Also known as gross up. A process to calculate the gross amount of a payment (that is, the before tax value of a payment) where only the net amount is known.
The term may arise in the following contexts:
In the context of a loan agreement, grossing up may arise where A is supposed to be paying 100% of interest to B but has to withhold tax at, say, 10% and therefore, it will pay 90% to B and 10% to HM Revenue & Customs (www.practicallaw.com/6-200-6399) (HMRC). In such a case, the loan agreement will often require A to pay to B such further sum as will ensure that B actually receives and retains 100%. At first glance, that sum may seem to be 10%. However, that 10% itself may be subject to withholding tax, in which case A should pay 9% to B and 1% to HMRC. A would then still be obliged to pay 1% to compensate B but again withholding might apply and it might pay 0.9% to B and 0.1% to HMRC. This process is called grossing up. A gross-up clause is one which makes it clear that A has to pay such further sum as, after deducting any tax, leaves B with 100%. If the withholding tax rate is 10%, the grossing up formula is: (amount of interest x 100) ÷ 90.
In the context of inheritance tax (www.practicallaw.com/3-382-5648), grossing up arises where a will contains a chargeable (www.practicallaw.com/9-382-5589) legacy to be paid free of tax and all or part of the residuary estate (www.practicallaw.com/4-382-6280) is exempt. The legacy needs to be grossed up to calculate the total value transferred (that is, the legacy and the tax on the legacy). While inheritance tax rates remain at 40%, simply multiply the legacy by 5/3. A legacy of £100,000 is grossed up to £166,666 (£100,000 x 5/3), meaning that tax of £66,666 is due on the total value transferred.