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Inheritance tax and estate planning – exemptions and reliefs

By Kim Jarvis, technical manager with Canada Life’s ican Technical Services Team

In this article we look at the main exemptions and reliefs that are available on death.
Within the article, spouse also means civil partner.

 

Nil-rate band

Under current rules, any part of the estate that falls within the available nil-rate band (NRB), currently £325,000 until at least 5 April 2021, is taxed at zero. Anything in excess of this amount is taxed at 40 per cent.

On death, any part of the estate that passes to the surviving spouse is an exempt transfer and will not use the NRB. Also, since 9 October 2007, any unused NRB can be transferred to a surviving spouse. For example, if a husband dies and leaves his estate to his widow, she can take his unused NRB and add it to her own. This means that, when she dies, her estate will incur IHT only if it’s worth more than £650,000 currently.

The unused NRB available to transfer to a spouse is expressed as a percentage rather than a monetary amount and so increases with any future increases to the NRB. Therefore if an individual does not use any of their NRB, their spouse can claim 100 per cent. If the NRB on the death of the spouse has risen to, say, £350,000 then the executors of the spouse’s estate can claim 100 per cent of NRB of £350,000.

Also, from 6 April 2017 each person will get a residential nil-rate band (RNRB) to use against the value of their home if it is left to direct descendants. Initially, it will be set at £100,000, increasing by £25,000 each year until it reaches £175,000 in April 2020, and like the standard NRB, any unused RNRB can also transfer to a surviving spouse. Remember, if the first spouse died before 6 April 2017, 100 per cent of the RNRB will be available to be transferred when the surviving spouse subsequently dies. However, the RNRB is tapered where estates are valued at over £2m, reducing by £1 for every £2 over this amount.

Spouse exemption

On death, all transfers to UK-domiciled spouses are exempt from IHT.

There are special rules that affect non-domiciled spouses which will be discussed in a later article but for now remember that, if an estate is passing to a non-domiciled spouse, it might not all be exempt.

Charity donations

All gifts to registered charities are exempt and, if death occurs after 5 April 2012, provided at least 10 per cent of the net estate is left to a registered charity, the IHT rate is reduced to 36 per cent. But remember, on death, an estate is divided into different components and at least 10 per cent of each component must be left to the registered charity.

Political parties

All gifts to political parties that have at least one member of parliament are exempt.

Maintenance of family

Any gift for the maintenance of a child (including step and adopted) who is either under 18, over 18 and in full-time education or training, or dependent upon the deceased because he is physically or mentally disabled, will be exempt from IHT. The gift must be reasonable for the child’s needs.

A gift to any other 'dependent relative' is also not a transfer of value to the extent that it is a reasonable provision for the relative's care or maintenance.

Armed forces

If a serving, or former, member of the armed forces dies from (or death can be shown to have been hastened by) an injury sustained or disease contracted while on active service against the enemy or other service of a warlike nature (such as operations against hostile forces in peace time or anti-terrorist operations), a complete exemption from IHT can be granted on their estate.

This little-known exemption could be very useful. It was used by the executors of the fourth Duke of Westminster in 1967. His family, one of the wealthiest in Britain, successfully claimed his death from cancer had been ‘hastened’ by a stomach wound he suffered fighting in France in 1944, and paid no IHT at all.

IHT reliefs

The term 'relief' applies to cases where there has been a chargeable transfer of value, but tax was not charged on the full value transferred.

Agricultural property relief

Agricultural property relief (APR) can be hugely valuable if the deceased owned and occupied property that was used for agricultural purposes for two years before their death.

Agricultural property is land or pasture that is used to grow crops or to rear animals intensively. It can also include farm buildings, farm cottages and farmhouses as well as stud farms for breeding and rearing horses and grazing. But it doesn’t include harvested crops or farm equipment and machinery.

Business property relief

Business property relief (BPR) provides relief from IHT on the transfer of relevant business assets at a rate of 50 per cent or 100 per cent. The deceased must have owned the business or asset for at least two years before they died.

A business or interest in a business and shares in an unlisted company will get 100 per cent BPR.

Whereas the estate will be entitled to only 50 per cent BPR on:

  • shares controlling more than 50 per cent 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, or
  • land, buildings or machinery used in the business and held in a trust that it has the right to benefit from.

Taper relief

Taper relief offers a gradual reduction in the amount of IHT due on gifts (potential and chargeable) made within seven years of death. A common misunderstanding is that taper relief achieves its tax saving by reducing the transfer of value. This is not the case – the value of the gift never changes, only the tax due.

Gifts made three to seven years before death are taxed on a sliding scale as follows:

Years between gift and death                       Tax paid
less than 3                              40%
3 to 4                              32%
4 to 5                              24%
5 to 6                               16%
6 to 7                                 8%
7 or more                                 0%

Looking at an example:

  • Ned died in August 2016 having made an outright gift of £500,000 to his daughter in July 2013
  • We will assume that Ned had already used his £3,000 annual exemptions
  • We will assume that Ned has only one available NRB and no RNRB
  • The PET becomes chargeable and is included in the estate
  • Part of the PET uses up the NRB and leaves a balance of £175,000, which is liable to tax
  • Death occurred between four and five years after the gift was made
  • The IHT of (£500,000 – £325,000) x 40 per cent = £70,000 can be reduced by taper relief
  • The IHT due on the gift would actually be (£500,000 – £325,000) x 24 per cent = £42,000

Let’s look at another example:

  • Ned died in August 2016 having made a gift into a discretionary trust of £500,000 in July 2013
  • We will assume that Ned had already used his £3,000 annual exemptions
  • On the initial CLT, tax of (£500,000 – £325,000) x 20 per cent = £35,000 was payable
  • We will assume that Ned has only one available NRB and no RNRB
  • The CLT uses up the NRB and leaves a balance of £175,000, which is liable to tax
  • Death occurred between four and five years after the gift
  • Tax liability is (£500,000 – £325,000) x 24 per cent = £42,000
  • But remember that, as £35,000 was paid during lifetime, only £7,000 is now payable

Quick succession relief

Quick succession relief  is designed to reduce the burden of IHT where an estate taxable on death includes assets received within the previous five years under an earlier transfer on which tax was (or becomes) payable. Relief is provided by reducing the tax payable on the death by a proportion of the tax payable on the earlier transfer. The proportion tapers at 20 per cent intervals from 100 per cent if the previous transfer took place within 12 months of the death, to 20 per cent if it took place between four and five years before the death.

A similar relief in respect of settled property is given subject to conditions where property is chargeable to tax within five years of a previous charge.

Double taxation relief

Where the deceased is domiciled in one country but resident in another, when they die they may pay IHT in both countries. This will depend on the terms of the double tax treaty between the UK and the other country in which the estate may be taxable. Generally the other country must have a tax similar in structure to UK IHT, and not all do, so it is important to seek specialist tax advice in such instances.

If the country where the person was living charges IHT on the same property or gift the UK is taxing, the estate may be able to avoid or reclaim the tax through a double taxation agreement.

If there is no double tax treaty in place, unilateral relief may help prevent any double charging on assets situated in a different country. The location of the asset is determined by UK legislation and the relief cannot exceed the amount of UK IHT that would have been payable.

Canada Life offers a range of wealth management solutions, including retirement income planning, estate planning and investment solutions from a choice of jurisdictions, including the UK, Isle of Man and Republic of Ireland.

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