An overview of what Inheritance tax is and when it applies.
This overview covers:
- When Inheritance Tax (IHT) is charged;
- The rate of tax; and
- The main exclusions, exemptions and reliefs.
IHT – When is it charged?
IHT is mainly charged on your assets on death, including your share of assets jointly held with another person. You need to be aware that lifetime gifts made within seven years prior to your death can also be brought back and taken into account.
Furthermore IHT is also charged where an asset appears to have been given away, but where you in fact retain the use of (or a significant benefit in) the asset given away.
For example you have given your home (in which you continue to live) to your children and do not pay them full market rent for your occupation.
IHT will also be charged on lifetime gifts to companies and to certain types of trusts (called “relevant property” trusts). These trusts also suffer periodic IHT charges.
We use the word “gift” in this note but IHT legislation is a lot more complex and covers scenarios that we may not immediately recognise as a “gift”.
To give an example, IHT legislation covers sales of assets at an undervalue (when made between certain family members, or your company, trust or partnership). Under IHT legislation it is considered a gift if for instance you sell your house worth £200,000 to your son or daughter for £10,000, you have effectively made a gift to them of £190,000.
Furthermore IHT can also cover the use of property and fixed-term interest free loans. Although IHT is a charge on individuals, you cannot avoid IHT by using a company which you control to make gifts on your behalf.
IHT – Who is liable for it?
That depends on if you have lived in the UK all your life or if you have not always lived in the UK. If you have lived in the UK all your life then IHT will apply to your worldwide assets. However, if you have not then different rules apply, see the section on Domicile, below.
IHT – What is the rate of tax
- The nil rate band is charged at 0% (see the section on the Nil Rate Band, below).
- The balance is charged at:-
♦ 20% for lifetime gifts to companies or to relevant property trusts
(with further tax due if the donor dies within seven years): or
♦ 40% on estates on death.
There is a reduction in the IHT rate on death from 40% to 36% for individuals who have died on or after 6 April 2012 and who have left 10% or more of their net estate to charity.
If lifetime gifts are brought back into account (because they were made in the seven years prior to death), then any IHT payable on these gifts may be reduced.
However, less IHT is payable depending on the length of time you survive from the date of the gift provided that you survive for at least three years.
There are different IHT rules for relevant property trusts which can see IHT charged (at a maximum rate of 6%) every ten years and also when capital is distributed to beneficiaries.
There are, however, various exclusions, exemptions and reliefs which can reduce the amount of IHT payable. A brief overview of these exclusions, exemptions and reliefs you will find below.
What is the Nil rate band?
The nil rate band is the amount which is chargeable at 0% IHT. The nil rate band currently stands at £325,000.
The £325,000 is the maximum amount, because the nil rate band can be used up by lifetime gifts made within the seven years prior to death.
If you are married, your surviving spouse or civil partner’s estate can “inherit” the unused portion of your nil rate band. When a claim is made, this increases the surviving spouse’s or civil partner’s nil rate band on a percentage basis (and not simply by the amount of your unused nil rate band).
To give an example:-
Say a husband dies during the tax year 2004/2005 and, on death, has an available nil rate band of £200,000. He leaves £50,000 to his children and the remainder of his estate to his wife. The spouse exemption exempts from tax the gift to his wife, which does not use up any of his nil rate band. The £50,000 gift to his children falls within his available nil rate band and is therefore free of IHT. However 75% of his available nil rate band is unused.
On the wife’s death (provided this is on or after 9 October 2007), her executors can claim to transfer the unused percentage of her husband’s nil rate band, which would otherwise be wasted. If, for example, the wife dies in 2008/2009 with an available nil rate band of £250,000 (reduced because she has made some lifetime gifts in the seven years before her death), the combined nil rate band available to set against her estate would be £484,000 (that is, her own nil rate band of £250,000, plus an additional 75% of £312,000, which is the nil rate band in force at the date of her death).
Are there Exemptions available for lifetime gifts and on death?
There are certain gifts that are exempt from IHT and which do not use up your nil rate band.
Briefly, the main exemptions are as follows:
- Gifts to your spouse or civil partner.
- Gifts to charities established in the UK, any other EU country, Norway or Iceland.
Exemptions available for lifetime gifts only
Additional exemptions are also available for lifetime gifts, if none of the above exemptions apply. They are as follows:-
- Normal expenditure out of income.
- Small gifts: up to £250 to any one individual per tax year is exempt (the exemption is only available if the gift does not exceed £250).
- Wedding or civil partnership gifts: each parent may give the couple £5,000; grandparents and great grandparents may give £2,500; others may give £1,000.
- Annual exemption: £3,000 a year.
- Potentially exempt transfers: outright gifts of any amount become fully exempt if you survive for seven years.
The “normal expenditure out of income” exemption is applied first and the “annual” exemption is applied last, after the application of any other available exemption.
Reliefs available for lifetime gifts and on death
If the gift is of a special type of asset and the necessary conditions are met, relief may apply to reduce the amount of IHT payable, sometimes to nil. The main reliefs are as follows:-
- Agricultural property relief: available for farmland and farm buildings anywhere in the European Economic Area (including the UK). Relief is given at either 50% or 100%, depending on the circumstances.
- Business property relief: available for certain business interests and qualifying company shares located anywhere in the world. Relief is given at either 50% or 100%, depending on the circumstances.
What is the impact of an individual’s Domicile on IHT?
IHT is chargeable on individuals who are domiciled in the UK, or those who have UK assets:-
- Individuals who are domiciled in the UK (which for IHT purposes includes those who have been resident in the UK for at least 17 out of the previous 20 tax years), are subject to IHT on their worldwide assets.
- Individuals who are not domiciled in the UK are subject to IHT on their UK assets only.
Where a married couple or civil partners have different domiciles for IHT purposes, the spouse/civil partner exemption is restricted: gifts from the UK domiciled spouse/civil partner to the non-UK domiciled spouse/civil partner, made before 6 April 2013, are only exempt up to £55,000 (which is an overall limit on gifts made during lifetime and on death). Gifts made on or after 6 April 2013 are only exempt up to the prevailing nil rate band. There is no limit on the exemption for gifts from the non-UK domiciled spouse to the UK domiciled spouse. Non-UK domiciled spouses and civil partners can also elect to be treated as UK domiciled for IHT to take advantage of the unlimited spouse exemption.
“Domicile” is an extremely complex concept. It has a specific legal meaning, beyond the simple dictionary definition of “place of residence”. If you are unclear as to your domicile status, it is important to discuss this with your adviser at the earliest opportunity.
Inheritance Tax law is complex and ever changing and you should therefore not rely on the above but always seek the advice of a professional.
For further information please contact Mrs Maria Cosslett on 029 2080 3116 or email email@example.com.
Mrs Cosslett is a Fellow of the Chartered Institute of Legal Executives and a Member of the Society of Estate and Trusts Practitioners (STEP) and of the Solicitors for the Elderly (SFE)