Luckily, charities are exempt from inheritance tax, but problems can still arise, particularly when estates are shared with non-charities.
When this is the case, consideration needs to be given to whether the division of an estate is calculated before deducting the inheritance tax - the gross approach - or after deducting it - the net approach. It is important to use the correct method, because the net approach results in a higher tax bill for the estate, which means less money for the charity or charities concerned.
The landmark cases in this area are Re Benham's Will Trust and Ratcliffe, Holmes v McMullan.
The court applied the net approach in the Benham case. This decision turned on the particular words used by the testator and is therefore of limited application. The words used implied that the estate was to be divided equally between the charities and non-charities after the payment of inheritance tax. This is different to the wording in most professionally drafted wills, which direct that estates should be divided after payment of debts and funeral and testamentary expenses, but do not direct that the charities and non-charities should receive equal amounts.
In the Ratcliffe case, the court applied the gross approach. The testator left her estate to the executors upon trust "as to one half-part thereof for [the non-charities] in equal shares absolutely ... and as to the remainder of my estate upon trust for the following charities in equal shares ... ". HM Revenue & Customs argued that, because inheritance tax is a testamentary expense, the net approach used in the Benham case should be adopted unless the testator provided otherwise. The court disagreed with this analysis because, although inheritance tax is a testamentary expense, it is unlawful for charities to bear tax unless very specific wording is used - such as the wording in the Benham case.
Charities must ensure that they look closely at the wording of wills when they share estates with non-charities, because the two approaches create different results.
- Kathryn Hillier is an assistant solicitor in the probate and trust team at Wilsons.