An introduction to inheritance tax

Introduction
In this chapter, we move on to inheritance tax (IHT). IHT is primarily a tax on
wealth left on death. It also applies to gifts within seven years of death and to
certain lifetime transfers of wealth.
The tax is different from income tax and CGT, where the basic question is: how
much has the taxpayer made? With IHT, the basic question is, how much has
he given away? We tax the amount which the taxpayer has transferred – the
amount by which he is worse off. If the taxpayer pays IHT on a lifetime gift, he
is worse off by the amount of the gift plus the tax due, and we have to take that
into account. Some transfers are, however, exempt from IHT.
We will see that the first £325,000 of transfers is taxed at 0% (the ‘nil rate
band’), and is therefore effectively tax-free. To stop people from avoiding IHT
by, for example, giving away £1,625,000 in five lots of £325,000, we need to
look back seven years every time a transfer is made to decide how much of the
nil rate band is available to set against the current transfer.
In the next chapter, we will look at transfers on death.

Study guide

    Intellectual level
3 Inheritance tax in situations involving further aspects of the scope of the tax and the calculation of the liabilities arising, the principles of valuation and the reliefs available, transfers of property to and from trusts, overseas aspects and further aspects of administration 
(a) The contents of the Paper F6 study guide for inheritance tax under headings: 2
D1 The basic principles of computing transfers of value
D2 The liabilities arising on chargeable lifetime transfers and on the death of an individual
D3 The use of exemptions in deferring and minimising inheritance tax liabilities
(b) The scope of inheritance tax:
(ii) Identify excluded property 2
(c) The basic principles of computing transfers of value:
(iii) Identify exempt transfers 2
(d) The liabilities arising on chargeable lifetime transfers and the death of an individual: 3
(i) Advise on the tax implications of chargeable lifetime transfers
(ii) Advise on the tax implications of transfers within seven years of death
(iv) Advise on the relief for the fall in value of lifetime gifts
(f) The use of exemptions and reliefs in deferring and minimising inheritance tax liabilities: 3
(i) Advise on the use of reliefs and exemptions to minimise inheritance tax liabilities, as mentioned in the sections above

Exam guide

In the P6 exam, you will be expected to deal with basic inheritance tax transfers and the more technical rules covered in this chapter such as fall in value relief for lifetime gifts, excluded property, and further exemptions. You will also be expected to use your knowledge of inheritance tax to advise clients about minimising inheritance tax liabilities.

 

 

This chapter revises the basic principles of inheritance tax covered in Paper F6. The examination team has identified essential underpinning knowledge from the F6 syllabus which is particularly important that you revise as part of your P6 studies. In this chapter, the relevant topics are:

    Intellectual level
D1 The basic principles of computing transfers of value
(b) Understand and apply the meaning of transfer of value, chargeable transfer and potentially exempt transfer. 2
(c) Demonstrate the diminution in value principle. 2
(d) Demonstrate the seven year accumulation principle taking into account changes in the level of the nil rate band. 2
D2 The liabilities arising on chargeable lifetime transfers and on the death of an individual
(a) Understand the tax implications of lifetime transfers and compute the relevant liabilities. 2

There are no changes in 2015/16 from 2014/15 in the material covered at F6 level. In particular, note that the nil rate band has remained at £325,000.

1 Basic principles

 

One of the competencies you require to fulfil Performance Objective 15 Tax computations and

assessments of the PER is to prepare or contribute to the computation or assessment of tax computations for individuals. You can apply the knowledge you obtain from this section of the text to help to demonstrate this competence.

IHT is a tax on gifts or ‘transfers of value’ made by chargeable persons. This generally involves a transaction as a result of which wealth is transferred by one person to another, either directly or via a trust.

1.1 Chargeable persons

Chargeable persons for IHT purposes are:

  • Individuals, and
  • Trustees of settled property.

Companies are not chargeable persons although if companies are used to transfer wealth an IHT liability can be charged on the shareholders (the details are outside the scope of your syllabus).

Spouses and civil partners are taxed separately although there is an exemption for transfers between the couple. There are also special valuation rules which are dealt with later.

1.2 The scope of the charge

All transfers of assets (worldwide) made by persons domiciled, or deemed domiciled, in the UK (see later in this Text) whether during lifetime or on death are within the charge to IHT.

For individuals not domiciled in the UK, only transfers of UK assets are within the charge to IHT.

2 Computing transfers of value

2.1 Introduction

There are two main chargeable occasions for individuals:

  • gifts made in the lifetime of the donor (lifetime transfers), and
  • gifts made on death, for example when property is left in a will (death estate).

We will look in detail at lifetime transfers later in this chapter and at the death estate in the next chapter.

First, however, we start our study of IHT by looking at some general principles which apply to both chargeable occasions.

2.2 Transfers of value and chargeable transfers

FAST FORWARD

IHT applies to transfers to trusts, transfers on death and to transfers within the seven years before death.

IHT cannot arise unless there is a transfer of value. This is any gratuitous disposition (eg gift) made by a person which results in his being worse off, that is, he suffers a diminution (ie reduction) in the value of his estate.

The measure of a gift is always the loss to the transferor (the diminution in value of his estate), not the amount gained by the transferee.

2.3 Chargeable transfers

Inheritance tax arises on any chargeable transfer. This is any transfer of value not covered by an exemption.

Chargeable transfers made during the individual’s lifetime are called chargeable lifetime transfers (CLTs).

On death, an individual is treated as if he had made a transfer of value of the property comprised in his estate. This, then, will be a chargeable transfer to the extent that it is not exempt.

2.4 Potentially exempt transfers

Key term                A PET is a lifetime transfer made by an individual to another individual. Any other lifetime transfer by an individual (eg gift to a trust) not covered by an exemption is a CLT.

A PET is exempt from IHT when made and will remain so if the transferor survives for at least seven years from making the gift. If the transferor dies within seven years of making the gift, it will become chargeable to IHT.

                                 2.5 Diminution in value                                                           6/13

In many cases the diminution in value of the transferor’s estate will be the same as the increase in the value of the transferee’s estate. However, sometimes the two will not be the same.

2.6 Example: diminution in value

Audrey holds 5,100 of the shares in an unquoted company which has an issued share capital of 10,000 shares. Currently Audrey’s majority holding is valued at £15 per share.

Audrey wishes to give 200 shares to her son, Brian. However, to Brian the shares are worth only £2.50 each, since he will have only a small minority holding in the company. After the gift Audrey will hold 4,900 shares and these will be worth £10 each. The value per share to Audrey will fall from £15 to £10 per share since she will lose control of the company.

The diminution in value of Audrey’s estate is £27,500, as follows.

£

Before the gift: 5,100 shares  £15                                                                      76,500

After the gift: 4,900 shares  £10  (49,000) Diminution in value           27,500

Brian has only been given shares with a market value of 200  £2.50 = £500. Remember, a gift is also a deemed disposal at market value for CGT purposes, and it is this value that will be used in any CGT computation. IHT, however, uses the principle of diminution in value which can, as in this case, give a much greater value than the value of the asset transferred.

2.7 Exceptions to the IHT charge

The following are not chargeable to IHT:

  • Transfers where there is no gratuitous intent: for example selling a painting for £1,000 which later turns out to be worth £100,000. The transaction must have been made at arm’s length between unconnected persons
  • Transfers made in the course of a trade: for example Christmas gifts to employees
  • Expenditure on family maintenance: for example school fees paid for a child
  • Waivers of remuneration
  • Waivers of dividends provided the waiver is made within the 12 months before the dividend is declared
  • Any transfer covered by a specific exemption (see further below)
  • Transfers of excluded property (see below)

3 Exemptions

One of the competencies you require to fulfil Performance Objective 17 Tax planning and advice of the PER is to mitigate and/or defer tax liabilities through the use of standard reliefs, exemptions and incentives. You can apply the knowledge you obtain from this section of the text to help to demonstrate this competence.

 

Exemptions may apply to make transfers or parts of transfers non chargeable. Some exemptions only apply on lifetime transfers (annual, normal expenditure out of income, marriage/civil partnership), whilst some apply on both life and death transfers (eg spouses/civil partners, charities, political parties).

FAST FORWARD

3.1 Introduction

There are various exemptions available to eliminate or reduce the chargeable amount of a lifetime transfer or property passing on an individual’s death. Some exemptions apply to both lifetime transfers and property passing on death, whilst others apply only to lifetime transfers.

The lifetime exemptions apply to PETs as well as to CLTs. Only the balance of such gifts after the lifetime exemptions have been taken into account is then potentially exempt.

Exam focus         Where CLTs and PETS are made in the same year the CLTs should be made first to use any available point               exemptions. If used up against the PETs an exemption will be wasted if the PET never becomes chargeable.

3.2 Exemptions applying to lifetime transfers only

                                 3.2.1 The small gifts exemptions                                        12/14, 12/15

Outright gifts to individuals totalling £250 or less per donee in any one tax year are exempt. If gifts total more than £250 the whole amount is chargeable. A donor can give up to £250 each year to each of as many donees as he wishes. The small gifts exemption cannot apply to gifts into trusts.

3.2.2 The annual exemption (AE)

The first £3,000 of value transferred in a tax year is exempt from IHT. The annual exemption is used only after all other exemptions (such as for transfers to spouses/civil partners or charities (see below)). If several gifts are made in a year, the £3,000 exemption is applied to earlier gifts before later gifts. The annual exemption is used up by PETs as well as CLTs, even though the PETs might never become chargeable.

Any unused portion of the annual exemption is carried forward for one year only. Only use it the following year after that year’s own annual exemption has been used.

 

 

Question Annual exemptions
Frank has no unused annual exemption brought forward at 6 April 2014.

On 1 August 2014 he makes a transfer of £600 to Peter.

On 1 September 2014 he makes a transfer of £2,000 to Quentin.

On 1 July 2015 he makes a transfer of £3,300 to a trust for his grandchildren. On 1 June 2016 he makes a transfer of £5,000 to Rowan.

Show the application of the annual exemptions.

 
Answer

 

2014/15                                                                                                                            £

1.8.14 Gift to Peter                                                                                                      600

Less AE 2014/15                                                                                                        (600)

£
1.9.14 Gift to Quentin 2,000
Less AE 2014/15  (2,000)
         0

      0

The unused annual exemption carried forward is £3,000 – £600 – £2,000 = £400.
2015/16                                                                                                                              £  £
1.7.15 Gift to trust  3,300
Less: AE 2015/16                                                                                                            3,000
           AE 2014/15 b/f                                                                                                        300
 (3,300)
         0

The unused annual exemption carried forward is zero because the 2015/16 exemption must be used before the 2014/15 exemption brought forward. The balance of £100 of the 2014/15 exemption is lost, because it cannot be carried forward for more than one year.

2016/17                                                                                                                            £

1.6.16 Gift to Rowan                                                                                                5,000

Less AE 2016/17                                                                                                    (3,000)

  2,000

 

                                3.2.3 Normal expenditure out of income                                     12/15

Inheritance tax is a tax on transfers of capital, not income. A transfer of value is exempt if:

  • It is made as part of the normal expenditure of the transferor
  • Taking one year with another, it was made out of income, and
  • It leaves the transferor with sufficient income to maintain his usual standard of living.

As well as covering such things as regular presents this exemption can cover regular payments out of income such as a grandchild’s school fees or the payment of life assurance premiums on a policy for someone else.

3.2.4 Gifts in consideration of marriage/civil partnership

Gifts in consideration of marriage/civil partnership are exempt up to:

  • £5,000 if from a parent of a party to the marriage/civil partnership
  • £2,500 if from a remoter ancestor or from one of the parties to the marriage/civil partnership (c) £1,000 if from any other person.

The limits apply to gifts from any one donor for any one marriage/civil partnership. The exemption is available only if the marriage/civil partnership actually takes place.

3.3 Exemptions applying to both lifetime transfers and transfers on death

3.3.1 Gifts between spouses/civil partners

Any transfers of value between spouses/civil partners are exempt provided the transferee is domiciled or deemed domiciled (see later in this Text) in the UK at the time of transfer. The exemption covers lifetime gifts between them and property passing under a will or on intestacy.

If the transferor spouse/civil partner is domiciled or deemed domiciled in the UK but the transferee spouse/civil partner is not domiciled nor deemed domiciled in the UK, the exemption is limited to a cumulative total equal to the amount of the nil rate band at the date of the transfer ie £325,000 for 2015/16. If neither spouse/civil partner is domiciled nor deemed domiciled in the UK there is no limit on the exemption. An election may be made for a non-UK domiciled individual who is, or was, the spouse or civil partner of a UK domiciled individual, to be treated as UK domiciled for IHT purposes. We look at this election later in this text when we deal with overseas aspects of IHT.

A simple planning point follows from this exemption. Spouses/civil partners may avoid IHT, at least in the short term, if each makes a will leaving his property to the other.

A claim can also be made to transfer any unused nil rate band from one spouse/civil partner to the surviving spouse/civil partner (see later in this Text).

 

 

Dale made a gift of £153,000 to her son on 17 October 2015 on the son’s marriage. Dale gave £400,000 to her spouse on 1 January 2018. Dale gave £70,000 to her daughter on 11 May 2018. The only other gifts Dale made were birthday and Christmas presents of £100 each to her grandchildren.

Show what exemptions are available assuming:

  • Dale’s spouse is domiciled in the UK; or
  • Dale’s spouse is not domiciled in the UK.

 

 

  • 17 October 2015

£

Gift to Dale’s son                                                                                      153,000

Less: ME                 (5,000)  AE 2015/16            (3,000)  AE 2014/15 b/f      (3,000) PET            142,000

  • January 2018

£

Gift to Dale’s spouse                                                                                400,000

Less spouse exemption         (400,000)                          0

11 May 2018

£

Gift to Dale’s daughter                                                                               70,000

Less: AE 2018/19 (3,000)  AE 2017/18 b/f       (3,000) PET          64,000

The gifts to the grandchildren are covered by the small gifts exemption.

  • 17 October 2015

As in part (a)

  • January 2018    £

Gift to Dale’s spouse                                                                                400,000

Less spouse exemption (restricted)                                                     (325,000)

Less: AE 2017/18  (3,000)  AE 2016/17 b/f      (3,000) PET          69,000

Note that the annual exemption is available to set against the gift remaining after deducting the spouse exemption.

11 May 2018

£

Gift to D’s daughter                                                                                    70,000

Less AE 2018/19                                                                                         (3,000)

PET                                                                                                              67,000

 

3.3.2 Other exempt transfers

Transfers (whether outright or by settlement) to UK charities are exempt from inheritance tax.

Gifts to a qualifying political party are exempt. A political party qualifies if, at the general election preceding the transfer of value, either:

  • At least two members were elected to the House of Commons, or
  • One member was elected and the party polled at least 150,000 votes.

Gifts for national purposes are exempt. Eligible recipients include museums and art galleries.

4 Excluded property

FAST FORWARD

If excluded property is given away, there are no IHT consequences.

4.1 Types of excluded property

The following are examples of excluded property.

(a)       A reversionary interest in settled property. A reversionary interest is a future interest in trust property. An example is when an income beneficiary (with the present interest) dies and the capital passes to the remainderman. A reversionary interest will not, however, be treated as excluded property if:

  • it has been acquired at any time for consideration in money or money’s worth, or
  • either the settlor or his spouse is or has been beneficially entitled to the interest at any time (b)               Foreign assets owned by non-UK domiciled individuals (see later in this Text).

                                 5 Calculation of tax on lifetime transfers

                                                               6/12, 12/12, 6/13, 12/13, 6/14, 6/15

5.1 Basic principles

FAST FORWARD

Transfers are cumulated for seven years so that the nil rate band is not available in full on each of a series of transfers in rapid succession.

There are two aspects of the calculation of tax on lifetime transfers:

  • lifetime tax on CLTs, and
  • additional death tax on CLTs and on PETs where the transferor dies within seven years of making the transfer.

Exam focus        You should always calculate the lifetime tax on any CLTs first, then move on to calculate the death tax on point     all CLTs and PETs made within seven years of death.

5.2 Lifetime tax
IHT is charged on what a donor loses. If the donor pays the IHT on a lifetime gift he loses both the asset given away and the money with which he paid the tax due on it. Grossing up is required.

FAST FORWARD

5.2.1 Transferee pays tax

When a CLT is made and the transferee (ie the trustees) pays the lifetime tax, follow these steps to work out the lifetime IHT on it:

Step 1       Look back seven years from the date of the transfer to see if any other CLTs have been made. If so, these transfers use up the nil rate band available for the current transfer. Work out the value of any nil rate band still available.

Step 2       Compute the gross value of the CLT. You may be given this in the question or you may have to work out the diminution of value, deduct reliefs (such as business property relief as described later in the Text) or exemptions (such as the annual exemption described earlier in this chapter).

Step 3       Any part of the CLT covered by the nil rate band is taxed at 0%. Any part of the CLT not covered by the nil rate band is charged at 20%.

The life rate of 20%, the current nil rate band and those for previous years are given in the rates and allowances section of the exam paper.

Exam focus point

 

 

Eric makes a gift of £336,000 to a trust on 10 July 2015. He has not used his annual exemption in 2015/16 nor in 2014/15. The trustees agree to pay the tax due.

Calculate the lifetime tax payable by the trustees if Eric has made:

(a)        a lifetime chargeable transfer of value of £100,000 in August 2007 (b)         a lifetime chargeable transfer of value of £100,000 in August 2008

(c)     a lifetime chargeable transfer of value of £350,000 in August 2008.

 

 

(a)                               Step 1     No lifetime transfers in seven years before 10 July 2015. Nil rate band of £325,000 available.

                                             Step 2                                                                                                               £

Gift                                                                                     336,000

Less: AE 2015/16        (3,000)  AE 2014/15 b/f        (3,000)

Chargeable lifetime transfer                                             330,000

                                             Step 3                                                                                                            IHT

£

£325,000  0%            0   £5,000  20%

£330,000

(b)                               Step 1     Lifetime transfer of value of £100,000 in seven years before 10 July 2015 (transfers after 10 July 2008). Nil rate band of £(325,000 – 100,000) = £225,000 available.

Step 2      Value of CLT is £330,000 (as before).

                                             Step 3                                                                                                            IHT

£

£225,000  0%    0  £105,000  20%           21,000

 £330,000                                                                           21,000

(c)                               Step 1     Lifetime transfer of value of £350,000 in seven years before 10 July 2015 (transfers after 10 July 2008). No nil rate band available as all covered by previous transfer.

Step 2      Value of CLT is £330,000 (as before).

                                             Step 3                                                                                                            IHT

£

£330,000 @ 20%                                                              66,000

 

5.2.2 Transferor pays tax

Where IHT is payable on a CLT, the primary liability to pay tax is on the transferor, although the transferor may agree with the transferee (as in the above example) that the transferee is to pay the tax instead.

If the transferor pays the lifetime IHT due on a CLT, the total reduction in value of his estate is the transfer of value plus the IHT due on it. The transfer is therefore a net transfer and must be grossed up in order to find the gross value of the transfer. We do this by working out the tax as follows.

(rate of tax) 

Chargeable amount (ie not covered by nil band)

(100 minus the rate of tax)

Formula to learn

When a CLT is made and the transferor pays the lifetime tax, follow these steps to work out the lifetime IHT on it: Step 1 Look back seven years from the date of the transfer to see if any other CLTs have been made. If so, these transfers use up the nil rate band available for the current transfer. Work out the value of any nil rate band still available.

Step 2       Compute the net value of the CLT. You may be given this in the question or may have to work out the diminution of value, deduct reliefs (such as business property relief as described later in the Text) or exemptions (such as the annual exemption discussed earlier in this chapter).

Step 3       Any part of the CLT covered by the nil rate band is taxed at 0%. Any part of the CLT not covered by the nil rate band is taxed at 20/80.

Step 4       Work out the gross transfer by adding the net transfer and the tax together. You can check your figure by working out the tax on the gross transfer.

 

 

James makes a gift of £336,000 to a trust on 10 July 2015. He has not used his annual exemption in 2015/16 nor in 2014/15. James will pay the tax due.

Calculate the lifetime tax payable, if James has made:

(a)        a lifetime chargeable transfer of value of £100,000 in August 2007 (b)         a lifetime chargeable transfer of value of £100,000 in August 2008

(c)     a lifetime chargeable transfer of value of £350,000 in August 2008.

 

 

  • Step 1 No lifetime transfers in seven years before 10 July 2015. Nil rate band of £325,000 available.
Step 2  £
Gift  336,000
Less: AE 2015/16  (3,000)
         AE 2014/15 b/f    (3,000)
Net CLT  330,000
Step 3 IHT
£
 £325,000  0%   0

 £5,000  20/80

£330,000

Step 4         Gross transfer is £(330,000 + 1,250) = £331,250. Check: Tax on the gross transfer would be:

 IHT

£

£325,000  0%            0      £6,250  20%

£331,250

  • Step 1 Lifetime transfer of value of £100,000 in seven years before 10 July 2015 (transfers after 10 July 2008). Nil rate band of £(325,000 – 100,000) = £225,000 available.

Step 2      Net value of CLT is £325,000 (as before).

                                             Step 3                                                                                                            IHT

                                                                                                       £

£225,000  0%                                                                            0

 20/80

 

Step 4         Gross transfer is £(330,000 + 26,250) = £356,250. Check: Tax on the gross transfer would be:

IHT

£

£225,000  0%                                                                            0

 20%

 

(c)                               Step 1       Lifetime transfer of value of £350,000 in seven years before 10 July 2015 (transfers after 10 July 2008). No nil rate band available as all covered by previous transfer.

Step 2        Net value of CLT is £330,000 (as before).

                                             Step 3                                                                                                            IHT

£

£330,000  20/80                                                             82,500

Step 4         Gross transfer is £(330,000 + 82,500) = £412,500. Check: Tax on the gross transfer would be:

IHT

£

£412,500  20%                                                               82,500

 

5.3 Death tax

The longer the transferor survives after making a gift, the lower the death tax. This is because taper relief applies to lower the amount of death tax payable as follows:

Years between transfer and death % reduction in death tax
3 years or less 0
More than 3 but less than 4 20
More than 4 but less than 5 40
More than 5 but less than 6 60
More than 6 but less than 7 80

Exam focus         The rates of taper relief will be given in the rates and allowances section of the exam paper.  point

Death tax on a lifetime transfer is always payable by the transferee, so grossing up is not relevant.

Follow these steps to work out the death tax on a CLT:

Step 1       Look back seven years from the date of the transfer to see if any other chargeable transfers were made. If so, these transfers use up the nil rate band available for the current transfer. Work out the value of any nil rate band remaining.

Step 2       Compute the value of the CLT. This is the gross value of the transfer that you worked out for computing lifetime tax.

Step 3       Any part of the CLT covered by the nil rate band is taxed at 0%. Any part of the CLT not covered by the nil rate band is charged at 40%.

Step 4     Reduce the death tax by taper relief (if applicable).

Step 5       Deduct any lifetime tax paid. The death tax may be reduced to nil, but there is no repayment of lifetime tax.

Exam focus        The death rate of 40%, the current nil rate band and those for previous years are given in the rates and point            allowances section of the exam paper.

 

 

Trevor makes a gross chargeable transfer of value of £220,000 in December 2005. He then makes a gift to a trust of shares worth £206,000 on 15 November 2010. The trustees pay the lifetime tax due.

Trevor dies in August 2015.

Compute:

(a)        the lifetime tax payable by the trustees on the lifetime transfer in November 2010, and (b)            the death tax (if any) payable on the lifetime transfer in November 2010.

 

 

Lifetime tax Step 1     Lifetime transfer of value of £220,000 in 7 years before 15 November 2010 (transfers after

15 November 2003). Nil rate band of £(325,000 [nil rate band in 2010/11] – 220,000) = £105,000 available.

                                 Step 2

£

Gift                                                                                                206,000

Less               AE 2010/11           (3,000)  AE 2009/10 b/f       (3,000)

200,000

                                 Step 3        

IHT

£

£105,000  0%      0  £95,000  20%               £200,000             Death tax

Step 1 Lifetime transfer of value of £220,000 in seven years before 15 November 2010 (transfers after 15 November 2003). Nil rate band of £(325,000 [nil rate band in 2015/16] – 220,000)
= £105,000 available.
Step 2 Value of CLT is £200,000.
Step 3  
IHT
£
£105,000  0%    0
  £95,000  40%  38,000
 £200,000  38,000
Step 4 Death more than 4 years but less than 5 years after transfer
£
Death tax  38,000
Less: taper relief @ 40%  (15,200)
Death tax left in charge  22,800
Step 5  Tax due £(22,800 – 19,000)   3,800

 

5.4 Death tax on potentially exempt transfers

If the transferor dies within seven years of making a PET it will become chargeable to death tax in the same way as a CLT. There will be no lifetime tax paid, so Step 5 above will not apply.

Remember that the exemptions which apply to lifetime transfers only, such as the annual exemption and the marriage/civil partner exemption, are available to set against PETs. You must apply them in chronological order, so that if a PET is made before a CLT in the same tax year, the exemption is set against the PET. This may waste the exemption (unless the donor dies within seven years), and is disadvantageous in cash flow terms since lifetime tax is paid on CLTs but not on PETs.

We will now work through an example where there is both a PET and a CLT.

Calculate lifetime tax on CLTs first. Then move on to death tax, working through all CLTs and PETs in chronological order. Remember: on death PETs become chargeable so must be taken into account when calculating the death tax on later CLTs.

Exam focus point

 

 

Louise gave £346,000 to her son on 1 February 2012. This was the first transfer that Louise had made.

On 10 October 2015, Louise gave £376,000 to a trust. The trustees paid the lifetime IHT due.

On 11 January 2016, Louise died.

Compute:

(a)        the lifetime tax payable by the trustees on the lifetime transfer made in 2015, (b)              the death tax payable on the lifetime transfer made in 2012, and (c)             the death tax payable on the lifetime transfer made in 2015.

 

 

(a)       Lifetime tax – 2015 CLT Step 1    There are no chargeable lifetime transfers in the seven years before 10 October 2015 because the 2012 transfer is a PET and therefore exempt during Louise’s lifetime. Nil rate band of £325,000 available.

                                             Step 2

£

Gift                                                                                     376,000

Less AE 2015/16         (3,000)   AE 2014/15 b/f     (3,000)

CLT                                                                                    370,000

                                             Step 3

IHT

£

£325,000  0%                                                                             0

£45,000  20%

£370,000

(b)       Death tax – 2012 PET becomes chargeable Step 1 No lifetime transfers of value in seven years before 1 February 2012 (transfers after 1 February 2005). Nil rate band of £325,000 available.

                                             Step 2

£

Gift                                                                                     346,000

Step 3
 IHT
 £
 £325,000  0%    0
   £15,000  40%  6,000
 £340,000  6,000

Less AE 2011/12              (3,000)                 AE 2010/11 b/f         (3,000)  PET now chargeable           340,000

Step 4       Death more than 3 years but less than 4 years after transfer

£

Death tax                                                                                6,000

Taper relief @ 20%      (1,200) Death tax due         4,800

(c)        Death tax – 2015 CLT additional tax Step 1           Lifetime transfer of value of £340,000 in seven years before 10 October 2015 (transfers after 10 October 2008). Note that as the PET becomes chargeable on death, its value is now included in calculating the death tax on the CLT. No nil rate band available.

Step 2      Value of CLT is £370,000 as before

                                             Step 3        

IHT

£

£370,000 @ 40%                                                              148,000

Step 4 Death within 3 years of transfer so no taper relief.
Step 5 Tax due £(148,000 – 9,000)  139,000

 

                                  6 Relief for the fall in value of lifetime gifts                                                       12/14

FAST FORWARD

If an asset falls in value between a lifetime gift and death, fall in value relief reduces the death tax payable. The relief affects the tax on the transfer concerned. It does not reduce the value of the gross chargeable transfer for the purpose of computing later IHT.

Where a PET or CLT becomes chargeable to IHT on death and the value of the gift has fallen between the date of the gift and the death of the transferor (or the sale of the property if this precedes death) fall in value relief may be claimed. Relief is available only if the transferee (or his spouse/civil partner) still holds the property at the date of death, or it has been sold in an arm’s length transaction to an unconnected person.

Only the tax on the transfer is reduced by the relief. It does not affect the value of the gross chargeable transfer when considering how much of the nil band is used by the gift.

 

 

H transferred a house worth £335,000 to his son on 1 June 2012. H then gave £205,000 cash to his daughter on 20 August 2014. Shortly before H’s death his son sold the house on the open market for £270,000. H died on 14 July 2015. Calculate the IHT liabilities arising.

 

 

1 June 2012

There is no IHT liability when the gift is made because it is a PET.

£

Gift                                                                                                                        335,000

Less AE 2012/13                (3,000) Less AE 2011/12 b/f               (3,000)

PET                                                                                                                        329,000

The PET becomes chargeable as a result of death within seven years. The value of the chargeable transfer is reduced by the fall in value of the house:

Death tax                                                                                                         Chargeable

 Transfer

£

PET                                                                                                                        329,000

Less relief for fall in value £(335,000 – 270,000)                                                            )

 

This is within the nil band so the IHT payable by the son is £Nil. 20 August 2014

There is no IHT liability when the gift is made because it is a PET.

 £
Gift  205,000
Less AE 2014/15  (3,000)
Less AE 2013/14 b/f    (3,000)
PET  199,000

Gross chargeable transfers in the seven years prior to the gift total £329,000 (not £264,000), so none of the nil band remains available to use when calculating IHT on the PET to the daughter. The IHT payable by her is, therefore, £199,000  40% = £79,600. No taper relief applies as gift was within three years of death.

 

IHT applies to transfers to trusts, transfers on death and to transfers within the seven years before death.
Exemptions may apply to make transfers or parts of transfers non chargeable. Some exemptions only apply on lifetime transfers (annual, normal expenditure out of income, marriage/civil partnership), whilst some apply on both life and death transfers (eg spouses/civil partners, charities, political parties).
If excluded property is given away, there are no IHT consequences.
Transfers are cumulated for seven years so that the nil rate band is not available in full on each of a series of transfers in rapid succession.
IHT is charged on what a donor loses. If the donor pays the IHT on a lifetime gift he loses both the asset given away and the money with which he paid the tax due on it. Grossing up is required.
If an asset falls in value between a lifetime gift and death, fall in value relief reduces the death tax payable. The relief affects the tax on the transfer concerned. It does not reduce the value of the gross chargeable transfer for the purpose of computing later IHT.

Chapter roundup

Quick quiz

  • What is a transfer of value?
  • Who is chargeable to inheritance tax?
  • What is the effect of property being excluded property?
  • What types of transfer by an individual are potentially exempt transfers?
  • To what extent may unused annual exemption be carried forward?
  • Don gives some money to his daughter on her marriage. What marriage exemption is applicable?
  • Which lifetime transfers may lead to tax being charged on death of the transferor?
  • Why must some lifetime transfers be grossed up?
  • What is taper relief?

Answers to quick quiz

  • A transfer of value is any gratuitous disposition by a person resulting in a diminution of the value of his estate.
  • Individuals and trustees.
  • Excluded property is ignored for IHT purposes.
  • A potentially exempt transfer is a lifetime transfer made by an individual to another individual.
  • An unused annual exemption can be carried forward one tax year.
  • The marriage exemption for a gift to the transferor’s child is £5,000.
  • An IHT charge on death arises on PETs and CLTs made within seven years of the transferor’s death.
  • Where the donor pays the lifetime tax due it must be grossed up to calculate the total reduction in value of the estate.
  • Taper relief reduces death tax where a transfer is made between three and seven years before death.

 

 

Number Level Marks Time
Q17 Introductory 16 31 mins

 

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