Inheritance Tax (IHT) is charged on the transfer of value to others. It is a tax most of us come across when someone dies and passes on their assets on death. In some circumstances IHT becomes payable earlier — for example, if you put assets into certain types of Trusts.
People who are domiciled in the UK are charged IHT based on the assets they own in the UK and worldwide. Those who are not UK domiciled are only charged IHT on their UK assets. This includes all UK residential property, owned by non-domiciled individuals, held within offshore structures such as Trusts and companies.
Domicile is a legal term. Your domicile is usually the country you regard as your permanent home. On birth, your domicile is taken from your father, although it can be shifted to another country if you have taken deliberate steps to settle elsewhere. From April 2017, if you have been resident in the UK for at least 15 of the past 20 tax years, you are treated as UK domiciled for IHT purposes ('deemed domicile').
This rule also applies to individuals who are born in the UK to parents domiciled in the UK, while they remain in the UK.
When someone dies, IHT needs to be considered. To evaluate whether or not tax is payable, all of the assets the person held at the date of death need to be valued, and reliefs and exemptions determined. The total is known as the deceased’s ‘estate’ or ‘death estate’.
IHT is currently charged on the value of the estate, after reliefs and exemptions plus certain lifetime transfers made in the last seven years. The tax is charged at 0% up to the IHT threshold, currently £325,000 (known as the nil rate band) and 40% on the balance of the estate.
The 40% rate is reduced to 36% where at least 10% of the net estate is left to UK or certain EU registered charities.
Each person has a nil rate band, currently £325,000, which allows for an estate of up to that amount to be left with no IHT liability. Married couples and civil partners have one nil rate band each.
A nil rate band can be transferred when a spouse or civil partner has died and their estate charged to IHT does not use up all of the nil rate band they are entitled to. Assets that pass from one spouse or civil partner to another are exempt from IHT.So, if on death, you leave everything you own to your spouse or civil partner, it is exempt from IHT and you will not have used any part of your personal nil rate band. Your unused nil rate band can be transferred to your spouse or civil partner and is used to work out the IHT liability on their estate when they die. This means that when your spouse or civil partner also dies, a maximum of two nil rate bands will be available, currently totalling £650,000.
The nil rate band has failed to keep pace with inflation and is expected to remain at the same level until April 2021. More and more estates are likely to be charged IHT.
Transfers between UK domiciled spouses or civil partners are fully exempt from IHT. However, if your spouse is domiciled outside the UK, your spouse’s exemption is limited to the nil rate band of £325,000. Any transfers exceeding this amount could be chargeable to IHT.
This restriction can be lifted if your non-domiciled spouse becomes domiciled in the UK for IHT purposes, in which case the unlimited spouse exemption will apply. Unmarried partners, no matter how long-standing, have no spouse exemption.
From April 2017, a residence nil rate band was phased in, enabling the family home to be passed on to children or grandchildren tax-free after death. This allowance is added to the existing nil rate band of £325,000 but is gradually withdrawn for estates worth more than £2 million.
Now fully phased in for deaths on or after 6 April 2020, the additional allowance adds a maximum of £175,000 to the existing nil rate band. Therefore, the total tax-free allowance available to the surviving spouse or partner from 2020/21 could be up to £1 million as any unused allowances are transferable.
There is also a relief in cases where individuals downsize or cease to own a home, leaving assets worth up to the equivalent of the new allowance to children or grandchildren.
Gifts made during your lifetime are categorised for IHT purposes. There
are three types of transfers.
This is where the value of the gift immediately falls outside the estate. These include:
Chargeable transfers are mainly gifts to certain Trusts. After deductions (the nil rate band and any other reliefs) the value of the transfer will be charged at the lifetime IHT rate of 20%.
If you die within seven years of making the gift, the value of the gift needs to be taken into account when calculating the IHT due and credit is given for the tax already paid. There is partial relief, called taper relief (see right), which could be available to reduce the tax on these gifts.
PETs are transfers which are neither exempt transfers nor chargeable transfers. This includes gifts which exceed the annual exemption of £3,000.
These gifts fall outside of your estate once you have survived the gift by seven years. If you die before the seven years have passed, the gift is added back to the estate when calculating IHT. Again, taper relief may be available to reduce the tax payable.
Taper relief can reduce the amount of IHT on gifts made within seven years before death where:
Many people have tried to avoid IHT by giving assets away but still retaining a benefit from them. Two rules can stop this from being effective.
This is an extension of the gift with reservation rule. It applies where a gift has been made but some benefit is still being enjoyed, although it is not classed as a gift with reservation and falls outside the IHT estate once the appropriate time has elapsed. Less of a direct benefit is required to fall under this rule. For example, you give a sum of money to your child who, after three years, decides to acquire a house in which you will live. Even though there was no intention at the time of the gift, this tax charge is applicable. Although the gift remains outside the estate once you survive it by seven years, there is still a benefit being received from the gift when you move into the property so the pre-owned asset tax applies. In this case, the pre-owned asset tax is an income tax charge based on the rental value of the property.
Various reliefs are available to reduce the amount of IHT an estate will pay, including a number of property exemptions.
Business Relief (formally known as Business Property Relief or BPR) is available on the value of transfers of business property, providing that certain conditions are met. Relief can be available at 100% — meaning the value is free from IHT. Full relief is available on the transfer of:
Relief of 50% is available for assets which you own personally but are used in a personal trade. For example, if you own an office building in which your own personal company trades, 50% IHT relief will be available on the value of the office building.
For Business Relief to apply, you need to have owned the asset for at least two years.
If an asset is sold and a new one is acquired, it is possible in some cases to structure the transfer so that replacement Business Relief applies — in this case the two year period does not need to restart.
Agricultural Property Relief can apply to land, woodlands, farm buildings and certain farmhouses which accompany land. For this relief to apply you must have owned the property and used it for agriculture for two years ending on the date of the transfer, or owned it for a seven year period if the land is used for agriculture by another person. Relief is available at 100% on the agricultural value in most cases.
Again, where an agricultural asset is sold and a new one acquired, it can be possible in some cases to structure the transfer so that the two year period does not need to restart.
The executors or legal personal representatives typically have six months from the end of the month of death to pay any IHT due. The executors cannot distribute to the beneficiaries until the IHT has been paid or until HMRC has agreed that no IHT liability arises.
IHT can be paid in instalments on certain types of assets including:
Depending upon the type of asset, interest may be chargeable on instalments paid more than six months after the date of death.
Ensuring your estate is Inheritance Tax efficient is a sensitive subject, and as a result planning opportunities can be missed.
Calculations and returns
Advisory and planning
For more information on the issues raised in this guide or to discuss your individual circumstances get in touch with your usual Crowe contact.