Inheritance Tax

Most gifts made during a person’s life are not subject to tax at the time of the gift. These lifetime transfers are known as 'potentially exempt transfers' or 'PETs'. These gifts or transfers achieve their potential of becoming exempt if the taxpayer survives for more than 7-years after making the gift. If the taxpayer dies within 3-years of making the gift, then the inheritance tax position is as if the gift was made on death. A tapered relief is available if death occurs between 3 and 7 years after the gift is made.

The effective rates of tax on the excess over the nil rate band are:

• 0 to 3 years before death            40%
• 3 to 4 years before death            32%
• 4 to 5 years before death            24%
• 5 to 6 years before death            16%
• 6 to 7 years before death            8%
• 7 or more years before death       0%

These tapered rates cannot reduce the tax due on a lifetime chargeable transfer below the amount chargeable when the transfer was made and so are of no benefit to a transfer within the nil rate band.

We would strongly recommend that you keep a list of any PETs that you make. It is also important to keep a record of any exemptions that are used as well as details of any regular gifts made out of surplus income.

We wanted to remind you of the Inheritance Tax (IHT) implications of making cash gifts during the current 2023-24 tax year that will end on 5 April 2024.

You can give away up to £3,000 worth of gifts each tax year. This is known as your annual exemption. Any unused part of the annual exemption can be carried forward, but only for one year. So, if you did not make any cash gifts in 2022-23, you could gift up to £6,000 this tax year.

There are also generous exemptions for normal gifts made out of your income, but you must be able to maintain your standard of living after making the gift. There are also reliefs available for wedding or civil ceremony gifts. You can gift up to £1,000 per person with higher limits of £2,500 for a grandchild or great-grandchild, and £5,000 for a child.

You can also give as many small gifts of up to £250 per person as you want during the tax year but only if you have not used another exemption on the same person. There is no IHT to pay on lifetime gifts between you and your spouse or civil partner as long as you both live permanently in the UK.

Other gifts, outside these limits, count towards the value of your estate and should be carefully considered.

The majority of gifts made during a person's life, including gifting a home, are not subject to tax at the time of the gift. These lifetime transfers are known as 'potentially exempt transfers' or 'PETs'. These gifts or transfers achieve their potential of becoming exempt from Inheritance Tax (IHT) if the taxpayer survives for more than seven years after making the gift. There is a tapered relief available if the donor dies between three and seven years after the gift is made.

HMRC’s guidance suggests that if the person gifting the home wants to continue living in the property after giving it away, they need to:

• pay rent to the new owner at the going rate (for similar local rental properties);
• pay their share of the bills; and
• live there for at least 7 years.

However, the rules are different if the person making the gift retains some 'enjoyment' of the gift made. This could apply if a person gave their home to their children but continued to live in the home rent-free. Under these circumstances, the taxman would contend that the gift falls under the heading of a gift with reservation of benefit and the 'gift' would remain subject to IHT even if the taxpayer dies more than 7 years after the transfer.

The Inheritance Tax residence nil rate band (RNRB) is a transferable allowance for married couples and civil partners (per person) when their main residence is passed down to a direct descendent, such as children or grandchildren, after their death. 

The allowance increased to the present maximum level of £175,000 from 6 April 2020. Any unused portion of the RNRB can be transferred to a surviving spouse or partner. The RNRB is in addition to the existing £325,000 Inheritance Tax nil-rate band.

Taken together with the current Inheritance Tax limit of £325,000, this means that married couples and civil partners can pass on property worth up to £1 million free of Inheritance Tax to their direct descendants. 

The transfer does not happen automatically and must be claimed from HMRC when the second spouse or civil partner dies. This is usually done by the executor making a claim to transfer the unused RNRB from the estate of the spouse or civil partner that died first. This transfer can also happen even if the first spouse or civil partner died before the RNRB was introduced on 6 April 2017.

There is a tapering of the RNRB for estates worth more than £2 million even where the family home is left to direct descendants. The additional threshold will be reduced by £1 for every £2 that the estate is worth more than the £2 million taper threshold. This can result in the full amount of the RNRB being tapered away. 

The RNRB maximum rate of £175,000 and the taper threshold are currently frozen until at least April 2028.

A trust is an obligation that binds a trustee, an individual or a company, to deal with assets such as land, money and shares which form part of the trust. The person who places assets into a trust is known as a settlor and the trust is for the benefit of one or more 'beneficiaries'. The act of transferring an asset – such as money, land or buildings – into a trust is often known as ‘making a settlement’ or ‘settling property’. For Inheritance Tax (IHT) purposes, each asset has its own separate identity. 

HMRC’s manuals states the following when describing what is a trust:

The law of trusts is based upon the concept of English law that property rights can be split into:

• the legal ownership, and
• the beneficial interest.

A person who is the absolute owner of property has both the legal and beneficial interest in it. This means that the owner will show up as legal owner, for example, on a land register or on a company register, and will also enjoy any benefit produced by the property.

The absolute owner may split the legal interest from the beneficial enjoyment. This can be done by giving the legal ownership to trustees and the beneficial interest to a named beneficiary (or beneficiaries). Alternatively the owner can keep the legal title and make themselves a trustee.

The rules are complex and there are different types of trusts that need to be considered, such as a joint property or bare trust.

A reduced rate of Inheritance Tax (IHT) of 36% (reduced from 40%) applies where 10% or more of a deceased’s net estate is left to charity. The lower rate applies where 10% or more of the ‘net value’ of the estate is left to charity.

The current IHT nil rate band is £325,000 per person, below which no Inheritance Tax is payable. Any unused nil rate band can usually be transferred to a surviving spouse or civil partner.

HMRC also have a calculator tool that will help work out the charity donation required to qualify for the reduced rate and will check whether an existing bequest is sufficient to qualify for the reduced rate. The calculator can be found at www.hmrc.gov.uk/tools/iht-reduced-rate/calculator.htm

In order to use the calculator, you will need to know:

• the value of the assets in the estate;
• how the assets are owned;
• the total value of the assets in each part of the estate (‘component’);
• the value of any debts and liabilities that must be paid out of the estate;
• the amount of any Inheritance Tax relief and exemptions;
• the amount of any charitable donations already made;
• the value of the threshold (‘nil rate band’); and
• the value of gifts the deceased made in the 7 years before death.

A gift smaller than 10% can also be left to charity in your Will. If this is the case, the charitable donation will be taken off the value of your estate before IHT is calculated.

The donation to charity can be a fixed amount, an item or the balance of what’s left after other gifts have been distributed.

It is important to make a Will to ensure that your estate is divided amongst your beneficiaries in accordance with your wishes. If you do not leave a Will the law decides who inherits the estate. This can result in a distribution of assets that would not have been in line with your wishes and can be especially problematic for cohabitees (a couple who live together but are not married and have not entered into a civil partnership).

HMRC’s internal manual lists the following characteristics of a valid Will:

• must be in prescribed form that satisfies all the formalities;
• operates only as declaration of intention and does not prevent a testator or testatrix from disposing during their lifetime of assets which may have been allocated to someone in the will;
• takes effect only on death and until that time the beneficiaries have no interest in the assets;
• may not only deal with dispositions of assets, for example, it may appoint a guardian of minors or give directions on burial or cremation arrangements;
• can be revoked or altered at any time before the testator/testatrix dies; and
• is ambulatory, that is to say it is capable of dealing with property acquired after it was made (provided the property is still owned by the testator at death).

It should be noted that even when a valid Will is in place, arguments between family members, beneficiaries or personal representatives can arise. Any disagreements must be sorted out before the affairs of the person who died can be settled. This can sometimes be so contentious that it has been left to the Courts to decide if a Will made by a deceased person was valid or invalid.

A Will can also be changed after death. This can be done by what is known as a Deed of Variation for up to two years from the date of death and is most often contemplated to reduce Inheritance Tax liability. A Deed of Variation can only be executed with the agreement of all the beneficiaries. It is more complicated if children are involved as they cannot themselves consent to changes.

The Inheritance Tax residence nil rate band (RNRB) is a transferable allowance for married couples and civil partners (per person) when their main residence is passed down to a direct descendent such as children or grandchildren after their death. 

The allowance increased to the present maximum level of £175,000 from 6 April 2020. The allowance is available to the deceased person’s children or grandchildren. Any unused portion of the RNRB can be transferred to a surviving spouse or partner. The RNRB is in addition to the existing £325,000 Inheritance Tax nil-rate band.

The allowance is available to the deceased person's children or grandchildren. Taken together with the current Inheritance Tax limit of £325,000 this means that married couples and civil partners can pass on property worth up to £1 million free of Inheritance Tax to their direct descendants. 

The transfer does not happen automatically and must be claimed from HMRC when the second spouse or civil partner dies. This is usually done by the executor making a claim to transfer the unused RNRB from the estate of the spouse or civil partner that died first. This transfer can also happen even if the first spouse or civil partner died before the RNRB was introduced on 6 April 2017.

There is a tapering of the RNRB for estates worth more than £2 million even where the family home is left to direct descendants. The additional threshold will be reduced by £1 for every £2 that the estate is worth more than the £2 million taper threshold. This can result in the full amount of the RNRB being tapered away. 

The RNRB maximum rate of £175,000 and the taper threshold are currently frozen until at least April 2026.

There are a number of reliefs available that can reduce liability to IHT. Of most interest to farmers is the Agricultural Property Relief (APR). Relief is available at a rate of 100% or 50% depending on who farms the land and how long the land has been owned.

The APR can be claimed on assets including farming land or pasture that is used to grow crops or to rear animals intensively, working farmhouses, farm workers’ cottages, barns and stud farms. There is no agricultural relief for farm equipment but the equipment itself may qualify for another relief known as business relief.

The APR is available for working farms in the UK, Channel Islands, the Isle of Man or the European Economic area. It is important to note that the relief is based on the agricultural value if the land. For example, a farmhouse is valued as if it could only be used for agricultural purposes rather than open market value. The valuations of farmhouses in particular is often the subject of debate.

It is important to ensure that any claim for APR is realistic as HMRC’s refusal to accept an APR claim could result in a significant amount of IHT being due together with the possibility of penalties being levied. There can also be issues where the faming business has diversified into non-farming activities such as wind farms, holiday lettings and farm shops.

There are special conditions to prevent exploitation of the relief by a person switching their assets into agricultural property shortly before death or making a transfer. 

There are a number of reliefs available that can reduce liability to Inheritance Tax (IHT).

One of these reliefs is known as IHT Business Relief and is a valuable tax relief for taxpayers with business interests, offering either 50% or 100% relief from IHT on the value of the business assets if certain conditions are met. For example:

• 100% Business Relief can be claimed on a business or interest in a business or on shares held in an unlisted company.
• 50% Business Relief can be claimed on:
  • shares controlling more than 50% of the voting rights in a listed company;
  • land, buildings or machinery owned by the deceased and used in a business they were a partner in or controlled; and
  • land, buildings or machinery used in the business and held in a trust that it has the right to benefit from.

Relief is only available if the deceased owned the business or asset for at least 2 years before they died. There are a number of restrictions to the relief, for example if the company in question mainly deals with securities, stocks or shares, land or buildings, or in making or holding investments. In some cases, partial Business Relief may be available.