies of non-relievable property, an interaction
calculation will be necessary if either a legacy or the whole or part
of the residue passes to an exempt beneficiary (e.g. spouse, charity
These provisions provide a formula for adjusting the quantum of the specific legacies. In some instances this can benefit the estate while, in others, it can benefit the Exchequer. If an adjusted legacy has to be grossed up, you gross up its reduced value.
Example: If the Will left cash legacies to A and B and the residue, which consists of a business, to C, which is a charity, the benefit of Business Relief on the business would otherwise be lost as charity exemption would apply. The interaction calculation allows us to give part of the benefit of the Business Relief to the specific legacies to A and B by reducing their value. In contrast, if, in the above example, A was a charity and C was the son, the effect of the interaction calculation will still be to reduce the value of the legacies to A and B and therefore to reduce the extent of the charitable exemption (legacy to A).
To see if you need an interaction calculation ask yourself the following questions
If the answer to the first three bullet points is yes and to the last bullet point is no, then interaction should be considered.
There are two quite different situations to keep in mind. Abatement of the quantum of the legacies because:
In the former case, the abated value of each specific gift is used in
any necessary grossing/interaction calculations (S.37 (1), IHTA). In
the latter case, S.37 (2), IHTA applies, to reduce, in a specified order,
the aggregate value of the grossed specific gifts to the value of the