Inheritance Tax

Question 1

What are the IHT Tax Rates and when is IHT payable?

Answer 1

HT is payable on transfers in excess of a nil rate band, currently £325,000 (2020/21).

£0-£325k @ 0% Tax
Over £325k @ 40% Tax

Reduced rate of 36% applies to an estate where at least 10% of the net estate (after deductions) is left to charity. Nil rate band yes, but not RNRB.

Any unused nil rate band on an individual’s death can be transferred to the estate of a surviving spouse or civil partner.

The proportion of the nil rate band that was not fully used in calculating IHT on the estate of the first death is uplifted to the same proportion of the nil rate band at the date of the second death.

Question 2

What is the residence nil rate band?

Answer 2

In addition to NRB. For 2020/21 it is £175k.

The RNRB can only be set against the chargeable estates of those who died on or after 6 April 2017.

• The RNRB is only available where a home is inherited on death by direct descendants.
• The RNRB can be transferred to a surviving spouse or civil partner – even if the first spouse or civil partner died before 6 April 2017.
• The value of the home is after deducting any repayment mortgage or interest-only mortgage secured on that property.
• If a home is valued at less than the available RNRB, then the RNRB is reduced to the value of the home.
• The availability of the RNRB is protected where a person has downsized or ceased to own their home after 7 July 2015 – provided assets of an equivalent value are then passed to direct descendants on death.

Question 3

What is the residence nil rate band taper?

Answer 3

There is a tapered withdrawal of the RNRB for estates with a net value of more than £2m (after deducting any liabilities but before reliefs and exemptions).

The withdrawal is at the rate of £1 for every £2 over the threshold.

For example, for an estate with a net value of £2.1m, the RNRB for 2020/21 would be restricted to £125,000 (£175,000 – ((£2.1m – £2m) ÷ 2)).

Any RNRB transferred from a predeceased spouse or civil partner is included within this tapered withdrawal.

• The tapered withdrawal also applies to the initial RNRB transferred from a spouse or civil partner if their estate had a net value exceeding £2m, even if death was before 6 April 2017.

RNRB will be available if a property passes to a trust with an immediate post-death interest (IPDI) provided direct descendants have an interest in possession.

The RNRB is also potentially available if property passes to a trust for a disabled person or a trust for a minor.

NOT for Discretionary trusts as trustees become the legal owners!

Question 4

What is the cumulative principle?

Answer 4

IHT is a cumulative tax applying to transfers during life and on death. The cumulation principle works as follows:

• All chargeable transfers over a 7 year period are added together + tax is payable once the nil rate band is exceeded
• A transfer drops out of the cumulation once it is older then 7 years.

HOWEVER a CLT made more than seven years before death can affect the amount of tax payable on failed PETs or CLTs. This is often referred to as ‘the 14 year rule’.

The tax on gifts in the seven years before death must be recalculated at the death rate of 40%.

Any chargeable transfers in the seven years prior to the gift will reduce the available nil rate band for the gift being re-assessed, and so increase the tax on it.

PETs more than seven years old will have become ‘exempt’ and will not affect the tax on later gifts.

Question 5

The 14 year rule - in practice

Answer 5

Henry made a gift of £185,000 into a discretionary trust for the benefit of his children and grandchildren on 1 July 2010 - no IHT was payable at the time as the CLT was within the NRB.

He also made a PET of £200,000 to his son John on 1 June 2017

He died on 1 May 2020, leaving an estate of £300,000
There was no transferable or residential nil rate band
The position on death:

No further IHT payable on CLT as it was made more than seven years before death

PET made within seven years will become chargeable

CLT was within seven years of failed PET and will reduce the NRB for the PET.

IHT on PET, payable by John:

[£200,000 - (£325,000 - £185,000)] x 40% = £24,000

IHT on estate payable by personal representatives:

[£300,000 - (£325,000 - £200,000)] x 40% = £70,000

If Henry had waited until 1 July 2017 to make the gift to his son (seven years after the CLT), it would have benefited from a full NRB and saved IHT of £24,000.

Question 6

When is somebody deemed domicile for IHT purposes?

Answer 6

• Individuals are deemed to be domiciled in the UK for IHT purposes if:

– they are resident (determined according to the usual income tax rules) in the UK for at least 15 out of the previous 20 tax years (deemed domicile status applying from the 16th year of UK residence), or

– they are born in the UK with a UK domicile of origin and return to the UK (becoming resident), having obtained a domicile of choice elsewhere (and have also been resident in the UK in at least one out of the two previous tax years).

• For IHT purposes, UK deemed domiciled status is lost once an individual has been non- resident for at least four consecutive tax years.

Question 7

What is a lifetime transfer?

Answer 7

A lifetime transfer could be:
• exempt;
• a PET;
• chargeable;
   – but not taxable, or 
   – taxable.

A lifetime transfer that is neither exempt nor potentially exempt is chargeable. If this takes the seven-year cumulation total over the nil rate band, the excess is taxable at the lifetime rate of 20%.

Question 8

IHT - Exempt vs Relief?

Answer 8

• An exemption means that the transfer does not count as a chargeable transfer and is therefore neither taxed nor included in the cumulation for the future.
• A relief reduces the value of a chargeable transfer. It does not remove the transfer from the tax regime but merely reduces its value.

Question 9

What are the main exemeptions?

Answer 9

• Transfers between spouses (£325k max exemption for gift to non-uk domiciled spouse)
• Annual exemption of £3k - can be carried over for a year + only applied to lifetime gifts
• Small gifts - £250. Cant be used in conjunction with annual exempt amount
• Normal expenditure. Exempt if our of normal expenditure, made out of income + as long as sufficient income to maintain standard of living. Money must come from income, therefore excludes capital content of purchased life annuity and withdrawals from an investment bond
• Other gifts eg at weddings (£5k for parents), £2.5k grandparents + £1k others

Question 10

What is a Potentially Exempt Transfer?

Answer 10

A PET is a lifetime transfer by an individual to:
• another individual;
• a bare trust; or
• a disabled trust.

The consequences of making a PET are:
• No tax is charged at the date of the gift.
• The gift does not have to be reported to HMRC.
• If the donor then survives for seven years, the gift becomes fully exempt and escapes tax entirely.

Die within 7 years, then PET becomes chargeable + the donee is liable to pay the tax.

PET EXAMPLE

If a donor dies one year after making a PET of a house worth £100,000 at the time of the gift, but £110,000 at death, the value of the PET is £100,000, not £110,000.

To calculate the tax, the gift of £100,000 is added to the total of chargeable transfers in the seven years before the date of the gift, not the seven years before death.

Because of this, events more than seven years before the death that were not PETs, but chargeable transfers, at the time they were made can affect the amount of tax payable.

Question 11

What is Taper Relief?

Answer 11

If the donor survives for at least three years after the gift, a reduced percentage of the full death rate is used to calculate the tax. This is called taper relief.

Reduction of tax, not the value of the gift!

Question 12

Gifts in Trust - which 2 trusts qualify as PETS?

Answer 12

Two types of gift into trust are PETs. Other gifts into trust are chargeable at the lifetime rates when they are made, unless they are otherwise exempt. For example, they are within the annual exemption.

• A gift into a bare trust is a PET because it is in effect a gift to an individual.
• The only other gifts into a trust that qualify as PETs are gifts into a disabled trust. A disabled trust is broadly a discretionary trust in which the settled property is applied for the benefit of the disabled person, or a trust in which a disabled person has an interest in possession.

Question 13

What is a chargeable lifetime transfer (CLT)?

Answer 13

A chargeable lifetime transfer (CLT) is one that is not exempt and not potentially exempt. The most common chargeable transfers occur on lifetime gifts to trusts other than trusts for a disabled person.

• A CLT results in a tax charge if it takes the donor’s seven-year cumulation over the nil rate band.
• Tax is payable at 20% on the excess over the nil rate band and there will be no further IHT to pay if the donor survives for the next seven years.
• If the donor dies within seven years of making a CLT, tax at the death rates will apply retrospectively to that transfer.
• Where tax has been paid at the time of the lifetime transfer, it is allowed as a credit against the tax payable at the death rates.
• The tax is reduced by taper relief if the donor survives more than three years after the gift. This is the same taper relief that applies to PETs.

Question 14

What is excluded property for the purposes of IHT?

Answer 14

Excluded property is ignored in valuing a person’s estate at death. The most common forms are:

• Pension funds. In addition to usually being free of IHT, there is no pension death benefit charge if the deceased was under age 75. Where pension funds are inherited on or after age 75, then subsequent pension withdrawals are taxed on the beneficiary as income and subject to the normal rates of income tax.
• Property situated outside the UK where the owner is not domiciled in the UK.
• Reversionary interests in trusts, unless the interest has been acquired for money or money’s worth. A reversionary interest is a right to capital when the current beneficiary’s right to income under the trust comes to an end.

An example would be the remainderman’s interest in a life interest trust.

• Holdings in authorised unit trusts and shares in open-ended investment companies (OEICs) where the beneficial owner is not domiciled in the UK.

Question 15

What is quick succession relief?

Answer 15

Quick succession relief is available where property in the deceased’s estate had passed to them by a chargeable transfer in the five years before the death.

The tax charged on death is reduced by a percentage of the IHT paid on the earlier transfer.

However, the percentage only relates to the tax on the net increase in the estate of the second to die.

The method of calculation is as follows:

1. Calculate the tax on the estate as usual.
2. A credit is then given:

Tax paid on first transfer × net transfer/ gross transfer and then × relevant percentage

Question 16

Reliefs and IHT

Answer 16

A relief reduces the value of a transfer in certain circumstances. In theory, it does not remove the transfer from the tax regime. However, if relief is at 100%, the practical effect is to make the transaction exempt.

The main reliefs are:
• business relief;
• agricultural relief; and
• relief for woodlands.

Question 17

What is Business Relief?

Answer 17

Business relief is a relief for transfers of business property. The property has to be owned for two years to qualify for relief. Relief is available for lifetime transfers and on death.

Business property may be:
• a business or an interest in a business;
• shares in an unlisted company;
• controlling shares in a listed company;
• land, buildings or machinery owned by the deceased and used in their business.

Only applies to certain types of business (not those who deal mainly in shares, land or property generally).

• Not applicable if business property subject to a binding contract for sale at the time of the transfer. For example, business relief would not be available on company shares if the personal representatives were obliged to sell, and the remaining shareholders obliged to buy, the shares on the death of their owner, a common situation under share purchase agreements of small companies.

100% business relief The relief is 100% for:

• Interests in unincorporated businesses (i.e. for sole traders and partnerships).
• Shareholdings of any size in unquoted and AIM companies. Shares in enterprise investment scheme (EIS) and seed enterprise investment scheme (SEIS) companies normally qualify, subject to a two-year holding requirement, but holdings in venture capital trusts (VCTs) do not.

Therefore, if a sole trader dies and leaves her business worth, say, £1m to her son, there is no IHT. This enables family businesses to be preserved intact through the generations.

50% BR for controlling shareholdings in fully listed companies, or land, buildings, plant or machinery used in a business controlled by the person doing the transfer.

Question 18

What is agricultural relief?

Answer 18

Agricultural relief is for agricultural property in the UK, Channel Islands, Isle of Man or European Economic Area (EEA). Relief is available for lifetime transfers and on death.

• Available for land, crops and buildings but not animals or equipment. The equipment will often qualify for BR instead.
• Relief on agricultural value of land, not development value not buildings on their own.
• No agricultural relief on the excess open market value of a farmhouse over its agricultural value
• 100% AR for owner-occupied farms and farm tenancies.
• 50% AR for landlord with interests in let farmland which extends to 100% AR if the tenancy is more than 12 months long (and started after 31 August 1995).
• Property must have been owned by transferor for agricultural purposes for at least two years, or seven years if let out during that period.
• Not applicable for property subject to a binding contract for sale at the time of the
transfer.
• If AR and BR both apply, AR is given first.

Question 19

What is a gift with reservation?

Answer 19

Property that a donor has given away is treated as still belonging to the donor for IHT purposes if the donor continues to enjoy a benefit from the property.

Examples of gifts with reservation are a donor giving away:
• a house, but continuing to live in it without paying full market rent;
• a painting, but leaving it on their own sitting room wall;

Question 20

What is Pre-Owned Asset Tax (POAT)?

Answer 20

POAT is an INCOME TAX charge NOT an IHT charge.

POAT basically converts the benefit someone gets from having free or low- cost enjoyment of an asset they formerly owned (or provided the money to buy) into a cash equivalent value which is added to their other income for the year and liable to INCOME TAX.

• In the case of land, the cash value of the benefit is based on market rentals.
• For chattels and intangible assets, the cash value will usually be a percentage of the capital value, the percentage being equal to the official interest rate for income tax purposes. For 2020/21, this is 2.25%.
• No tax is charged in any year in which the cash value of benefits is £5,000 or less.
• The valuation date for property subject to the charge is 6 April in the relevant tax year, or the date it becomes subject to the charge if that is later.
• Where the property is land or chattels, it must be revalued every five years.
• If a person pays for the benefit obtained from the asset, the amount paid is deducted from the taxable cash value. Of course, there is no POAT where the person pays full market value for the use of the asset, because there is no benefit.
• For UK-domiciled people, the charge applies to worldwide assets.
• For people who are not UK domiciled and not deemed to be UK domiciled, the charge applies only to UK assets.

POAT can be avoided if the individual elects for the asset to be a GWR instead (and therefore liable to IHT). This can be done by completing form IHT500 and submitting it by 31st January following the tax year in which the income tax liability arises.

Question 21

Inheritance Tax & Bare Trusts - whose responsible if tax becomes payable?

Answer 21

• Any transfer of value to a bare trust is a PET.
• The value of the trust is included in the beneficiary’s estate for IHT purposes.
• The beneficiary is liable for any IHT payable on a failed PET.

Question 22

Inheritance Tax & Interest in Possession Trusts - whose responsible for paying the tax?

Answer 22

• PRE-22 MARCH 2006
o Creation of the trust during the settlor’s lifetime was a PET.
o No tax charge if the settlor survived for seven years, but if not, the trustees were liable for IHT if in excess of available NRB
o The trust assets are generally regarded as belonging to the beneficiaries with an interest in possession and therefore divided amongst them equally.
o The value therefore forms part of their estates for IHT purposes.

• POST-22 MARCH 2006

o Creation of the trust is a chargeable lifetime transfer

Where there is a life interest (an entitlement to income for life), the life tenant has the interest in possession. Under a flexible trust the ‘gift over’ (i.e. default) beneficiary has the interest, until an appointment is made.

The trust is subject to entry, exit and periodic charges.

There are two exceptions to this; these charges do not apply to:
• trusts for disabled or vulnerable persons; or
• immediate post death interest (IPDI) trusts created on death by will or intestacy.

The Finance Act 2006 defined an IPDI trust as one where a person has an interest in possession in settled property and both of the following apply:

• the settlement was effected by will or under intestacy; and
• the beneficiary became beneficially entitled to the interest in possession on the death of the testator or intestate.

Question 23

IHT & Discretionary trusts and other relevant property trusts created by lifetime gifts on or after 22 March 2006 - the creation of the trust.

Answer 23

The IHT rules have always been different for a trust that has no interest in possession, i.e. a discretionary trust. However, the discretionary trust rules now also apply to most other trusts created in lifetime and on or after 22 March 2006.

The creation of the trust is a CLT, and tax will be payable at 20% if the transfer into trust takes the settlor’s cumulative total of CLTs in the previous seven years over the nil rate band (£325,000 in 2020/21).

There may also be further tax to pay if the settlor dies within seven years.

Taper relief will be available to reduce any IHT payable where the transfer is in excess of any available nil rate band and the settlor survived at least three years from the date of the gift.

If a beneficiary dies, there is no value to add to the beneficiary’s estate for being a beneficiary of either a discretionary trust or an interest in possession trust created on or after 22 March 2006.

Question 24

IHT & Discretionary trusts - how to calculate period & exit charges?

Answer 24

An IHT periodic charge is made on the tenth anniversary of the creation of a discretionary trust.

This is 30% of the lifetime rate of 20%, i.e. 30% x 20% (or 6%) of the excess value of the trust over the current NRB.

This is payable by the trustees.

Example
10 years after the trust was established, the value of the assets was £400,000. The NRB at this time is £325,000.

£400,000 - £325,000 = gives us a figure of £75,000 in excess of the NRB. This is then taxed at 30% of the lifetime rate:

£75,000 x 30% x 20% = £4,500.

An IHT exit charge is payable every time a capital distribution or appointment is made to a beneficiary.
It is generally based on the number of quarters since the last periodic charge.

The distribution is multiplied by the number of quarters over 40 and the effective rate at the previous 10-year periodic charge.

Example
Our fund has now grown to £450,000 and a distribution of £300,000 is made after 11 years and 8 months.
Number of whole quarter years since periodic charge = 6
The effective rate at the time of the periodic charge was 1.125%. We work this out by dividing the value of the fund at that time by the tax charged at that time and expressing it as a percentage. ((£4,500 / £400,000) x 100)
Therefore:
£300,000 x (6/40) x 1.125% = £506.25 tax payable