Module 2 - Inheritance Tax

Question 1

Aside from death - when else could IHT be due?

Answer 1

On lifetime transfers

Question 2

What are the 4 rates of tax associated with IHT?

Answer 2

• 0% on £325,000 - this being the nil rate band and on the first £175,000 of property value for most estates.
• 40% above £325,000
• 36% where at least 10% of the net estate is donated to charity on death.
• 20% on lifetime gifts above £325,000 (this being half of the death rate) over a 7-year period.

Question 3

What is loss to the donor’s estate principle?

Answer 3

Where considering the value of any gift made by an individual in the context of IHT, the value of the gift is not the market value of the asset but rather the amount by which the donor’s estate falls as a result.

To give an example, if John has a pair of candlesticks worth £10,000 but one candlestick alone is only worth£1,000, should he give away a single candlestick the value of the gift for IHT is £9,000.

This is because at the start of the process he had two candlesticks worth £10,000 and now he only has one, worth £1,000. His estate has fallen by £9,000.

Question 4

What is the cumulation or the ‘7 year look back’ principle?

Answer 4

When making a chargeable transfer, to work out whether a tax liability might arise at the time of the transfer, it is necessary to look back seven years and consider any other chargeable transfers in the last seven years.

Where the total of all chargeable transfers in a seven year period exceeds the nil rate band, tax will be due on the excess.

After seven years the transfer drops out of the ‘look back period’ and is no longer relevant to future chargeable transfers.

Question 5

On what will IHT be due for UK domiciled or those deemed-domiciled?

Answer 5

IHT will be due on worldwide assets.

Question 6

On what will IHT be due for non-UK domiciled individuals?

Answer 6

For those non-UK domiciled only UK based assets fall within the UK IHT net.

Question 7

What is the residence nil rate band and from when has it applied and how much is it for (22/23)?

Answer 7

Since April 2017, a further nil rate band has applied where part of the estate is made up of a mainresidence. £175,000.

Question 8

In terms of combined nil rate bands - how much can a couple benefit?

Answer 8

£1m combined - £325,000 standard + £175,000 residence each.

Question 9

What are the three main qualifying conditions for the residence nil rate band to apply?

Answer 9

► The person in question must die on or after 6 April 2017 (though they can benefit from a residence nil rate band transferred from a spouse or civil partner who died before this date)

► The person in question owns a home, or a share of one, which is included in their estate, and

► Their direct descendants such as children or grandchildren inherit the property or a share of it.

Question 10

When may an estate be entitled to the additional threshold in regards to the residence nil rate band?

Answer 10

An estate may also be entitled to the additional threshold when an individual has downsized to a less valuable home or sold, or given away their home after 7July 2015

Question 11

The residence nil rate band is progressively withdrawn for estates over….?

Answer 11

£2M

Question 12

Explain the transferable nil rate band.

Answer 12

Where the second partner in a married couple (or civil partnership) dies after 9th October 2007 (regardless of when the first death occurred) the estate of that person can make an application to transfer to the second to die, any percentage of the nil rate band not used by the first to die.

This now includes any unused residence nil rate band.

To give an example, assume that James dies in December 2022 when the nil rate band is £325,000. His wife, Martha died in October 2007, when the nil rate band was £300,000. She left £60,000 to their daughter and the rest of her estate to James. The gift to their daughter used 20% of her £300,000 nil rate band whereas the gift to James was an exempt gift as they were married. This means that 80% of her nil rate band was unused at the time of her death. When James dies, his estate can make an application to have this unused 80% of her nil rate band transferred to him. His estate will therefore have 1.8 x the current nil rate band to offset against his assets.

Based on the current nil rate band of £325,000 this means that he can pass on 1.8 x £325,000 = £585,000 before any IHT liability will arise.

In addition, if part of the estate on his death or the first death comprised a main residence, the residence nil rate band may also be used.

The important point to take out of this example is that the unused amount he inherited was a percentage of the nil rate band, not an amount in monetary terms. As she didn’t use 80% of her nil rate band, his estate had an extra 80% of the nil rate band in the year of HIS death, not hers.

Question 13

What happens when someone re-marries and then subsequently outlives the second spouse?

Answer 13

The rules allow their estate to claim the unused element of each spouse’s estate up to ONE full nil rate band.

To give another example, assume that Kim was married to Ben. He died in July 2007 when the nil rate band was£300,000, leaving £20,000 to each of their three children and the rest to her. As a result, 80% of his nil rate band is unused.

Kim then remarries David. Unfortunately, David died in May 2014 when the nil rate band was £325,000 and left £243,750 to his son, using 75% of his nil rate band.

Kim inherited no assets but she did inherit the unused 25% of his nil rate band. For simplicity we will assume no property was involved so no residence nil rate band applies. When she subsequently dies, Kim’s estate can claim the unused 80% from Ben’s estate and the unused 25% from David’s estate but this will be capped at an overall limit of 100% of the nil rate band.

As a result, 5% of the transferred allowance is effectively lost.

Question 14

Key exemptions available to those considering IHT planning are only available when?

Answer 14

During lifetime and can’t be used at the point of death.

Question 15

In relation to IHT How much is the annual exemption? And can it be carried forward and under what circumstances?

Answer 15

► The annual exemption of £3,000. If this is not used in a given year it can be carried forward for up to one year but you must use the current years before last years. So if you’ve never used this and give £5,000 this year, you use all of this year’s £3,000 first and then carry forward £2,000 from last year. Next year you will only be able to give £3,000 since you used all of this year’s allowance and there is nothing to carry forward.

Question 16

How much is the small gift exemption and how many people can it be given to?

Answer 16

► Small gifts exemption of £250 available to an unlimited number of people provided none benefit from any part of the annual £3,000 exemption.

Question 17

What is the ‘normal out of income’ exemption?

Answer 17

It’s for gifts made from surplus income provided the individual’s standard of living is not compromised. There is no limit on the size of these gifts provided they are part of a regular pattern of giving and don’t reduce the donor’s standard of living. Typical examples are protection premiums or regular savings for children (e.g JISA’s)

Question 18

What are the different amounts relating to gifts in consideration of marriage/civil partnership?

Answer 18

• £5,000 from parents
• £2,500 from grandparents/great grandparents etc. or to each other (i.e. from one party to the marriage/civil partnership to the other party)
• £1,000 from anyone else
• Where the marriage does not ultimately take place, the gift becomes a potentially exempt transfer

Question 19

How do you qualify for charity tax rate?

Answer 19

10% of net estate donated to charity AFTER death - this gift itself is also exempt.

Question 20

How to calculate net estate?

Answer 20

Deduct nil rate band (or x2 if widow) and anything to which IHT does not apply. I.e gifts to spouse can be deducted. However residence nil rate band cannot be deducted.

Question 21

Residence nil rate band applies to….

Answer 21

direct descendants only. Adopted & stepchildren count - nieces nephews, don’t.

Question 22

What is a chargeable lifetime transfer?

Answer 22

A chargeable lifetime transfer is one where one person’s estate goes down in value but no-one else’s estate rises in value.

Most commonly, but not exclusively, this would be gifts to trusts other than a bare or absolute trust (for example, a discretionary
trust).

The significance of a gift being a CLT is that it can result
in an immediate lifetime inheritance tax charge where
the total of such gifts made in the seven year ‘look back’ period exceeds the nil rate band for the year in
question.

Where this happens, the excess is taxed at half of the
death rate – so currently 20% - immediately.

Practically speaking, payment is due six months after the end of the month when the transfer was made, but for a transfer made after 5th April and before 1st October in any year, the tax is due on 30th April the following year.

Even if the person making the gift then survives seven
years, this cannot be reclaimed and if they don’t survive the seven years, there is a chance that further tax could be due.

Where death occurs within the seven years the CLT is
brought back into the estate. It will take first call on the
nil rate band for IHT but any amount above this will
attract tax.

Tax will be calculated in the normal way, but an allowance will then be given for the tax originally paid.

Taper relief may be available at this point providing at
least three years has elapsed

Question 23

What is a potential exempt transfer? (PET)

Answer 23

A potentially exempt transfer is a gift which is neither
chargeable nor exempt. As covered above, this is a gift
where one person’s estate falls in value and another’s
estate goes up in value.

This therefore covers outright gifts to another person and transfers into absolute trusts.

Such gifts are potentially exempt because they have yet
to make their minds up whether they are chargeable or
exempt! If the donor survives for seven years from the
point of making the gift, it ‘drops the P’ and becomes an Exempt Transfer.

On the other hand, if the donor dies within seven years, the PET is deemed to ‘fail’ and
becomes a chargeable transfer, coming back into the
donor’s estate.

As with CLT’s it will be offset against the nil rate band first with the oldest gift sitting on the
bottom of the tax tower.

Importantly, because they are ‘potentially exempt’, PETs attract no inheritance tax at the time of the gift,
however much is given.

As we have seen, providing the
person making the gift survives for seven years from the point of the gift, there is no inheritance tax to pay on later death. It is only if they don’t survive the seven
years that the gift is deemed to come back into the
estate and IHT may be due.

For example, if someone gives £100,000 and then dies
2 years later when the nil rate band is £325,000, leaving
a residual estate of £1m, the PET would fail. This would
use the first £100,000 of the nil rate band, leaving only
£225,000 to offset against the £1m estate.

This effectively means that an individual can reduce or
eliminate an inheritance tax bill provided they are willing and able to make outright gifts and then survive for seven years.

As an aside to this, however, it is always
worth considering the capital gains tax position on a
transfer.

Remember that capital gains tax is not due on
death, so gifting an asset which is pregnant with gain
can result in a saving to inheritance tax but a heavy
penalty in capital gains tax. It is always worth
considering matters from all angles.

Note: Neither the transferable nil rate band nor the
residence nil rate band can be offset against gifts during lifetime. They are only available to be offset against an estate on death.

Question 24

What is taper relief?

Answer 24

There is a tapered reduction in tax where someone dies more than three years after making a gift, but fewer than seven years.

Question 25

What does taper relief reduce and when?

Answer 25

Taper relief serves to reduce only the tax on the gift, not the gift itself.

One of the most commonly made mistakes in IHT is to assume that a failed PET or CLT will attract taper relief in all cases.

When a gift comes back into the estate, it takes the first call on the nil rate band. If the gift is all within the nil-rate band, no tax is due and so no taper relief will apply.

What does happen, however is that other assets that would have been covered by the nil rate band are now pushed into the 40% bracket and become taxable.

Where taper relief does apply is in cases where the gift is above the nil rate band. For example, a failed PET of £500,000 would attract taper relief on the £175,000 that sits above the nil rate band.

Because taper relief can be quite valuable, HMRC rules state that the oldest failed PET will take first call on the nil rate band, leaving the new gifts, on which less taper will apply, to potentially sit above the nil rate band.

Question 26

What is quick succession relief? How long does it apply?

Answer 26

Where tax is paid on transfer at death then the beneficiary dies shortly afterwards, it would
not be fair for a second liability to tax to arise.

To counter this, quick succession relief allows
for a reduction in tax on second death as a percentage of the tax paid on first death. See Tax Tables.

Up to 5 Years.

Question 27

What is cumulation?

Answer 27

Essentially cumulation is looking at how transfer in life are taxed and how their taxation may be impacted on the death of the person making the gift.

Question 28

PETS are only chargeable….

Answer 28

When the person making the gift dies - never when they are alive. So when looking at exam questions don’t forget to determine if the person is still alive.

Question 29

Thinking of cumulation calculation…PETs made outside of a 7 year window of death are exempt / successful therefore….

Answer 29

Have no impact on a cumulation calculation

Question 30

Thinking of cumulation calculation… CLT made outside a 7 year window of death are…

Answer 30

Not chargeable on death but could impact the availability of the Nil Rate Band on other gift made within 7 years of death. Super complicated but this is the 14 year trap.

Question 31

In regards to a PET - what is the IHT rate charged on anything that exceeds the NRB? And when does it occur.

Answer 31

40% but only on the death of the donor and only if the PET is still with a 7 year window of death.

Question 32

In regard to a CLT - what is the IHT rate charged on anything that exceeds the NRB? And when does it occur.

Answer 32

Any excess over the NRB will be charged at 20% from the outset.

Upon death, if within 7 years, anything over the NRB will be charged at 40% but tax paid at the outset will be deducted to avoid double taxation.

Question 33

With CLTs can tax paid at outset be reclaimed?

Answer 33

No

Bonus - tax is 20% of excess over the NRB.

Question 34

Quick Succession applies to what?

Answer 34

The net increase of the estate - in other words the tax on the assets they inherited.

Question 35

Where both parties of a married couple or civil partnership dies together for IHT purposes they are deemed to…

Answer 35

Have died together…

Question 36

What are the 3 reliefs for IHT?

Answer 36

• Business Relief
• Agricultural Relief
• Woodland Relief

Question 37

Where a business qualifies for business relief there are two rates which are and apply to?

Answer 37

• 100% for interests in unincorporated businesses (e.g.sole traders or partnerships) or for any shareholding in Alternative Investment Market companies (AIM) or for holdings in EIS and SEIS (not VCT)
• 50% for controlling interests in fully listed companies or land, buildings, plant or machinery used in connection with the business.

Question 38

What are two instances where business relief would not apply?

Answer 38

No relief is available for interests in investment companies

or

where the company is subject to a binding agreement for sale at the point of death. This can have significant consequences for business protection arrangements.

Question 39

How long must an asset be held before qualifying for business relief?

Answer 39

To qualify, the asset must usually have been owned for 2 years prior to death.

Question 40

Does business relief apply to EIS & SEIS?

Answer 40

Yes

Question 41

Does business relief apply to VCTs?

Answer 41

No

Question 42

What is agricultural property relief? Where and what does it apply to?

Answer 42

This applies to agricultural property situated in the EEA and applies to land, buildings and growing crops but not livestock or equipment.

The relief only applies to the agricultural value of the land so it it were worth much more, perhaps to put a shopping centre on it, only its value as agricultural value would apply.

The value of the relief is 100% for owner occupied farms and farm tenancies and 50% for interests in let farms though where the lease is long term (over 1 year) and started after 31/8/1995, this is increased to 100%.

Question 43

How long must the farm have been owned for
- if owner occupied
- if let
- what must it not be subject to?

Answer 43

As with business relief, the farm must have been owned for 2 years before death

or owned for 7 years and occupied by someone else (for the purposes of agriculture during that time)

and can’t be subject to a binding contract for sale at the time of death.

Question 44

What are the rates for agricultural relief?

Answer 44

The value of the relief is 100% for owner occupied farms and farm tenancies

and 50% for interests in let farms though where the lease is long term (over 1 year) and started after 31/8/1995, this is increased to 100%.

Question 45

What is considered to be a long term lease in relation to let farms and agricultural relief?

Answer 45

Over 1 year

Question 46

What is woodland relief and what does it apply to?

Answer 46

For qualifying woodland in the EEA, this relief applies to timber not land value and does not apply on lifetime gifts – only on death.

Where the qualifying rules are met, the relief defers the tax until the timber is eventually
sold.

Where business property relief might be available on the same assets, this would be preferable as woodland relief is only a deferment not an exemption.

Question 47

What is a gift with reservation of benefit and what are the implications on tax?

Answer 47

Sometimes, someone will make a gift to try to reduce or eliminate a liability to inheritance tax, but still keep access to it.

For example, if someone gave away a painting to their brother, but left it hanging over their
own fireplace, they have given away ownership, but still have enjoyment of the asset.

For IHT purposes, this is known as a ‘gift with reservation of benefit’.

Where such a gift is made, for IHT purposes, the asset is still deemed to be in the estate of the donor and on death the value of the asset will be included in their estate when calculating tax due.

Equally, where such a gift with reservation is made to a discretionary trust, tax could be due in lifetime and again on death despite the
ownership having changed hands.

Question 48

What is the pre-owned asset tax? (POAT)

Answer 48

Where a transaction falls under the POAT rules, the benefit that someone obtains from use of an asset they once owned is taxed on them on an annual basis.

For land this is the rental value of the asset while for other assets, the capital value is multiplied by the government’s standard interest rate (2% in 2022/23) to give the cash value.

This is then taxed through income
tax.

Question 49

No tax will be due on benefit relating to pre owned assets and the POAT if the benefits do not exceed how much? After which point it gets taxed at…?

Answer 49

£5000 and the individuals highest nominal tax rate.

Question 50

Difference between GWROB and POAT?

Answer 50

GWROB - falls back into the estate on death - recipient/beneficiary pays

POAT - taxed on benefit yearly - donor pays

Question 51

If the donor is paying that tax what is shorthand way of calculating the loss to the donors estate and why?

Answer 51

25% because HMRC charges tax on the tax - don’t understand this at all.

Question 52

How to calculate IHT?

Answer 52

► Calculate the value of the estate – this is a matter of adding up the value of the deceased’s assets (exclude assets that are not liable to IHT such as Gilts or pensions held under trust)

► Establish value of the available NRB – is there any transferable nil rate band to take into account? Does the estate qualify for residence nil rate band?

► Identify any PETs / CLTs made in the last 7 years

► Reduce the value of PET / CLT by any unused annual exemptions (can go back one year) – remember, you can’t reduce the value of the death estate, but at the time those gifts were made, if the £3,000 allowance was available, part of the gift was exempt and therefore doesn’t need to come back into our equation now.

► Calculate the total taxable estate

► Apply NRB

► Consider which rate of tax will apply – has more than 10% of the net estate been given to charity? If so, the correct rate will be 36%, if not, it will be 40%.