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Inheritance Tax (IHT) replaced capital transfer tax (CTT) with effect
from 18 March 1986. In many respects, IHT closely resembles the old
Estate Duty, which was replaced by CTT in 1974.
Certain types of gift made by individuals are not subject to IHT at
the time they are made. These are known as potentially exempt transfers
(PETs) and include:
• Outright gifts to another individual;
• Gifts
to (and some from) trusts with an interest in possession;
• Gifts
to an accumulation and maintenance trusts;
• Gifts
to a trust for a disabled person.
Once made, the value of the gift is frozen, but if it subsequently
transpires that the gift was made within seven years of the donor’s
death, it will be charged to IHT at the death rate in the year of
death. That charge will be reduced by a prescribed percentage if the
gift has been made more than three years before death.
Other gifts made by an individual during his lifetime, typically gifts
into discretionary trusts will be chargeable to IHT at half the death
rate applicable to the time of the gift. This charge could be increased
if the transfer takes place within seven years of death because the
rates applicable at the date of death (subject to any tapering) will
be applied.
Although there has been a reduction in rates of IHT in recent years,
the impact of the tax on an estate remains devastating. For example,
the tax on an estate of £500 is £100K with each successive
£1 in the estate being taxed at 40%. Careful, early planning
is essential to reduce this impact.
Although gifts between a husband and wife are normally exempt from
IHT (see below), they are taxed as separate individuals and each has
his or her own exemptions and tax rates. This presents important planning
opportunities.
The value of each gift for tax purposes is measured by the difference
in the value of the transferor’s estate before and after the
transfer. There can be a substantial difference between the value
lost and the value gained. For example, a disposal of 2% of the shares
in a company could take the transferor from 51% to a 49% holding causing
a large reduction in the value of the estate but the increase in the
recipient’s estate would be small. Considerable care needs to
be taken in planning such transactions.
Residence has no bearing on IHT liabilities: domicile is the key factor.
If you are domiciled in the UK, all your worldwide assets are in the
scope of IHT, but if you are non-domiciled, only assets situated in
the UK are liable. This gives rise to planning possibilities. For
example, the UK shares of a non-domiciled individual may be held in
an overseas company so that they remain property outside the UK for
tax purposes.
It should be noted that there is a concept known as deemed domicile
which applies for IHT only. This takes two forms:
• An
individual is deemed to have acquired a UK domicile if he has been
resident in the UK for 17 out of the previous 20 tax years;
• An
individual who has been domiciled in the UK is deemed to retain that
domicile for three years from the date of leaving the UK even if he
aquires a new domicile elsewhere.
The impact of double tax treaties also needs to be considered.
Substantial IHT savings can be made by making systematic use of available
exemptions.
These are exempt without limit (whether made during lifetime or on
death) unless the transferor spouse is UK domiciled and the transferee
spouse is not. In this case, only the first £55,000 is exempt.
The balance will be treated as a PET.
This applies to the total gifts made by a transferor to any one person
in each tax year. Any number of gifts up to £250 may be made
to separate persons.
This applies to the total gifts made by a transferor in each tax year.
If it has not been fully used, the balance of the previous year’s
exemption may be brought forward for one year only and used when that
of the current year has been fully utilised.
This covers transfers of net income after tax provided that they form
part of normal (i.e. typical of habitual) expenditure and leave sufficient
income for the transferor to maintain his usual standard of living.
It is necessary to submit a claim for this exemption.
These are exempt up to a limit of £5,000 from each parent, £2,500
from each grandparent and £1,000 from any other person. Either
party to the marriage may give the other £2,500.
Certain gifts for the support and maintenance of children and dependent
relatives are not charged to IHT.
Gifts to charity are exempt without any limit.
You should make sure that you use all your exemptions as fully as
possible each year.
A substantial part of all chargeable (i.e. non-exempt) transfers,
whether during lifetime or on death, is taxed at a nil rate. The nil
rate band for 2002/2003 is £250K and this is normally index-linked
so that a small increase can be expected each year. The nil rate threshold
provides important tax planning opportunities, particularly when used
in conjunction with the inter-spouse exemption and other reliefs'
such as those for business and agricultural property. Significantly,
husband and wife each have their own nil rate band.
IHT is charged at a single rate of tax on the total of an individuals
chargeable lifetime transfers within a period of seven years. Each
successive transfer is added to the previous total and any transfers
made more than seven years earlier would drop out.
On death, the value of the estate is added to the cumulative total
for the previous seven years although this figure may require further
adjustment to take account of PETs, which become chargeable.
These provisions are extremely far-reaching and are aimed at the donor
who gifts an asset but retains some interest or benefit in it, e.g.
gifting a house but continuing to live in it. Where the provisions
apply, the asset involved will remain part of the donor’s estate
for IHT purposes.
Reductions of up to 100% in the value of gifts can be obtained where
those gifts are assets, which qualify for either business property
relief or agricultural property relief. Assets include business assets,
holdings of unquoted shares and agricultural land. In each case, the
asset must have been owned for at least two years. Where a PET becomes
chargeable, relief will only be available if the qualifying conditions
can be met by the recipient.
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