Gifting Out of Surplus Income: Inheritance Tax Rule Explained

4th February 2026

Normal Expenditure Out of Income Exemption (Inheritance Tax)

The Normal Expenditure Out of Income exemption provides valuable Inheritance Tax (IHT) relief. When the conditions are met, qualifying gifts are immediately exempt from your Inheritance Tax estate, and there is no upper limit to the exemption. Ordinarily, when you make a gift to a person or a trust, that gift is only exempt from Inheritance Tax if you survive seven years from the date of the gift.

The rules for this exemption are set out in legislation at Section 21 of the Inheritance Tax Act 1984. To rely on the exemption, you need to be able to show that:

• The gift formed part of your normal expenditure, meaning it fits a regular pattern, and
• Taking one year with another, it was a gift made out of income, not from your capital or savings, and
• The gifting leaves you with enough income to maintain your standard of living, without needing to dip into capital

What counts as “normal expenditure”?

Normal expenditure means what it is usual for you to spend, rather than an external judgement about what is normal. This is why there is no limit on the exemption, provided you have sufficient income.

The word normal is not defined in statute, so it takes its natural meaning. Dictionary definitions include terms such as standard, regular, typical, habitual, usual.

There is no legislated minimum number of gifts, and no set period over which gifts must be made. HM Revenue’s guidance suggests it is reasonable to consider a timeframe of three to four years when deciding whether there is a regular pattern of gifting.

Can a single gift qualify?

A single gift may qualify as normal expenditure if it is intended to be the first gift in a pattern of gifts. In that case, you need to show that you had assumed a commitment, or adopted a firm resolution, regarding future expenditure. You, or your tax adviser or the administrators of your estate, will need compelling evidence that the single gift is genuinely intended as the start of a pattern, and that there is a realistic expectation of further payments.

Recording your intentions at the outset of the gifting arrangement can be very helpful on this point.

What does “made out of income” mean?

The income you can use for gifts is the income you have received after taxes have been paid and your expenses have been deducted.

A practical issue that often arises is the treatment of 5% withdrawals from investments made into insurance wrappers, for example, offshore bonds. Such withdrawals are generally a return of capital and should not be included when calculating the income available for making gifts.

“One year with another”

Income should be taken one year with another, which means your income can fluctuate. A gift may exceed income in the year it is made but still qualify once income from another year is considered.

This is a grey area, because income does not retain its status as income indefinitely and becomes capital at some point. HM Revenue’s view is that income becomes capital after two years.

Maintaining your standard of living

The key question is whether your usual expenses can be paid out of the income remaining after gifts have been made. The standard of living considered is what is usual for you when the gifts are made.

This means the exemption may remain available if your lifestyle changes after a gift due to a sudden unforeseen drop in income, for example, after a redundancy.

HM Revenue’s approach is that commitments made before a change in circumstances may continue to qualify, for example, continuing to pay insurance premiums that must now be paid from capital due to reduced income. However, the exemption will not apply where the income reduction could be foreseen.

Relevant factors HM Revenue may consider

When deciding whether gifts qualify under the Normal Expenditure Out of Income exemption, a number of practical factors can matter.

Frequency

Normal does not necessarily mean annual, although regular giving is more likely to be seen as normal. HM Revenue’s manual suggests that averaging the yearly amount of the transferor’s gifts of a particular type can help when assessing this.

Amount

Gifts should generally be of comparable size, although variations can meet the tests in some instances. This may apply where the funds required vary over time, for example, school fees, or where gifts are made from an income source that varies, for example, company dividends.

A gift can be partially exempt if income is limited, in which case the excess amount will not qualify for the exemption.

Nature of the gift

Gifts are generally expected to be gifts of money, since the exemption applies only to gifts made out of income.

Gift recipients

Gifts do not always need to be made to the same person. Gifts to people within the same category to which regular gifts are made may be exempt. One example is gifts totalling £10,000 to your grandchildren each year, with the amount received by each individual grandchild varying.

Motives and circumstances

The reasons for gifting and the surrounding circumstances can indicate whether a gift falls within a pattern of habitual giving. You may make regular gifts to a particular group, but not every gift within that category will necessarily qualify. A large one off gift to a child to set up a business is different from regular gifting to children.

Gifts that are excluded from the exemption

Some transfers are not eligible for the Normal Expenditure Out of Income exemption, including:

• Transfers made on death
• Transfers on the termination of a Qualifying Interest In Possession
• Deemed Potentially Exempt Transfers when a Gift With Reservation of Benefit ceases
• Apportionment under Close Company apportionment rules
• Generally, gifts of capital assets

In addition, payment of some insurance premiums related to an annuity on the life of the person making the gift will not be regarded as normal expenditure.

Some exclusions are technical, and it is sensible to discuss your circumstances with a financial planner or tax adviser.

Record keeping and evidence

Good records matter, because HM Revenue may request evidence for gifts made in the seven years preceding your passing. Records of income, spending, and patterns of gifts should be maintained.

The Inheritance Tax form IHT403 contains a detailed schedule that HM Revenue refers to as a guide for determining an individual’s income and expenditure. It is sensible to keep records in line with HM Revenue’s schedule, and prudent to record your intention to make regular gifts out of income.

Conclusion

The Normal Expenditure Out of Income exemption provides a valuable Inheritance Tax exemption. Qualifying gifts can be made directly to individuals, and can also be gifted into a trust.

Making such gifts directly to a trust does not use your Inheritance Tax Nil Rate Band, so the gifts are not subject to the potential Inheritance Tax charges that can apply to making gifts into a trust. This can be a useful way to set aside funds for the future for your intended beneficiaries.

Care should be taken to determine the extent to which you have the capacity to make gifts within the scope of the rules, and adequate records should be maintained.

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Please note this is a general guide and is not advice that can be relied on. It is important that you seek specific advice for your own circumstances. 

This material is intended for both Professional and Retail Clients, as defined by the Dubai Financial Services Authority. Metis Financial Planning Limited is regulated by the Dubai Financial Services Authority.