Inheritance Tax: An Overview

This note provides a guide to UK inheritance tax (IHT) for those who are unfamiliar with the charge. It covers:

When IHT is charged.
The rate of tax.
The main exclusions, exemptions and reliefs.

When is Inheritance Tax charged?

IHT is primarily a charge on your assets on death, including your share of assets jointly held with another person. However, lifetime gifts made within seven years prior to your death can also be brought back into charge.

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. For example, where you give your home (in which you continue to live) to your children and do not pay them full market rent for your occupation.

It is also charged on lifetime gifts to companies and to certain types of trust (called “relevant property” trusts) and these trusts also suffer periodic IHT charges.

For ease of explanation, the word “gift” is used in this note. However, the IHT legislation is more complex and covers scenarios that might not be immediately recognised as a gift. For example, the legislation covers sales of assets at an undervalue (when made between certain family members, or your company, trust or partnership). Therefore, if you sell a house worth £100,000 to your son or daughter for £10,000, you have effectively made a gift to them of £90,000.

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.

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).
- 40% on estates on death.

The rate of IHT on death is reduced from 40% to 36% for individuals who leave 10% or more of their net estate to charity.

Where lifetime gifts are brought back into charge (because they were made in the seven years prior to death), any IHT payable on these gifts may be reduced. The longer you survive from the date of the gift, the less IHT is payable, provided that you survive for at least three years.

Relevant property trusts have their own IHT regime, 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. These are outlined in brief below.

Nil rate band and residence nil rate band

The nil rate band and residence nil rate band are amounts which are chargeable to IHT at 0%. The basic nil rate band is currently £325,000. There is also an extra nil rate band (called the residence nil rate band) of between £100,000 and £175,000 (depending on the year of death) if the family home is inherited by lineal descendants.

If you are married, your surviving spouse, or civil partner can “inherit” the unused portion of your nil rate band or residence nil rate band. When a claim is made, this increases the surviving spouses or civil partner’s nil rate band and residence nil rate band on a percentage basis (and not simply by the amount of your unused nil rate band and residence nil rate band).

Example

Mr X died a number of years before Mrs X. On his death, he had an available nil rate band of £325,000.

He left £1,000 to a charity and the remainder of his estate to his wife, Mrs X. The gift to charity was exempt from inheritance tax and the ‘spouse exemption’ applied to the residuary gift to Mrs X, so none of Mr X’s nil rate band was used.

When Mrs X dies, her executors can claim to transfer Mr X’s unused nil rate band, which would otherwise be wasted. Mrs X did not use up any of her basic nil rate band of £325,000 and so the combined nil rate bands mean that Mrs X can leave up to £650,000 tax free.

In addition, as Mrs X leaves the family home to her children (lineal descendants), her executors can claim the residence nil rate band of up to £175,000. As Mr X’s residence nil rate band was not used on his death then Mrs X’s executors can also claim this meaning that Mrs X can potentially leave an additional £350,000 tax free.

It is important to note that the residence nil rate band is capped at the value of the property so if the property was worth £300,000 then only a total of £300,000 in respect of the residence nil rate bands could be claimed. There are also limits on when then the residence nil rate band is available and so it is always important to seek legal advice.

Exemptions available for lifetime gifts and on death

Certain gifts are exempt from IHT and 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: you can give as many gifts of up £250 to as many individuals as you want (but not to anyone who has already received a gift of your annual exemption allowance – see below).
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.

For further information regarding inheritance tax or if you would like to discuss a Wills & Probate related query with one of the team, please call us on 0800 011 6666 or e-mail the team at legal@timms-law.com.