Grossing, Interaction and Abatement - A brief Guide

 

Grossing

Why?

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.

When?

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.

How?

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:

Nominal legacy 300,000
Less nil rate band 250,000
  50,000
   
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.:

  • free estate;
  • property passing by survivorship;
  • settled property in which the deceased had a life interest;
  • foreign property devolving under local law; or
  • GWRs charged as part of the death estate;

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.

What is “re Benham”?

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.

What is circular grossing?

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.

Interaction

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 or heritage).
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

  • Is any part of the transfer exempt from tax?
  • Is any property subject to Agricultural or Business Relief?
  • Are there any specific gifts of non-relievable property, to exempt or chargeable beneficiaries?
  • Is the whole of the relievable property, on which Agricultural/Business Relief has been claimed, the subject of a specific gift?

If the answer to the first three bullet points is yes and to the last bullet point is no, then interaction should be considered.

Abatement

There are two quite different situations to keep in mind. Abatement of the quantum of the legacies because:

  • There are insufficient assets in the estate to meet the specific gifts in full, even before the IHT liability is taken into account.
  • The effect of the grossing/interaction rules increases the adjusted values of the specific gifts above the value transferred (i.e. the value of the free estate). This can happen, for example, where the greater part of the estate devolves by means of a free of tax chargeable legacy and the residue is exempt.

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 free estate.