Inheritance tax: valuation, reliefs and the death estate

Introduction
We started our study of IHT in the previous chapter with a look at which
transfers are exempt from IHT and the charge to IHT on lifetime transfers which
are, or become, chargeable.
This chapter opens with a section on how assets are valued. Pay particular
attention to the related property rules, which prevent one way of avoiding IHT.
Two of the reliefs described in this chapter, business property relief and
agricultural property relief, are very generous. If the conditions are satisfied,
assets can be exempted from IHT without any limit on the value of the assets.
These reliefs are meant to ensure that a family business or farm does not have to
be sold when an owner dies, but they also extend to non-family businesses and
farms.
Finally, we will see how to bring together all of a deceased person’s assets at
death, and compute the tax on the estate.
In the next chapter, we turn our attention to some additional aspects of IHT
including the overseas aspects and administration rules.

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:
D2 The liabilities arising on chargeable lifetime transfers and on the death of an individual 2
(c) The basic principles of computing transfers of value:
(i) Advise on the principles of valuation 3
(ii) Advise on the availability of business property relief and agricultural property relief 3
(d) The liabilities arising on chargeable lifetime transfers and on the death of an individual: 3
(iii) Advise on the tax liability arising on a death estate
(v) Advise on the operation of quick succession relief
(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 may be required to deal with advanced aspects of inheritance tax such as valuing overseas property and quick succession relief. These are covered in this Chapter.

Business and agricultural property reliefs are a new topic for P6. They are extremely valuable reliefs as they enable assets to be passed on tax free, and they are therefore likely to feature in IHT planning. You should note the withdrawal of the relief on lifetime transfers if the donee sells the property or ceases to use if for business or agricultural purposes. There is no such limitation for gifts on death. Another new topic is the reduced rate of IHT on the death estate where at least 10% of the net estate passes to charity.

Knowledge brought forward from earlier studies

The basic principles of valuation of assets for inheritance tax and computing inheritance tax on the death estate were covered in the F6 syllabus. The valuation of quoted shares is new at P6 level. 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 topic is:

Intellectual level
D2 The liabilities arising on chargeable lifetime transfers and on the death of an individual
(b) Understand and compute the tax liability on a death estate. 2

There are no changes in 2015/16 in the topics covered at F6 in 2014/15.

1 The valuation of assets for IHT purposes

There are special rules for valuing particular kinds of assets, such as quoted shares and securities. The related property rules prevent artificial reductions in value.

FAST FORWARD

1.1 The general principle

The value of any property for the purposes of IHT is the price which the property might reasonably be expected to fetch if sold in the open market at the time of the transfer.

Two or more assets can be valued jointly if disposal as one unit is the course that a prudent hypothetical vendor would have adopted in order to obtain the most favourable price: Gray v IRC 1994.

                                 1.2 Quoted shares and securities                                       12/13

The valuation of quoted shares and securities is easy: the Stock Exchange daily official list gives the closing bid and offer prices of all quoted securities. Inheritance tax valuations are done by taking the lower of:

  • The value on the quarter up basis.
  • The average of the highest and lowest marked bargains for the day, ignoring those marked at special prices.

Exam focus         Note the difference between the valuation of quoted shares for capital gains tax purposes and inheritance point      tax purposes.

The transfer may take place on a day on which the Stock Exchange is closed, in which case the valuation is done on the basis of the prices marked on the last previous day of business or the first following day of business. The lowest of, in this case, the four alternatives will be taken.

Valuations for transfers on death must be cum dividend or cum interest, including the value of the right to the next dividend or interest payment. However, if the question gives an ex dividend or an ex interest price and the transfer is on death then the valuation is done on the basis of adding the whole of the impending net dividend, or the whole of the impending interest payment net of 20% tax.

Exam focus         If a question just gives a closing price you may assume that it is the cum dividend or cum interest price. point

For lifetime transfers, the Stock Exchange list prices are used without adjustment, whether they are cum or ex dividend or interest.

1.3 Example: securities quoted ex interest

If someone owned £10,000 12% Government stock (interest payable half yearly) quoted at 94-95 ex interest, the valuation on death would be as follows.

£                                                                                                                                         £

£10,000 at 94.25 (quarter up rule)                                                                                                                                                                    9,425

Add ½  12%  £10,000               600                     Less income tax at 20%     (120)

   480

9,905

1.4 Unquoted shares and securities

There is no easily identifiable open market value for shares in an unquoted company. Shares and Assets Valuation at HMRC is the body with which the taxpayer must negotiate. If agreement cannot be reached, an appeal can be made to the Tax Tribunal.

1.5 Unit trusts

Units in authorised unit trusts are valued at the managers’ bid price (the lower of the two published prices).

1.6 Life assurance policies

Where a person’s estate includes a life policy which matures on his death, the proceeds payable to his personal representatives must be included in his estate for IHT purposes. But where a person’s estate includes a life policy which matures on the death of someone else, the open market value must be included in his estate.

If an individual writes a policy in trust, or assigns a policy, or makes a subsequent declaration of trust, the policy proceeds will not be paid to his estate but to the assignee or to the trustees for the trust beneficiaries. The proceeds will, therefore, not be included as part of his free estate at death. It is common to write policies in trust for the benefit of dependants to avoid IHT. If the individual continues to pay the premiums on such policies, each premium constitutes a separate transfer of value. However, in many cases these transfers will be exempted as normal expenditure out of income.

1.7 Overseas property

The basis of valuation is the same as for UK property. The value is converted into sterling at the exchange rate (the ‘buy’ or ‘sell’ rate) which will give the lower sterling equivalent. Overseas debts are deductible.

If the property passes on death, the costs of administering and realising overseas property are deductible up to a maximum of 5% of the gross value of the property, so far as those expenses are attributable to the property’s location overseas. Capital taxes paid overseas which are the foreign equivalent of IHT may give rise to double taxation relief (see later in this Text). Such taxes are given as a credit against the IHT payable; they do not reduce the value of the asset.

                                 1.8 Related property                                                     12/11, 6/13

FAST FORWARD

Related property must be valued as a proportion of the value of the whole of the related property if this produces a higher value than the stand alone value.

Key term             Property is related to that in a person’s estate (related property) if:

  • It is included in the estate of his spouse/civil partner, or
  • It has been given to a charity, political party, national public body or housing association as an exempt transfer by either spouse or civil partner and still is, or within the preceding five years has been, the property of the body it was given to.

To reduce the value transferred individuals might fragment an asset into several parts which are collectively worth less than the whole. This way of reducing the value of an asset or set of assets is normally prevented using the diminution in value principle. However, this application of the principle could be thwarted by use of exempt inter-spouse/civil partner transfers. To deter this method of avoiding IHT, there are provisions under which related property is taken into account.

Property which is related to other property must be valued as a proportion of the value of the whole of the related property but only if, by so doing, a higher value is produced. For example, where a husband and wife each hold 40% of the issued shares of a company, the husband’s holding will normally be valued as a proportion (one half) of the price which an 80% shareholding would fetch, as an 80% interest would normally be more valuable than two 40% interests.

1.9 Example: related property

Lenny has a leasehold interest in a property. The value of his interest is £25,000. His wife Mandy holds the freehold reversion of the property, which has a market value of £40,000. The value of the freehold not subject to the lease (that is the value of the freehold reversion plus the lease) is £80,000. If Lenny wishes to transfer his interest to their daughter Sarah the value transferred will be the greater of:

  • The value of the interest by itself, £25,000, and
  • The value of his part of the total related property, which is

The value of the property transferred                 The value at its unrelated value                    of the

The value of the property transferred at            +             The value of any related property      whole its unrelated value at its unrelated value     property

 £80,000 = £30,769.

The higher value is £30,769. This is therefore the value transferred by Lenny.

If the property in question is shares, then in arriving at the fraction set out above, the numbers of shares held are used instead of unrelated values.
Exam focus point
 

Question Valuation of shares
Shares in an unquoted company are held as follows. Number of shares
Husband (H) 4,000
Wife (W) 2,000
Son (S) 750
Shares given by H to a charity by an exempt transfer eight years ago   (and still owned by the charity) 3,250

10,000

Estimated values for different sizes of sharehol

Number of shares

ding are as follows.

Pence per share

£
750 60 450
2,000 90 1,800
4,000 130 5,200
7,250 200 14,500
            9,250                                                                    250

What is the value of H’s holding, taking into account related property?

23,125
Answer

 

There are three related holdings.

Shares

H                                                                                                                                4,000

W                                                                                                                               2,000

Charity                                                                                                                      3,250

9,250

The value of H’s 4,000 shares is  £23,125 = £10,000 (ie 250 pence  4,000 shares).

If in the above exercise H gives away half of his holding to his son, the transfer of value is as follows.

£
Holding before transfer (as above) 10,000
Less holding after transfer

 £14,500                                                                                                 (4,000)

Transfer of value                                                                                                     6,000

If H transferred all his shares the value transferred would be £10,000 (no holding after, so no value in the calculation performed above).

                                 2 Business property relief (BPR) 6/11, 6/13, 6/14

 

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.

FAST FORWARD

BPR can reduce the values of assets by 100% or 50%. However, there are strict conditions, which are largely intended to prevent people near death from obtaining the reliefs by investing substantial sums in businesses.

2.1 Business property

BPR is applied to the value of relevant business property transferred, to prevent large tax liabilities arising on transfers of businesses.

Relevant business property is:

  • Property consisting of a business or an interest (such as a partnership share) in a business
  • Securities of a company which are unquoted and which (alone or with other securities or unquoted shares) gave the transferor control of the company immediately before the transfer (control may be achieved by taking into account related property)
  • Any unquoted shares (not securities) in a company
  • Shares in or securities of a company which are quoted and which (alone or with other such shares or securities) gave the transferor control of the company immediately before the transfer (control may be achieved by taking into account related property)
  • Any land or building, machinery or plant which, immediately before the transfer, was used wholly or mainly for the purposes of a business carried on by a company of which the transferor then had control, or by a partnership of which he was then a partner

Shares or securities listed on the AIM sub-market of the London Stock Exchange count as unquoted.

The reliefs available are percentage reductions in the value transferred: 100% for assets within Paragraph (a), (b) or (c) above, and 50% for assets within Paragraph (d) or (e) above.

2.2 Conditions for BPR

BPR is only available if the relevant business property:

  • was owned by the transferor for at least the two years preceding the transfer, or
  • replaced other relevant business property (which includes agricultural property used in a farming business) where the combined period of ownership of both sets of property was at least two out of

the last five years. In this situation relief is given on the lower of the values of the two sets of property.

If the property was inherited, it is deemed to have been owned from the date of the death unless it was inherited from the transferor’s spouse or civil partner, in which case the transferor is deemed to have owned it for the period the spouse or civil partner owned it.

BPR is still available even if the transferor cannot fulfil either of the two year ownership criteria if when he acquired the property it was eligible for BPR and either the previous or this current transfer was made on death.

2.3 Additional conditions for BPR on lifetime transfers

If, as a result of the donor’s death within seven years of a gift, a PET becomes chargeable or additional tax is due on a CLT, two further conditions must be fulfilled for BPR to be available.

  • The donee must still own the original property at the date of the donor’s death, or the donee’s death if earlier.
  • The original property must still qualify as relevant business property at the date of the donor’s death, or the donee’s death if earlier.

These conditions are fulfilled if the donee disposed of the original property but reinvested all of the disposal proceeds in replacement property within three years of the disposal.

2.4 Non-qualifying businesses

BPR is not available if the business consists wholly or mainly of:

  • Dealing in securities, stocks and shares (except for discount houses and market makers on the Stock Exchange or on LIFFE)
  • Dealing in land or buildings
  • Making or holding investments (including land which is let)

Shares in holding companies, where the subsidiaries have activities which would qualify shares in them for BPR, are eligible for relief.

2.5 Excepted assets

Relevant business property excludes assets which were neither used wholly or mainly for the purposes of the business in the two years preceding the transfer nor required at the time of the transfer for future use in the business.

For shares or securities in a company, the value which we compute BPR on (at 100% or 50%) is:

the company’srelevantbusinessproperty

Total value 

the company’s total assets before deducting liabilities

Formula to learn
2.6 Contracts for sale

BPR is not available if at the date of transfer there is a binding contract for the sale of a business or an interest in a business, unless the sale is to a company which will continue the business and the consideration is wholly or mainly shares or securities in the company.

BPR is not available if at the date of the transfer there is a binding contract for the sale of shares or securities of a company unless the sale is for the purpose of reconstruction or amalgamation.

If any other relevant business property is subject to a binding contract for sale, BPR is not available on it at all.

Partnership agreements often contain a buy/sell clause under which surviving partners must buy a deceased partner’s share in the partnership. HMRC regard such a clause as a binding contract for sale which disentitles the deceased partner to BPR. However, neither an accruer clause whereby the deceased partner’s share accrues to the surviving partners, nor an option for the surviving partners to buy the deceased partner’s share is regarded as binding contract for sale. This means that from a tax planning point of view the latter types of arrangement should be used.

On 31 July 2015 relevant business property valued at £16,800 is transferred to a trust. Assuming that the 2014/15 and 2015/16 annual exemptions have not been used what will the chargeable transfer be if:

  • The property consists of unquoted shares?
  • The property consists of land used by a company in which the transferor has a controlling interest?
  • The property consists of quoted shares which formed part of a 20% interest before the transfer?
(a) (b) (c)
£ £ £
Value transferred 16,800 16,800 16,800
Less BPR (16,800) (8,400)          0
0 8,400 16,800
Less: AE 2015/16 (3,000) (3,000)

2014/15 b/f                       ((3,000) ) Chargeable transfer                  0          2,400

J had shares in a quoted trading company, J plc. The shares in the company were held as follows.

%

J                                                                                                                                      40

J’s wife                                                                                                                            30

Other unconnected persons  30        100

The shareholdings have been unchanged since 2002. On 1 May 2015 J gave a 30% holding to his son. The values of the shares in May 2015 were agreed as follows.

£
70% holding 1,600,000
40% holding 900,000
30% holding 840,000
10% holding 200,000

J, who had made a previous chargeable lifetime transfer of £350,000 in 2008, died in January 2016.

Calculate the IHT arising on the gift of the shares, if

  • J’s son still holds the shares in January 2016
  • J’s son sells the shares in June 2015 and retains the cash proceeds.

 

No IHT arises when the gift was made, because it was a PET. It becomes chargeable as a result of J’s death within seven years as follows.

PET – May 2015

  • If J’s son still holds the shares, BPR at 50% is available to reduce the chargeable transfer:

£

Before:        40%        £1,600,000                                                         914,286

40%+30%

10%+ 30% (225,000)
689,286
Less BPR at 50% (control (with related property) of quoted company) (344,643)
344,643
Less: AE 2015/16 (3,000)
        AE 2014/15 b/f    (3,000)
Chargeable transfer 338,643

After:        10%        £900,000

Gross chargeable transfers in the seven years before May 2015 amount to £350,000. This means none of the nil band remains and IHT payable on death amounts to:

IHT at 40% = £135,457

  • If J’s son does not hold the shares on J’s death, BPR is not available to reduce the value of the chargeable transfer: £

Transfer (see above)                                                                                689,286

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

Chargeable transfer                                                                                 683,286

IHT @ 40% = £273,314

3 Agricultural property relief (APR) 6/12

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.

FAST FORWARD

APR usually reduces a transfer of agricultural property by 100% of agricultural value.

3.1 Agricultural property

APR is available on the agricultural value of agricultural property.

Agricultural property is agricultural land or pasture (including short rotation coppice) situated in the UK, the Channel Islands, the Isle of Man or a country other than the UK which is in the European Economic Area at the time of the transfer. It includes woodland and any building used in connection with the intensive rearing of livestock or fish where the occupation of the woodland or building is ancillary to that of the land or pasture. It also includes cottages, farm buildings and farm houses of a character appropriate to the property. Exam focus         The agricultural value will be given to you in the exam.

point

APR works like BPR in reducing the value being transferred by a certain percentage before any exemptions. APR is given before BPR and double relief cannot be obtained on the agricultural value. If

the non-agricultural part of the value of the property meets the relevant business property conditions, however, BPR will be available on that value. The percentage reduction in agricultural value is, in general, 100% (it is 50% on some land held under pre-September 1995 tenancies).

3.2 Conditions for relief

For relief to apply the transferor must either:

  • Own the property and have occupied it themselves for the purpose of agriculture for the two years before the transfer (ie they farm the land themselves), or
  • Own the property for at least the seven years before the transfer, during which it must have been occupied for the purposes of agriculture by either the transferor or a tenant (ie the property is or has been let out).

If a company controlled by the transferor occupies the property the transferor is treated as occupying it. A farmhouse which is being redecorated, renovated or altered is not treated as though it is occupied for agricultural purposes.

If the property transferred replaces other agricultural property, the condition will be satisfied provided that:

  • The transferor has occupied the properties for the purposes of agriculture for at least two out of the last five years, or
  • The transferor has owned the properties (and somebody has occupied them for agricultural purposes) for at least seven out of the last ten years.

If agricultural properties have been replaced the APR will apply only to the lowest of the values of the various properties considered.

If the property transferred was acquired on the death of the transferor’s spouse or civil partner then the period of ownership or occupation of the first spouse or civil partner can count towards the seven years or the two years required. If the property transferred was acquired on the death of somebody else the transferor will be deemed to own it from the date of death and if he subsequently occupies it, to have occupied it from the date of death.

APR is still available even if the transferor cannot fulfil any of the two or seven year ownership criteria if when he acquired the property it was eligible for APR and either the previous or this current transfer was made on death.

3.3 Additional conditions for lifetime transfers

If, as a result of the donor’s death within seven years of a gift, a PET becomes chargeable or additional tax is due on a CLT, two further conditions must be fulfilled for APR to be available.

  • The donee must still own the original property at the date of the donor’s death, or the donee’s death if earlier.
  • The original property must still qualify as agricultural property immediately prior to the date of the donor’s death, or the donee’s death if earlier, and must have been occupied as such since the original transfer.

These conditions are fulfilled if the donee disposed of the original property but reinvested all of the disposal proceeds in replacement property within three years of the disposal.

3.4 Shares in companies owning agricultural property

If a company owns agricultural property and satisfies the occupation or ownership conditions above then APR is available in respect of the agricultural value that can be attributed to shares or securities transferred by an individual who controls the company. The shares or securities must have been held by the transferor for the relevant period (two years or seven years).

On 13 June 2015 Kevin gives his shares in Farm Ltd to his son. Kevin owns 65% of the shares in issue, with an agreed value of £400,000. Kevin has owned the shares for nine years. The company has owned and occupied farmland (for agricultural purposes) for the last eight years. The agricultural value of this land represents 20% of the total value of the company’s net assets.

Calculate the chargeable transfer assuming that Kevin dies on 14 July 2016 and the son still holds the shares at the date of his father’s death.

 

Unquoted trading company shares                                                                                 £

Value of holding                                                                                                  400,000

Less: APR 100%  20%  £400,000 (on agricultural value)                           (80,000)

BPR 100%  80%  £400,000 (on balance)                                        (320,000)

Chargeable transfer                                                                                                        0

3.5 Contracts for sale

No APR is available if, at the time of the transfer, a binding contract for sale of the agricultural property exists unless the sale is to a company (the consideration being wholly or mainly shares or securities which will give the transferor control), or is to enable a reorganisation or reconstruction of a farming company.

                                 4 The death estate                    12/12, 12/14, 9/15

FAST FORWARD

When someone dies, we must bring together all their assets to find the value of their death estate.

4.1 Composition of death estate

An individual’s death estate consists of all the property he owned immediately before death, with the exception of excluded property. The estate also includes anything acquired as a result of death, for example the proceeds of a life assurance policy.

The estate at death may include:

  • Free estate (assets passing by will or intestacy).
  • Property given subject to a reservation. This is property given away before death, but with strings attached (see next chapter). For example, someone might give away a house but continue to live in it.

The primary responsibility for payment of tax depends on the type of property:

  • Tax on the free estate is payable by the personal representatives (PRs) (executors or administrators).
  • Tax on property given subject to a reservation is payable by the person in possession of the property.

The whole of the death estate will be chargeable to tax, subject to reliefs (such as BPR and APR) and any exemptions which may be available on death. In particular, if property passes to the deceased person’s spouse this will be an exempt transfer. A transfer to any other person eg children, will be chargeable to IHT, whether this is made outright or to any type of trust.

In order to calculate the tax on the death estate, use the following steps:

Step 1    Look back seven years from the date of death to see if any CLTs or PETs which have

become chargeable have been made. If so, these transfers use up the nil rate band available for the death estate. Work out the value of any nil rate band still available.

Step 2     Compute the gross value of the death estate (see further below).

Step 3   Any part of the death estate covered by the nil rate band is taxed at 0%. Any part of the

death estate not covered by the nil rate band is charged at 40%. Deduct relevant reliefs from the death tax (eg quick succession relief – see below)

Step 4       Where relevant divide the tax due between PRs and the person in possession of a gift subject to a reservation.

Usually, it will not be necessary to consider grossing up. The situation where it will be needed is dealt with below.

Laura dies on 1 August 2015, leaving a free estate valued at £400,000 consisting of quoted shares and cash to a discretionary trust for her children. Laura had made a transfer of value of £163,000 to her sister on 11 September 2014. The amount stated is after all exemptions and reliefs.

Compute the tax payable by Laura’s personal representatives.

 

Death tax

Note. There is no death tax on the September 2014 PET which becomes chargeable as a result of Laura’s death, as it is within the nil rate band at her death. However, it will use up part of the nil rate band, as shown below.

Step 1          Lifetime transfer of value of £163,000 in seven years before 1 August 2015 (transfers after 1 August 2008). Nil rate band of £(325,000 – 163,000) = £162,000 available.

Step 2      Value of death estate is £400,000.

                                 Step 3

IHT

£

£162,000  0%                                                                                      0

 40%                                                                                  95,200

95,200

Step 4       Tax payable by personal representatives                                   £95,200

Death estate £ £
Personalty
Stocks and shares X
Insurance policy proceeds X
Personal chattels X
Cash X
X
Less debts due by deceased X
          funeral expenses X
(X)
X
Realty
Freehold property (keep UK and foreign property separate) X
Less mortgages (X)
X
Net estate X
Gifts with reservation X
Chargeable estate X

The computation of an individual’s chargeable estate at death should be set out as follows.

4.2 Debts and funeral expenses
  • Debts incurred by the deceased can be deducted if they can be legally enforced as they are either imposed by law or they are a debt for which the deceased received consideration. Specific examples of the application of these rules include:

Taxes – deductible as imposed by law.

  • Electricity and gas bills – deductible as incurred for consideration.
  • Gambling debts – deductible if relates to legal gambling (eg in a licenced casino or betting shop), not deductible if relates to illegal gambling or any gambling in Northern Ireland as not legally enforceable.
  • Promise to pay an amount to a relative – not deductible as no consideration received.
  • Oral agreement for sale of interest in land – not deductible as not legally enforceable since contracts for such sales must be evidenced in writing.
  • Debts incurred by the deceased but payable after the death may be deductible under the above rules, but the amount should be discounted because of the future date of payment.
  • Rent and similar amounts which accrue day by day should be accrued up to the date of death.
  • If a debt is charged on a specific property it is deductible primarily from that property. For example, a mortgage secured on a house is deductible from the value of that house.

This does not include endowment mortgages as these are repaid upon death by the life assurance element of the mortgage.

Repayment mortgages and interest-only mortgages are deductible (although there may be separate life assurance policies which become payable at death and which will effectively cancel out the mortgage).

Reasonable funeral expenses may also be deducted:

  • What is reasonable depends on the deceased’s condition in life.
  • Reasonable costs of mourning for the family are allowed. (c) The cost of a tombstone is deductible.

Zack died on 19 June 2015. His estate consisted of the following.

10,000 shares in A plc, quoted at 84p – 89p with bargains marked at 85p, 87p and 90p

8,000 shares in B plc, quoted ex div at 111p – 115p. A net dividend of 4p per share was paid on 21 July 2015.

Freehold property valued at £150,000 subject to a repayment mortgage of £45,040 Liabilities and funeral expenses amounted to £2,450.

Zack had made a chargeable lifetime transfer of £340,000 in July 2010. Calculate the IHT liability on the death estate.

Free estate
Personalty £ £
A plc shares
                       10,000 at lower of 85.25p and 87.5p
                       10,000  85.25p 8,525
B plc
                        8,000  112p 8,960
                       Net dividend 8,000  4p      320
   9,280
17,805
Less debts and funeral expenses (2,450)
15,355
Realty
                       Freehold property 150,000
                        Less mortgage (45,040)

 

Chargeable estate                                                                                                

Chargeable transfers in the seven years prior to death exceeded the nil band, so IHT on the death estate is £120,315 at 40% = £48,126.

                                 4.3 Transfer of unused nil rate band                                 12/11
 

One of the competencies you require to fulfil Performance Objective 17 Tax planning and advice of the PER is to review the situation of an individual or entity advising on any potential tax risks and/or additional tax minimisation measures. You can apply the knowledge you obtain from this section of the text to help to demonstrate this competence.

4.3.1 How the transfer of unused nil rate band works

If:

  • an individual (“A”) dies; and
  • A had a spouse or civil partner (“B”) and A and B were married or in a civil partnership immediately before B’s death; and
  • B had unused nil rate band (wholly or in part) on death;

then a claim may be made to increase the nil rate band maximum at the date of A’s death by B’s unused nil rate band in order to calculate the IHT on A’s death. The revised nil band will apply to the calculation of additional death tax on CLTs made by A, PETs made by A and death tax on A’s death estate.

The transfer of the nil rand band between spouses was tested in December 2011 Question 4 Surfe. The examiner commented that ‘the majority of candidates identified the availability of the husband’s nil rate band.’

Exam focus point

4.3.2 Example

Robert and Claudia were married for many years until the death of Robert on 10 April 2015 leaving an estate of £500,000.

In his will, Robert left £100,000 to his sister and the remainder of his estate to Claudia. He had made no lifetime transfers.

Claudia died on 12 January 2016 leaving an estate (including the assets passed to her by Robert) of £850,000 to her brother. Claudia had made a chargeable lifetime transfer of £50,000 in 2013.

The inheritance tax payable on the death of Claudia, assuming that a claim is made to transfer Robert’s unused nil rate band, is calculated as follows:

Step 1 (a)          Lifetime transfer of value of £50,000 in seven years before 12 January 2016 (transfers after 12 January 2009).

(b)          Nil rate band at death is £325,000. Nil rate band is increased by claim to transfer Robert’s unused nil rate band at death £(325,000 – 100,000) = £225,000. The maximum nil rate band at Claudia’s death is therefore £(325,000 + 225,000) = £550,000 and the available nil rate band is £(550,000 – 50,000) = £500,000.

Step 2

Step 3

Value of death estate is £850,000.

                                                                                                     IHT

£

£500,000  0%                                                                                                            0

 40%                                                                                 140,000

140,000

Step 4     Tax payable by personal representatives                                 £140,000

Note that the legacy to Robert’s sister was a chargeable death transfer but that the gift of the rest of the estate to Claudia was exempt under the spouse exemption.

4.3.3 Changes in nil rate band between deaths of spouses/civil partners

If the nil rate band increases between the death of B and the death of A, the amount of B’s unused nil rate band must be scaled up so that it represents the same proportion of the nil rate band at A’s death as it did at B’s death.

For example, if the nil rate band at B’s death was £300,000 and B had an unused nil rate band of £90,000, the unused proportion in percentage terms is therefore 90,000/300,000  100 = 30%. If A dies when the nil rate band has increased to £325,000, B’s unused nil rate band is £325,000  30% = £97,500 and this amount is transferred to increase the nil rate band maximum available on A’s death.

The increase in the nil rate band maximum cannot exceed the nil rate band maximum at the date of A’s death eg if the nil rate band is £325,000, the increase cannot exceed £325,000, giving a total of £650,000.

Jenna and Rebecca were civil partners until the death of Jenna on 19 August 2007.

Jenna made no lifetime transfers. Her death estate was £440,000 and she left £200,000 to Rebecca and the remainder to her mother.

Rebecca died on 24 February 2016. Her death estate was £550,000 (including the assets passed to her by Jenna) and she left her entire estate to her nephews and nieces. She had made no lifetime transfers.

You are required to calculate the inheritance tax payable on the death of Rebecca, assuming that any beneficial claims are made.

Answer

 

Step 1       (a)    No lifetime transfers of value in seven years before 24 February 2016.

(b)       Nil rate band at death is £325,000. Nil rate band is increased by claim to transfer Jenna’s unused nil rate band at death. The nil rate band at Jenna’s death in August

2007 was £300,000. Unused proportion was £(300,000 – 240,000) =

60,000/300,000  100 = 20%. The adjusted unused proportion is therefore £325,000 x 20% = £65,000. The maximum nil rate band at Rebecca’s death is therefore £(325,000 + 65,000) = £390,000 and this is also the available nil band.

Step 2      Value of death estate is £550,000.

Step 3

                                                                                          IHT

£

£390,000  0%           0  40%             64,000

64,000

Step 4 Tax payable by personal representatives £64,000

4.3.4 Claim

The claim to transfer the unused nil rate band is usually made by the personal representatives of A. The time limit for the claim is two years from the end of the month of A’s death (or the period of three months after the personal representatives start to act, if later) or such longer period as an officer of HMRC may allow in a particular case.

If the personal representatives do not make a claim, a claim can be made by any other person liable to tax chargeable on A’s death within such later period as an officer of HMRC may allow in a particular case.

4.4 Reduced rate on death estate                           12/14, 9/15

FAST FORWARD

The rate of inheritance tax on a death estate is reduced to 36% if at least 10% of the estate is left to charity.

We saw earlier in this Text, that gifts to charities are exempt. To encourage more people to leave gifts to charity on their death, there is also a reduced rate of inheritance tax (36%, rather than 40%) available on the remaining death estate if an individual leaves at least 10% of his net estate to charity.

There are therefore two benefits of leaving such a legacy – the donated part of the estate is exempt and the remainder is charged at a lower rate of IHT.

For the purpose of determining whether the 10% condition is met, the net estate is calculated as the assets owned at death as reduced by liabilities, exemptions, reliefs and the available nil rate band, but before the charitable legacy itself is deducted. However the inheritance tax itself is then charged (at 36%) on the usual death estate (ie after the legacy has been deducted).

Margie died on 1 September 2015. The assets in her estate are valued at £380,000, and she had made a gross chargeable transfer of £100,000 in 2010. In her will she left £20,000 to charity and the rest of her estate to a trust for her children. Calculate the inheritance tax payable on her death estate.

 

First, work out whether the reduced rate of IHT applies, as follows.

£

Death estate (before deduction of charitable legacy)                                       380,000

Less: available nil rate band £(325,000 – 100,000)                                        (225,000)

Net estate                                                                                                            155,000

£
Death estate 380,000
Less charitable legacy (20,000)
Chargeable estate 360,000
IHT
£225,000  0% 0
£135,000  36% 48,600
£360,000
IHT payable on death estate 48,600

10% of £155,000 is £15,500, so the legacy of £20,000 is at least 10% of the net estate and therefore the reduced rate of 36% applies.

The calculation can become complicated where there are assets owned jointly with other people or assets held on trust but the examination team has stated that the reduced rate will only be examined where all of the assets are 100% owned by the deceased.  

Exam focus point

A variation of the will (see later in this Text) may be entered into after the death of an individual in order to increase the amount given to charity, such that the estate then qualifies for the reduced rate. Although the gross value of the remaining estate is then lower for the other beneficiaries of the will, the reduced rate of IHT on this lower amount may outweigh the cost of the increased gift to charity and increase the net assets passing to other beneficiaries.

4.5 Example

Barry died on 1 July 2015 leaving a gross chargeable estate valued at £860,000. In his will, he left a donation of £60,000 to charity and the rest of his estate to his son, Trig. Barry’s available nil rate band at his death was £170,000.

Barry’s net estate for the purposes of working out whether the reduced rate applies is £(860,000 – 170,000) = £690,000. Therefore at least 10% × £690,000 = £69,000 must be left to charity for the reduced rate of IHT to apply to the death estate.

The reduced rate is not available because Barry’s charitable donation is less than £69,000. The inheritance tax on Barry’s death estate is therefore £(860,000 – 60,000 – 170,000) = £630,000 × 40% = £252,000. Trig will received net assets of £(860,000 – 60,000 – 252,000) = £548,000.

However, a variation of the will could be used to increase the charitable donation by £9,000 to £69,000. This would reduce the inheritance tax liability to £(860,000 – 69,000 – 170,000) × 36% = £223,560. This is a saving of £252,000 – £223,560 = £28,440 which is greater than the additional charitable donation. Trig will receive net assets of £(860,000 – 69,000 – 223,560) = £567,440.

5 Quick succession relief (QSR)

FAST FORWARD

Quick succession relief applies where there are two charges to IHT within five years.

If a person dies shortly after receiving property by way of a chargeable transfer the same property will be taxed twice within a short space of time: it will be taxed as the original chargeable transfer and it will be taxed again as part of the estate of the deceased transferee. QSR reduces the tax on the estate.

The tax on the estate is calculated normally. A credit is then given as follows.

net transfer

Tax paid on first transfer   percentage

gross transfer

Formula to learn

The percentage to use is as follows.

Period between the transfer and the death of the transferee Relief
%
1 year or less 100
1-2 years 80
2-3 years 60
3-4 years 40
4-5 years 20
Over 5 years 0

If the period is precisely two years, 80% relief is given, and so on.

The relief applies even where the asset has been disposed of before death.

Oscar died on 29 September 2015 leaving an estate valued at £385,000 to his son. Oscar had received £28,000 gross in July 2011 from his uncle’s estate. IHT of £4,200 had been payable by Oscar on this legacy.

Calculate the IHT payable on Oscar’s estate, assuming he has made no lifetime transfers.

 

£

IHT on £385,000 (£325,000 @ 0% + £60,000 @ 40%)                                       24,000

Less QSR: £4,200  (23,800/28,000)  20% (4-5 years)                                       (714)

IHT payable on Oscar’s estate                                                                              23,286

                                 6 Grossing up gifts on death                        6/14

Gross up specific gifts on death if the residue of the estate is left to an exempt recipient.

FAST FORWARD

We saw that grossing up applies to CLTs when the donor pays the IHT. We must also gross up on a death when there is a specific legacy (ie gift on death) of UK property, and the residue of the estate (ie what’s left of the estate after specific gifts have been paid out) is exempt. This can happen when the residue is left to a spouse/ civil partner or charity.

The reason for this is that the recipients of specific gifts of UK property do not pay the tax on the gift (unless this is specifically stated). Instead this must be borne by the residue of the estate – which is exempt. Specific gifts of foreign property, on the other hand, do bear their own tax (ie the recipient must pay any IHT) and do not need to be grossed up.

Do not gross up specific gifts if the whole estate is chargeable. In such cases, work out IHT as normal.

Specific gifts of UK property are given to the heirs in full (unless there is not enough residue to pay the IHT), and the IHT on those gifts comes out of the residue. In this case, the formula used to calculate the tax is as follows.

                                                                           rateof tax

Chargeable amount (in excess of the nil band)  ie

100minus therateof tax

Formula to learn

Rory dies on 29 May 2015 leaving an estate valued at £490,000. Included in this is a house in Manchester valued at £400,000 which he leaves to his son, Ian. He leaves the residue of the estate to his wife, Sonya.

Calculate the IHT liability arising on death assuming Rory has made no lifetime transfers.

 

There is an exempt residue and a specific gift of a UK asset. Therefore the specific gift must be grossed up:       IHT

£

£325,000 @ 0%               0  £75,000 @ 40/60

£400,000

The gross transfer is £(400,000 + 50,000) = £450,000.

Check tax £(450,000 – 325,000) = £125,000 @ 40% = £50,000.

Ian receives £400,000, HMRC receives £50,000.

The residue available to Sonya is £490,000  £450,000 = £40,000.

This calculation would not have applied if:

  • The residue of the estate had been chargeable rather than exempt, in which case IHT would have been calculated on a gross chargeable estate of £490,000 in the normal way, or
  • The will had left a specific gift of £90,000 to Sonya and the residue to Ian. In that case, Ian would have received £400,000 less tax of £(400,000  325,000)  40% = £30,000, giving him a net amount of £370,000 and Sonya would have received £90,000. This would be a tax saving of £20,000.

Chapter roundup

There are special rules for valuing particular kinds of assets, such as quoted shares and securities. The related property rules prevent artificial reductions in value.
Related property must be valued as a proportion of the value of the whole of the related property if this produces a higher value than the stand alone value.
BPR can reduce the values of assets by 100% or 50%. However, there are strict conditions, which are largely intended to prevent people near death from obtaining the reliefs by investing substantial sums in businesses.
APR usually reduces a transfer of agricultural property by 100% of agricultural value.
When someone dies, we must bring together all their assets to find the value of their death estate.
The rate of inheritance tax on a death estate is reduced to 36% if at least 10% of the estate is left to charity.
Quick succession relief applies where there are two charges to IHT within five years.
Gross up specific gifts on death if the residue of the estate is left to an exempt recipient.

Quick quiz

  • How are quoted securities valued?
  • What is related property?
  • What rate of BPR is given on a controlling shareholding in
    • a quoted trading company, and
    • an unquoted trading company?
  • What periods of ownership or occupation are required to obtain agricultural property relief?
  • How is quick succession relief calculated?
  • Sonia dies leaving the following debts:
    • Grocery bill
    • HM Revenue and Customs – income tax to death
    • Repayment mortgage on house (d)          Debt from illegal gambling

Which are deductible against her death estate and why?

  • Mark and Hilary had been married for many years. Mark died on 11 May 2015 leaving his estate to Hilary. He had made a chargeable lifetime transfer of £160,000 in July 2012. If Hilary dies in February 2016, what is the nil rate band maximum on her death?

Answers to quick quiz

  • The value is the lower of:
    • the value on the quarter up basis (bid price plus 1/4 of the difference between the bid and offer prices).
    • the average of highest and lowest marked bargains for the day (ignoring special price bargains).
  • Related property is property:
    • comprised in the estate of the transferor’s spouse, or
    • which has been given to a charity, political party, national public body or housing association as an exempt transfer by either spouse and still is, or has been within the past five years, been the property of the body it was given to.
  • (a) 50%

(b)       100%

  • For APR the transferor must have either:
    • owned and farmed the land themselves for two years before the transfer, or
    • owned the property for at least seven years before the transfer during which time it was farmed either by the transferor or a tenant.
  • QSR is calculated as:

net transfer

Tax paid on first transfer

gross transfer

  • (a) grocery bill – deductible as incurred for full consideration
    • income tax to death – deductible as imposed by law
    • repayment mortgage – deductible, will be set against value of house primarily
    • debt from illegal gambling – not deductible as not legally enforceable
  • Hilary’s nil rate band is £325,000. Mark’s unused nil rate band is £(325,000 – 160,000) = £165,000. The nil rate band maximum on Hilary’s death is therefore £490,000.
Number Level Marks Time
Q18 Examination 25 49 mins
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