Inheritance Tax

Inheritance tax is governed principally by the Inheritance Tax Act 1984 (IHTA 1984).
Tax applies to death estates and can also catch transfers made during life.
There are three main occasions when IHT may be charged:
 on death
 on lifetime gifts made to individuals within 7 years prior to death
 on lifetime gifts to a company or into a trust

On death Lifetime gifts made to individuals within Lifetime gifts to a company

seven years prior to death or into a trust
Transfers on death Potentially exempt transfers Lifetime chargeable transfers
Inheritance tax is If IHT were limited to a charge on death, one Inheritance tax might also be
intended primarily to way to avoid tax would be to reduce the size avoided by the use of a trust
take effect on death. of one’s estate by making lifetime gifts or corporate entity.
 When an  IHT is therefore also charged on certain  At present a lifetime gift
individual dies, IHT lifetime gifts or ‘transfers’ if the donor to a company or into a
is charged on the dies within 7 years after making them. trust is immediately
value of his estate  At the time when the transfer is made no chargeable to IHT at the
(broadly, his assets IHT is chargeable, the transfer is time when it is made,
less his liabilities) ‘potentially exempt’. If the transferor unless the trust is for a
subject to various survives for 7 years, the transfer becomes disabled person.
exemptions and exempt. If dies, transfer is chargeable.
reliefs.

The main charging provisions

STEP Identify the  A lifetime transfer of value is any disposition which reduces the value of
1 transfer of the transferor’s estate.
value  On death, tax is charged as if the deceased had made a transfer of value
of his estate.
STEP Find the  For a lifetime transfer, this is the amount of the reduction in the
2 value transferor’s estate.
transferred  On death, it is the value of the estate.
STEP Apply any  Various exemptions and reliefs exist for public policy reasons which can
3 relevant reduce or eliminate the IHT charge on any given transfer.
exemptions  Some exemptions apply both to lifetime transfers and to the transfer on
and reliefs death (e.g. to spouse or civil partner).
 Others are more restricted, and many apply only to lifetime transfers
(e.g. annual exemption).
 The main reliefs are business and agricultural property relief, which may
apply both to lifetime transfers of such property and to the transfer on
death.
STEP Calculate RATE OF TAX: A range of tax rates apply to IHT, the lowest being zero per
4 tax at the cent – there are two bands
appropriat 1. the nil rate band (currently £325,000) – available for all transfers of
e rate value;
2. the residence nil rate band (currently £150,000) – available only on a
transfer on death where there is a ‘qualifying residential interest’.
o 2017/18 - £100,000
o 2018/19 - £125,000
o 2019/20 - £150,000
o 2020/21 - £175,000
 The rate of tax that applies in excess of the nil rate band and the
residence nil rate band (where applicable) varies according to the type
of transfer
CUMULATION: whether the nil rate band is available for any chargeable
transfer.
 In order to calculate the available nil rate band on any transfer, whether
during lifetime or on death, one must first look back over the 7 years
immediately preceding the transfer.
 Any chargeable transfers made by the transferor during the 7-year
period must be taken into account in order to determine how much of
the nil rate band remains available.
 As the residence nil rate band is not available for lifetime transfers, it
will be available in full on death, subject to any adjustments in relation
to estates over £2 million. Cumulation is not relevant.
 Transfers on Death

The Charging Provision Steps

Step 1: identify the transfer of value
When someone dies, he is treated as having made a transfer of value immediately before his
death - “X is deemed to make a transfer of value on death of everything to which he was
beneficially entitled”.
Step 2: find the value transferred
“Value  “Value transferred” = value of the deceased estate immediately before
transferred” = his death.
The deceased  “Estate” = all the property to which he was beneficially entitled
estate immediately before his death with the exception of ‘excluded property’
(s5(1) IHTA 1984)
o Property which passes under the deceased’s will or on intestacy.
o Property to which deceased was ‘beneficially entitled’ immediately
before his death but which does not pass under his will or
intestacy, e.g. joint tenancy.
o Property included because of special statutory provisions, e.g.:
 Under the Finance Act 1986, if property is gifted but the donor
still actually enjoys possession and enjoyment of it at the time
of death, it is “subject to reservation” and still forms part of
estate (donor treated as being ‘beneficially entitled’)
 Some trust interests if they are qualifying interests in
possession.
Excluded property – reversionary interest (future interest under a
settlement)
Property outside the estate
o Life assurance policy once it is written in trust for a named
beneficiary
o Discretionary lump sum payment made from a pension fund to the
deceased’s family
How are assets  Assets are valued at “the price which the property might reasonably be
valued? expected to fetch if sold in the open market” immediately before death:
s160 IHTA
o Change in value on death (increase or decrease) should be
considered: s171
o Quoted shares: normally two prices are given, so take ¼ of
difference between lower and higher price and add it to lower price.
o DEDUCT:
 Liabilities owed by the deceased at the time of time: s505
 Reasonable funeral expenses: s162
Step 3: apply exemptions/relief
Spouse or civil  s18: Any property included in the estate is exempt if it passes to the
partner deceased’s spouse or CP under the deceased’s will or intestacy, or
exemption survivorship (joint property).
 N.B. if transferor domiciled in the UK but transferee is not, exemption
limited to £325,000 or transferee can elect to be treated as UK-
domiciled for IHT purposes and receive full exemption (s18(2))
 N.B. does NOT apply to CO-HABITEES
Charity  s23(1): Any property included in deceased’s estate is exempt if it passes
exemption to charity.
 N.B. when large charity gifts are made by deceased, it may affect the tax
rate on the rest of the death estate
Business and  Applies to reduce the value of ‘relevant business property’ by a certain
agricultural percentage, provided that the transferor owned the property for the
property two years immediately before the transfer.
o Reduction of 100% for:
 A business or interest in a business (e.g. share in a
partnership); (NOT small shares in quoted) and
 Unquoted shares
o Reduction of 50% for:
 Quoted shares which gave the transferor control of the
company; and
 Certain land, buildings and machinery owned by the
transferor but used in his company or partnership
 Agricultural property relief applies in a similar manner to reduce the
agricultural value of agricultural property
Step 4: calculate tax at appropriate rate
Rate of tax  If the deceased has made no chargeable transfers in the 7 years before
death, rate on the first £325,000 of his estate is 0% (nil rate band).
o If the date of death is after 6 April 2017 and the deceased
owner a qualifying residential interest (HOUSE) and being
closely inherited (child, grandchild, or their spouses or widows),
the new ‘residence nil band’ will be available in addition to the
nil rate band in the following amounts:
 6 April 2017 – 5 April 2018: £100,000
 6 April 2018 – 5 April 2019: £125,000
 6 April 2019 – 5 April 2020: £150,000
 6 April 2020 – 5 April 2021: £175,000
o Where the estate is valued at £2 million or more, the residence
nil band is reduced by £1 for every £2 over the £2 million
threshold.
Has the deceased survived a spouse or CP?
 The nil rate band is increased by whatever percentage of the nil rate
band of the spouse that was unused by them (max of 100%). This also
applies to residence nil rate band.
Joe dies having only used £225,000 of his nil rare band, Mrs Joe dies –
hers increases to £425,000.
Estate transferred to different people?
 Where the estate is transferred to different people, the estate rate
calculates how much tax each beneficiary has to pay.

Cumulation  Chargeable transfers in seven years before death

o Cumulation will apply
o Lifetime transfers use up the deceased’s nil rate band first.
o Reduces amount available for the estate
 If the estate exceeds the nil rate band, the excess is charged at 40%,
unless at least 10% of chargeable estate is passing to charity, in which
case the rate is 36%.
 Potentially Exempt Transfers (PETs)
Only chargeable if transferor dies within 7 years

The Charging Provision Steps

Step 1: identify the transfer of value
Any lifetime disposition made by a person which reduces the value of the estate: s3(1) IHTA
Excluded dispositions – transfer for the maintenance, education or training of the transferor’s
child under 18, or over that age if still undergoing full-time education or training, or for the
maintenance of a dependent relative (s11 IHTA)
Step 2: find the value transferred
“Value  “Value transferred” = This is the amount by which the value of the
transferred” = loss transferor’s estate is less than it would be but for the transfer – value
in value to the transferred is the loss in value to the estate (s3(1) IHTA)
estate o Market value at time of gift (not death)
Step 3: apply exemptions/relief
Spouse or civil  s18: Any property included in the estate is exempt if it passes to the
partner deceased’s spouse or CP under the deceased’s will or intestacy, or
exemption survivorship (joint property).
Charity exemption  s23(1): Any property included in deceased’s estate is exempt if it
passes to charity.
Business and  Applies to reduce (relief) the value of ‘relevant business property’ by a
agricultural certain percentage, provided that the transferor owned the property
property for the two years immediately before the transfer.
o Applies to reduce the value transferred by a transfer of
‘relevant business property’ made during lifetime.
o If transferor dies within seven years after the transfer, relief
will only be available if the transferee still owns property
when he dies.
 Reductions
o Reduction of 100% for:
 A business or interest in a business; and
 Unquoted shares
o Reduction of 50% for:
 Quoted shares which gave the transferor control of the
company; and
 Certain land, buildings and machinery owned by the
transferor but used in his company or partnership
Annual exemption  s19: Applies to first £3,000 transferred by lifetime transfers in each tax
year (exempt)
 Unused exemption may be carried forward for one year only (max of
£6,000) (use up current year’s exemption before carrying forward)
o If more than one transfer is used in one tax year, exemption is
used to reduce first transfer. Any unused exemption is used
against the second and further transfers
Small gifts  s20: Gifts in any one tax year of £250 or less to one person are exempt.
Normal  s21: Lifetime expenditure is exempt if:
expenditure out o It was made as part of transferor’s normal expenditure
of income o It was made out of transferor’s income; and
o After allowing payments, transferor was left with sufficient
 income to maintain his usual standard of living.
Gifts in  s22: Lifetime gifts on marriage are exempt up to:
consideration of o £5,000 by a parent of a party to the marriage.
marriage o £2,500 by a remoter ancestor of a party to the marriage (e.g.
grandparent)
o £1,000 in any other case
= Potentially exempt status
 Any value remaining after exemptions and reliefs have been applied is
potentially exempt.
 The transfer will become chargeable only if the transferor dies within 7
years.
 If he survives for 7 years, it will automatically become exempt.
 If he dies, transfer becomes chargeable and must be assessed.

Effect of death on PETs

Step 4: calculate tax at appropriate rate

Rate of tax and The final step is to identify the rate or rates of tax applicable to the transfer
cumulative total in question. In order to do this, one must first establish the transferor’s
cumulative total of transfers at the time of the PET, as this will reduce the
available nil rate band.

 The cumulative total will be made up of:

 any LCTs made in the seven years before the PET being assessed
(even if the LCT was made more than seven years before the
transferor’s death – therefore a taxpayer who makes a LCT may
have to survive for 14 years before it ceases to have any
impact); and
 any other PETs made during the seven years before the PET
being assessed which have become chargeable as a result of the
transferor’s death.

 The rates of tax applicable to chargeable transfers made within

seven years of death of the transferor are:
 0% on the available nil rate band; and
 40% on the balance (the lower 36% charity rate is not
applicable).
Tapering relief Where a PET has become chargeable, tapering relief is available if the
transferor survives for more than three years after the transfer. The relief
works by reducing any tax payable on the PET.

 Tax is reduced to the following percentages:

 transfers within three to four years before death: 80% of death
charge
 transfers within four to five years before death: 60% of death charge
 transfers within five to six years before death: 40% of death charge
 transfers within six to seven years before death: 20% of death
charge
 Lifetime Chargeable Transfers (LCTs)
Immediately chargeable

The Charging Provision Steps

Step 1: identify the transfer of value
Any lifetime disposition made by a person which reduces the value of the estate: s3(1) IHTA
which does not fall within the definition of a PET
E.g. Lifetime transfer made on or after 22 March 2006 into any trust (other than a disabled trust)
or to a discretionary trust or company (no date restriction for company)
Step 2: find the value transferred
“Value  “Value transferred” = This is the amount by which the value of the
transferred” = loss transferor’s estate is less than it would be but for the transfer – value
in value to the transferred is the loss in value to the estate
estate o Market value at time of gift (not death)
Step 3: apply exemptions/relief
Spouse or civil  s18: Any property included in the estate is exempt if it passes to the
partner deceased’s spouse or CP under the deceased’s will or intestacy, or
exemption survivorship (joint property).
Charity exemption  s23(1): Any property included in deceased’s estate is exempt if it
passes to charity.
Business and  Applies to reduce (relief) the value of ‘relevant business property’ by a
agricultural certain percentage, provided that the transferor owned the property
property for the two years immediately before the transfer.
o Applies to reduce the value transferred by a transfer of
‘relevant business property’ made during lifetime.
o If transferor dies within seven years after the transfer, relief
will only be available if the transferee still owns property when
he dies.
 Reductions
o Reduction of 100% for:
 A business or interest in a business; and
 Unquoted shares
o Reduction of 50% for:
 Quoted shares which gave the transferor control of the
company; and
 Certain land, buildings and machinery owned by the
transferor but used in his company or partnership
Annual exemption  s19: Applies to first £3,000 transferred by lifetime transfers in each tax
year (exempt)
 Unused exemption may be carried forward for one year only (max of
£6,000)
o If more than one transfer is used in one tax year, exemption is
used to reduce first transfer. Any unused exemption is used
against the second and further transfers
Normal  s21: Lifetime expenditure is exempt if:
expenditure out o It was made as part of transferor’s normal expenditure
of income o It was made out of transferor’s income; and
o After allowing payments, transferor was left with sufficient
 income to maintain his usual standard of living.
Gifts in  s22: Lifetime gifts on marriage are exempt up to:
consideration of o £5,000 by a parent of a party to the marriage.
marriage o £2,500 by a remoter ancestor of a party to the marriage
o £1,000 in any other case
Step 4: calculate tax at appropriate rate
Rate of tax  0% on the first £325,000 (the nil rate band); and
 20% on the balance of the chargeable transfer
Chargeable  Lifetime transfers use up the deceased’s nil rate band first.
transfers in seven o Reduces amount available for the estate.
years before o In other words, the value transferred by chargeable transfers
death made in the seven years before the current chargeable transfer
must be ‘cumulated’ with that transfer
o If a new transfer is made, it is necessary to re-calculate the
cumulative total because each transfer has own cumulation period
o Whilst the transferor is alive, any PETs made by him are ignored for
cumulation purposes because they may never become chargeable.

Effect of Death on LCTs

The death of a transferor may result in an additional charge to IHT on any transfers of value which
he has made in the seven years immediately preceding his death
 The IHT liability on LCTs made in that period is recalculated and the trustees will be liable for
any extra tax payable.

The charging provision steps

Steps 1-3
As above for LCT. N.B. check if reliefs claimed in Step 3 are still available
Step 4: calculate tax at appropriate rate
Rate of tax and Inheritance tax is recalculated in accordance with the rates of tax in force at
cumulative total the transferor’s death if these are less than the rates in force at the time of
the transfer; if not, the death rates at the time of the transfer are applied
(the lower 36% charity rate is not applicable).

 The cumulative total relevant to the LCT will determine how much (if
any) of the nil rate band is available.
 The cumulative total is made up of:
o any other LCTs made in the 7 years before the LCT being
assessed (even if such earlier LCTs were made more than 7
years before the transferor’s death); and
o any PETs made during the 7 years before the LCT being
assessed which have become chargeable as a result of the
transferor’s death.

Remember that each transfer that becomes chargeable or rechargeable has

its own cumulation period, which means that a taxpayer who makes an LCT
may have to survive for 14 years before it ceases to have an impact.
Tapering relief and Once the IHT on the LCT has been recalculated, and if more than three
credit for IHT years have elapsed between the transfer and the subsequent death,
already paid tapering relief applies to reduce the recalculated tax.

 Tax is reduced to the following percentages:

 transfers within three to four years before death: 80% of death
charge
 transfers within four to five years before death: 60% of death
charge
 transfers within five to six years before death: 40% of death
charge
 transfers within six to seven years before death: 20% of death
charge
 Credit is then given for any IHT paid on the LCT at the time it was
made but if the recalculated bill is lower than the original amount
paid (which may occur if tapering relief is available) no tax is
refunded.
 Paying IHT

Who will pay?  Deceased executors (are they named?) or PRs will usually be liable to pay
the IHT on the estate generally
 PET – the transferee is usually liable for any IHT
 LCT – the transferor is primarily liable for any IHT, but in practice HMRC
can claim from trustees and they usually pay it
 On recalculation, if extra IHT owed, the transferee is primarily liable.
When?  Basic rule: 6 months after death
 Instalment option: IHTA 1984, s227 and s228.
Instalment option
Provided requirements are met, payment of IHT can be made in 10
instalments, the first being due when the tax would have been due.

Qualifying assets:
 Land
 Business/interest in business
 Shares (unquoted or quoted) which immediately before death gave
control of the company to the deceased; and
 Unquoted shares which do not give control if either…
o A holding of at least 10% of the nominal value of the
company’s shares and worth more than £20,000, or
o HMRC is satisfied that the tax cannot be paid in one sum
without undue hardship, or
o The IHT attributable to the shares and any other instalment
option property in the estate amounts to at least 20% of the
IHT payable on the estate

Where recipient of PET or LCT is paying tax, instalment option may be

available if:
 Either due to liability on death where recipient still owns asset or its
replacement;
 Liability on gift (LCT)
 If asset sold later, outstanding tax must then ALL be paid.
Tax implications  Was there a disposal of a capital asset? Consider CGT implications.
 Is there a risk of a donee being liable for a hefty tax burden on the death
of donor? Consider taking out insurance policy on her life to provide
funds to meet liability
 What if the done sells an asset that was subject to relief?