Inheritance Tax — Update

Inheritance tax (IHT) is a complex area of tax that needs careful consideration both in life and at the point of death. IHT is technically charged on value transferred in the form of a chargeable transfer. The value of each chargeable transfer for IHT purposes is measured by the loss to the ‘donor’. A chargeable transfer for IHT purposes can be either a lifetime gift or a transfer on death.

Whether inheritance tax is paid on just UK assets or Worldwide assets depends on domicile status. Generally UK domiciled individuals are liable to IHT on their worldwide assets whereas non-domiciled individuals are only liable to IHT on their UK assets.

Chargeable Transfers that are ignored for IHT

Gifts made without any gratuitous intent.
Maintenance of family members.
Giving up the right to receive remuneration, or a shareholder waiving their right to a dividend.

Chargeable Transfers

The most common type of chargeable transfer is a gift to a trust. If an individual transfers an asset into a trust, there will be an immediate lifetime IHT charge.

Exempt Transfers

Certain types of transfers are completely exempt from IHT, such as:

Any transfers and gifts to a spouse or civil partner, either during a lifetime or upon death, are exempt from IHT. The only exception is when the recipient spouse or civil partner is not domiciled in the UK. In this instance, only the first £325,000 of the transfer is exempt from IHT.
Gifts to UK and EEA charities, charitable trusts, political parties, housing associations, and national heritage bodies (e.g., museums) are also completely exempt, either during a lifetime or upon death.
Small gifts up to £250 to an individual in a tax year are exempt.
Lifetime gifts on marriage or civil partnership are also exempt from IHT, but there are certain limits:
- A parent can give up to £5,000 to their child as a wedding gift.
- A grandparent can gift up to £2,500 to their grandchild as a wedding gift.
- Any individual can give a wedding gift of up to £1,000.
A lifetime gift is exempt if it constitutes normal expenditure out of income. "Normal" in this context means habitual or typical, such as a gift given year after year. The gift will be treated as having been made out of the donor’s income if the donor has enough income left to maintain their normal standard of living. There is no monetary limit on this exemption, as income levels and normal expenditure vary from person to person.
An annual exemption of £3,000 is available on lifetime transfers. An individual can give away up to £3,000 in value each year without triggering an IHT charge. The previous year’s exemption can also be used if it was unused.

Potentially Exempt Transfers (PETs)

If a transfer is neither a chargeable transfer nor an exempt transfer, it is classified as a potentially exempt transfer (PET). A PET becomes completely exempt if the donor survives for seven years after making the transfer. If the donor dies within seven years, the transfer becomes chargeable. Taper relief may be available to reduce the tax, and any IHT due will be payable by the recipient of the gift. All non-spousal gifts between individuals are classified as PETs.

Chargeability of IHT

When calculating IHT, the nil rate band (NRB) is currently set at £325,000 is available. IHT is only payable if the transfer during the lifetime or the estate at the time of death exceeds this £325,000 limit. The unused NRB of a deceased spouse can also be applied.
The residence nil rate band (RNRB) is available if the main residence is left to lineal descendants. This is currently set at £175,000 and is only available at the time of death. As with the NRB, the unused RNRB of a deceased spouse can be applied. However, RNRB is tapered if the estate exceeds £2 million.
In summary, spouses between them can claim up to £1 million in NRBs (2 x £325,000 + 2 x £175,000).
Chargeable lifetime transfers over the NRB limit are taxed at 20%. For example, if an individual transfers an asset into a trust, the trustees will pay 20% tax on the value of the transfer. If the donor decides to pay the IHT instead, the charge is 25%.
At the time of death, if an individual's estate exceeds the NRBs, it is taxed at 40%.

Charges on Death

Upon death, there are three types of transfers chargeable to IHT:

PETs made by the deceased within seven years of death become chargeable. The tax on these failed PETs is payable by the recipient.
Any lifetime chargeable transfers made within seven years of death become chargeable. Additional tax on these is payable by the trustees.
Finally, upon death, an individual is deemed to have made a chargeable transfer equal to the value of assets in their estate.

Notable IHT Reliefs

Taper Relief: Taper relief is available if there are more than three years between the date of the PET and the donor’s death. The percentage reduction depends on the time between the gift and death. Note that taper relief reduces the tax payable, not the amount of the transfer.
Quick Succession Relief (QSR): QSR applies if an individual’s estate was increased by a chargeable transfer within five years before their death. Like taper relief, QSR reduces the tax payable.
Reduced IHT Death Rate: The standard IHT death rate of 40% is reduced to 36% if at least 10% of the deceased’s net chargeable estate is left to charity.
Business Property Relief (BPR): BPR reduces the value of relevant business property for IHT purposes. A 100% relief is given for transfers of sole trade businesses or shares in an unquoted trading company. A 50% relief applies to shares in a quoted trading company where the donor owns more than 50%, or to assets used in a business controlled by the donor, such as land and buildings or plant and machinery.
Agricultural Property Relief (APR): APR reduces the value of agricultural property for IHT purposes. Agricultural property includes farmland or farm buildings in the UK, Channel Islands, Isle of Man, or an EEA state. APR is given at either 100% or 50%, depending on the property type.
Fall in Value Relief: This relief is available if the value of a lifetime gift decreases before the donor’s death. The relief is the difference between the asset's value at the date of the gift and its value at the donor's death.

IHT Pitfalls to Avoid

Gift with Reservation of Benefit (GWROB): GWROB rules apply if the donor gives away an asset but continues to derive some benefit from it. The effect of GWROB is that the asset is treated as still part of the donor’s estate at death. GWROB rules can be avoided if the donor pays full market rent to the donee for use of the asset, or if the donor is excluded from benefiting from the asset.
Pre-Owned Assets Tax (POAT): POAT imposes an income tax charge on benefits received by the former owner of property and the transfer is not subject to GWROB rules. The notional income on which this tax is applied is declared on the taxpayer's self-assessment return. Where an individual is caught by the POAT rules, they can elect to forgo the income tax charge and instead make a GWROB, meaning the asset will form part of their estate for IHT purposes.