Covenants contain tax advantages which reduce cost

When parents grow older and have to rely on a fixed income, their children - now earning an income of their own - may look for ways to make their retirement easier or more enjoyable. One way of doing so is to provide parents with gifts such as cash or property.

Under the gift and inheritance tax rules, these are tax free up to £25,720 in 1999. However, all gifts and inheritances received by a recipient, on or after the base date of December 2nd, 1988, must be added together to determine the amount of tax payable on the current gift.

If this combined amount passes 80 per cent of the £25,720 threshold, or £20,576, then the gift should be reported to the Revenue Commissioners. However, it is only taxable when it breaches the £25,720 threshold. This issue was raised by a reader, Mrs M from Stoneybatter, who wishes to make a small gift of money to her parents following the receipt of a voluntary severance payment. Her semi-retired parents still earn a small income.

Since gift tax is a self-assessment tax, the persons receiving the gift are responsible for declaring it when taxable. In this case, Mrs M's parents bear sole responsibility for reporting and paying tax on the gift. First, they must add together all gifts to them since December 2nd, 1988. The initial reporting of the gifts should occur only when that combined amount exceeds £20,720.

Tax is only payable when the total amount exceeds £25,720. An IT-38 form must be lodged with Revenue within four months of receiving the gift that breaches this amount. However, the first £1,000 accepted by any donee in each tax year is exempt.

If Mrs M's parents are over 65 years of age, a second option is a covenant which would provide tax relief for her. Ideally, the recipient - in this case, her parents - should not be liable for income tax as it would reduce the benefits of taking out a covenant. Under a covenant, the recipient may receive up to 5 per cent of the giver's annual income for seven years. If Mrs M decides to give her parents £1,000 a year for seven years, she needs only to give them £760 pounds. The other £240 is paid to the parents through a tax rebate while the daughter, Mrs M, receives tax relief of £220. This reduces her actual cost to £540 from £760.

To draw up a covenant, Mrs M should obtain tax form R185 and an information leaflet which suggests the proper wording for a declaration of covenant from her local tax office. Declaring a covenant is an inexpensive process and a solicitor is not required. Once the covenant is established through simple paperwork, a tax reclaim form should also be obtained from the local tax office. Covenants may also be subjected to gift tax.

If Mrs M wishes to use this option, she must write the cheque and lodge it before April 5th.