Inheritance tax (IHT) is a tax on the transfer of value from an individual’s estate to others. Where the individual is UK domiciled, the charge is on their worldwide estate, non-UK domiciled individuals are subject to IHT on their UK estate only. Domicile is a complicated matter and is extremely difficult to change, we do not have scope to discuss it in this article, but more information can be found here.
A charge to IHT will principally arise on an estate following an individual’s death (40%). However, it can also apply to certain lifetime transfers, such as when assets are transferred to a trust (20/25%).
Contrary to popular belief, IHT is chargeable on the person making the gift (although it is typically paid by the beneficiaries of inherited assets). The same can usually be said for gifts made within the person’s lifetime. IHT is calculated with reference to the reduction in the value of the person’s estate, which is not always the same as the standalone value as the asset. Take shares for example, if an 80% shareholder transfers 25% of their holding a third party, the difference in value between and 80% and 60% shareholding is vastly different to a 20% shareholding due to the control (or lack thereof) one has over the company in each scenario.
Chargeable Lifetime Transfers
Chargeable lifetime transfers (CLTs) are broadly those to discretionary or interest in possession trusts. After deduction reliefs and the available nil rate band, any excess is subject to a lifetime inheritance tax rate of 20% or 25% (dependent on whether the IHT is met by the donor or the trustees).
Potentially Exempt Transfers
A lifetime gift which is not exempt (see below) or classed as a CLT will be a potentially exempt transfer (PET) meaning it will not form part of the taxable death estate, provided the donor survives by seven years. If an individual dies within seven years, the PET is included in their estate for IHT purposes, although taper relief will be available after three years.
The Nil Rate Band
Each individual can transfer up to £325,000 without incurring a charge to IHT. Where, upon their death, a person transfers their main residence to their direct descendants they are entitled to an additional £175,000 in respect of that transfer. This additional Residence Nil Rate Band is tapered where the estate is valued in excess of £2 million.
Certain lifetime transfers are exempt, or partially exempt, and with enough forethought, can be a simple way to pass on wealth:
|Description||Annual Limit (£)|
|Any transfers to a UK domiciled spouse||Unlimited|
|Gifts to charity||Unlimited|
|Recurrent gifts out of excess income||Unlimited – but professional advice should be sought|
|An annual gift allowance||3000|
|Small gifts (per person)||250|
|Gifts on the occasion of marriage:|
|To any other person||1000|
In addition to the exemptions, reliefs are available on transfers qualifying for either Business Property Relief or Agricultural Property Relief. Depending on the nature of the asset, relief will be given at either 50% or 100% and is deducted before the NRB. There are qualifying conditions for both relief and advice should be sought if this something being considered.