Inheritance Tax (IHT)

What is Inheritance Tax (IHT)?

  Where you (donor) make a gift with gratuitous intention during your life time or on death, you pay for Inheritance Tax (IHT) on value of the gift.  However, you pay for IHT only on the excess of Nil Rate Band (NRB) of £325K.

If you gift during your lifetime, it’s called a potentially exempt transfer (PET) which means that you pay for  IHT only if you die within 7 years of the gift.

If you gift assets into a discretionary trust ie CLT (Chargeable Lifetime Transfer), you have to pay for IHT immediately at 20% or 25% (where donor pays IHT) on the excess of nil rate band (NRB) £325k.

Donor must report all CLT to HMRC but for PET, donee needs to report if only the donor dies within 7 years of the gift. 

You have to submit IHT return within 12 months from the end of the month in which the CLT (Chargeable Lifetime Transfer) was made and pay for the IHT by later of  6 months from end of months of gift, or 30 April in following tax year.

What are Inheritance Tax Free Gifts?

     Following gifts are Inheritance Tax (IHT) free gifts:

  1. Gifts to spouse/civil partner – if you gift any assets to your spouse/civil partner either during your life time or on death, it’s Inheritance Tax free except to Non-UK domicile spouses. For Non-UK domicile spouses, only up to £325K is free.
  2. Gifts to UK and EEA charities
  3. Small gifts –  lifetime gifts up to £250 to any donee in a tax year, which is “all or nothing” exemption.
  4. Gift on marriage – gift from parents up to £5k, from grand parents up to £2.5k or from anyone up to £1K.
  5. Normal expenditure out of income – if you give habitual gifts out of your income without affecting your standard of living.
  6. Annual exemption – £3k per tax year for 2 years.
What is Resident Nil Rate Band (RNRB)?

   

  • Resident Nil Rate Band (RNRB) is Inheritance Tax (IHT) relief in addition to Nil Rate Band (NRB) £325K.
  • You can use RNRB £175K against your residence.
  • You can transfer your unused RNRB to your surviving spouse.
  • Therefore, for a married couple, you have maximum £1m of Nil Rate Band (NRB) and RNRB in total. 
  • If you have more than £2 million of ‘Net value‘ in your estates, you have tapered RNRB by reducing by £1 every £2 over the excess.
  • The ‘Net value‘ means assets less liabilities but before deducting relief (such as Agricultural Property Relief/Business Property Relief) and exemptions (spouse/charity etc).
  • You can use the RNRB where you passed your residential property to ‘linear descendants’ as children (including step-children, adopted children and foster children), grandchildren, great-grandchildren and spouse/ civil partners of such descendants only.
  • You can use RNRB where you left  qualifying residence to certain types of trust for the benefit of direct descendants except general discretionary trusts.
  • Your descendants don’t need to occupy the residence after your death.
  • You can use RNRB not only for your main residence but also any private resident as long as at some point you have used as private residence.
  • You can use RNRB against sold property or downsized property prior to your death.
  • You don’t need to have minimum ownership period for a qualifying residence. Therefore, you case use the RNRB against a property where you lived for short term just before you died.
  • You can use your RNRB for your death estate only. 
What is Business Property Relief (BPR)?

Where you gift ‘relevant business assets’,  you can reduce Inheritance Tax (IHT) by claiming Business Property Relief (BPR).

You can claim following BPR where:

  • 100% on transfer of business or shares in unquoted trading companies.
  • 50% on shares in controlling holding in a quoted trading company.
  • 50% on gifts of land/buildings/plant & machinery used  by donor’s partnership or by company the donor controls.
  • However, you can’t clam BPR on gift of Investment companies or property dealing companies .
  • You should own the property for 2 years before the gift or if the asset was replaced within 3 years, then 2 of 5 years.
  • Donee needs retain the property on your death.
What is Agricultural Property Relief (APR)?

       

  • When you gifted farmland and farm buildings during lifetime or on death, you can reduce Inheritance Tax (IHT) by claiming Agricultural Property Relief (APR).
  • You can claim APR before any available annual exemptions, at either 50% or 100%.
  • Agricultural property means either agricultural land or buildings, used for the purposes of agriculture and situated either in the UK, the Channel Islands, the Isle of Man or an EEA State.
  • A farmer who owns the land and buildings and uses these assets in his own business can claim APR.
  • Also, a landowner who is letting out agricultural land or buildings to a farmer can claim APR. 
  • You can claim APR only at a rate of 50% where:

(i) Tenanted land; and

(ii) Pre 1.9.95 lease; and

(iii) Lease has > 2 years left to run at date of transfer

  • If you meet the all three of these conditions, you can claim APR at a rate of 50% of the agricultural value and for any other cases, you can claim 100% of APR of the agricultural value.
  • You must own the agricultural property for the purposes of agriculture throughout the 2 years prior to the transfer.
  • In the case of tenanted land, you need to own it minimum  for seven years.
  • If you replaced the agricultural land  with new land, you should own it for combined period,  two out of the last five years.
  • In the case of tenanted land, you need to own it for seven out of the last ten years.
Inheritance Tax on Death

        

      On the death, you should pay for Inheritance Tax (IHT) at 40% on three types of transfers:

  • Potential Exempt Transfer (PET) made within 7 years of the death.
  • Chargeable lifetime transfers (CLT) within 7 years of the death.
  • Assets in death estate.

  • To be able to claim Agricultural Property relief (APR) or Business Property Relief (BPR) for IHT on the donor’s death, the donee must either have:

    1. Retained the property until the death of the donor; or
    2. Sold the original property and replaced it within three years with other business or agricultural property.
  • Trustees pay for IHT on CLT whereas donees pay for IHT on Potential Exempt Transfer (PET) and Executors pay for IHT on Death Estate by 6 months from the end of the month of death.
  • You can deduct allowable liabilities and reasonable funeral expenses against the value of the estate assets.
  • However, you can NOT deduct any cost incurred by the Executors in administering the deceased’s estate such as probate fees etc in calculating IHT.

  • The only exception to this rule is that you can deduct any additional expenses of administering or realising property situated abroad, maximum of 5% of the value of the foreign assets.

  Lower rate of IHT where part of Estate left to Charity:

  • Where you left 10% or more of your net estate ie “Baseline amount” to a charity (or a registered community amateur sports club),  you pay for IHT on the taxable estate at a lower IHT rate 36% instead of normal 40%.

  • The “baseline amount” is the value of the estate charged to IHT after deducting all available reliefs, exemptions and the available general nil rate band, but excluding relief for the charitable legacy itself. The Residence Nil Band is ignored.

Gifts With Reservation Of Benefits” (GWROB) rules

  • If you (donor) give away an asset, but continue to have a benefit from that asset, the transfer is called a “gift with reservation of benefit” (GWROB). Eg) You give away a house, but continue to occupy the property after the gift.
  • The effect of a GWROB, is to treat the asset as still forming part of your estate at the date of death – i.e., we pretend that you still owns the asset at your death.
  • Exception GWROB rules:

You (donor) pay a full market rent to the donee for the use of the asset.You (donor) are “virtually” excluded from benefiting from the asset given away or with limited benefit.

  • Double charge arises when the original gift becomes a chargeable transfer i.e. you (donor) give a house to a donee thereby making a Potential Exempt Transfer (PET) and you die within 7 years. If you (donor) are still occupying the property at the date of death, you have a reservation of benefit. Therefore, as well as the house being treated as forming part of your (donor’s) death estate for Inheritance Tax purposes, the PET on the original gift has become chargeable.
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