Q&A: Covenants – saving tax while you support an elderly family member

In regard to your query last week about Mr B.H.'s 93-year-old father whose pension pot is close to empty and how the family can financially assist him in a tax efficient way, you refer in passing to the possibility of Mr B.H. making a tax free gift of €3,000 each year to his aged father. Would it not be legal for him to make similar gifts to several family members (assuming that he is a person of means), with the unwritten agreement that the several gifts be gifted onwards to Dad in tax free moieties of €3,000? It sounds too easy to be allowable but I'd welcome your views. He is not alone in his situation.

Mr C.Q., email

He is certainly not alone, if the postbag following last week’s column is anything to go by. The issue of older people running out of assets before they die is already becoming a serious concern and it is a situation that seems certain to get considerably more acute and more widespread over the next decade or so.

However, the suggestion you make will not work in Mr B.H.’s case. What he was looking to do was to offer some form of financial maintenance to his father but in a manner that would grant him some tax relief. I assume from this that he is already aware of the possibility of availing of the small gift exemption. In any case, the gift under the exemption – and indeed other gifts – would come from already taxed income and so would provide no relief to him, or his father.

Covenant

However, there is another option which I did not have time to consider properly last week. Aside from relief payable if his father is deemed in need of care and he, possibly with other family members, pays for that care, a position which we covered last week, the main avenue for investigation in his circumstances is probably the possibility of using a covenant.

Covenants are written legal agreements made between two people and formally witnessed by a third.

They can be used for several purposes, including providing for those who are permanently incapacitated but, for your purposes, there is provision for the use of a covenant to pay monies to an adult over the age of 65.

There are rules, of course. First, a covenant can only be considered when it is capable of running for at least six years. At 93, that might be a stretch for Mr B.H.’s father but it is certainly technically possible and therefore, to my understanding, meets the threshold.

The money must be paid without reciprocal gain – ie the person paying does so without expecting anything in return, directly or otherwise. That doesn’t mean that someone making a covenant to a relation rules themselves out of any inheritance but they cannot be favoured simply by virtue of having provided funds through a covenant.

So what about the tax relief. This depends on both the income of the person making the covenant and the person receiving funds under it.

Essentially, the person paying the funds is entitled to relief on the money at the difference between the standard rate and their higher rate. What that means is people paying tax only at the standard rate will receive no benefit at all: anyone paying tax at the higher 40 per cent will be able to secure relief at 20 per cent.

Exemption limit

The recipient of the money under the covenant can also claim relief at the standard rate of income tax but only if their income, including the covenant monies, does not exceed the exemption limit, which is currently €18,000.

There is a further restriction, which applies to covenants providing funds to people over 65. The maximum relief that can be claimed by the person providing the funds is 5 per cent of the total income. This limit applies not just per covenant but across all such covenants. So if a person is covenanting money to a number of people, the 5 per cent threshold applies to the total sum covenant.

Coming back to the small gift exemption, this is provided under Revenue rules explicitly to facilitate the ability of people to make small gifts. It operates largely on a good faith basis.

The one thing that Revenue is wary of, however, is abuse of the rules to allow one person channel money to another person through a variety of conduits. Thus, if a father (or mother) gives €3,000 to each of their four children, it is grand. If however, the money is gifted to all four but three of them subsequently gift the same sum to the remaining sibling, Revenue will consider that the full €12,000 gift was made from the parent to the one child and ignore the “middleman”, so to speak.

That will see anything over €3,000 being deducted from the lifetime giving/inheritance limit and, if that limit is already reached, a tax bill of 33 per cent on €9,000 of the gift.

Having said that, although it does nothing to provide relief for the donor, there is nothing to stop this man organising other family members to each gift up to €3,000 to help financially support the father without the father facing any tax bill. Send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara St, D2, or email dcoyle@irishtimes.com. This column is a reader service and is not intended to replace professional advice.