INHERITANCE TAX      October 2019

The focus of this Newsletter is Inheritance Tax, given that the Office of Tax Simplification has proposed recommendations aimed at removing some of the complexities, whilst various proposals from the Labour and Conservative Parties have given Inheritance Tax more media space over the last few months.

Inheritance Tax (IHT) planning is often put on the “to do” list but HMRC figures suggest that IHT collection generated £5.4 billion of revenue in 2018/19 tax year. As IHT is often referred to as a “voluntary” tax, it is a good time to consider the basics of IHT and what can be done to mitigate the tax.

WHO PAYS IHT AND WHEN? 

Inheritance Tax is payable on an individual’s death by his or her personal representatives and is payable within 6 months of the end of the month in which death occurs (IHT on land and buildings can sometimes be paid by instalments over up to 10 years or until the land/property is sold if earlier).

For anyone domiciled in the UK, IHT applies to your assets wherever they are situated, so includes assets abroad.

INHERITANCE TAX RATES

IHT is currently payable at a flat rate of 40% on the value of an individual’s estate that exceeds the “nil rate band”. IHT can sometimes be chargeable during your lifetime – these are known as chargeable lifetime transfers and can occur if you make a gift into most forms of trust (except absolute trusts for named beneficiaries). Such gifts are subject to an immediate IHT charge of 20% on the value of the gift above the nil rate band.

THE NIL RATE BAND

1) The IHT threshold or nil rate band is the amount up to which an estate will have no IHT to pay and is currently fixed at £325,000 until at least 2020/21 tax year. Above this level, IHT is payable at 40%. 

2) The Transferable Nil Rate Band was introduced in 2007 and means that any unused nil rate band of the first to die for a married couple or civil partnership can be transferred to the surviving spouse/partner, so a potential £650,000 can pass free of IHT on the death of the survivor. 

THE RESIDENCE NIL RATE BAND 

There is an additional nil rate band available where the main residence passes on death to direct descendants such as children and grandchildren. This additional nil rate band has been phased in and worth £100,000 in 2017/18, £125,000 in 2018/19, £150,000 in 2019/20 and £175,000 in 2020/21. 

This additional nil rate band can mean that from April 2020 an individual can have a total estate of up to £500,000 before IHT is payable on death. The Residence Nil Rate Band is also transferable between spouses/civil partners, so that on death of the first, the survivor could have a total estate of up to £1 million before IHT becomes payable (assuming the first to die has not used up any of his/her nil rate bands through lifetime gifts within 7 years of death or by gift of Will). 

There are certain qualifying conditions and possible confusions that apply to this additional nil rate band:- 

1) It applies to main residences only, not any property (ie “the home”).

2) The property must be “closely inherited” – inherited by the deceased’s child (or adopted/foster/step-child) or other direct descendant such as a grandchild or great grandchild, and can include the spouse/civil partner of a descendant.  

3) Children do not need to take physical ownership of the property – the deceased’s will may make specific reference to the home being passed to a direct descendant. Even if there is no specific direction in the will and the home falls into the residue of the estate, the Residence Nil Rate Band can still be claimed provided a share of the residue passes to direct descendants.

4) The Residence Nil Rate Band is not available if the home passes into a discretionary trust (unless assets are distributed within 2 years of death) or a trust where a direct descendant’s rights are contingent upon them attaining a particular age. It should still be available for bare trusts.

5) The transferable Residence Nil Rate Band applies even if the first spouse died before its introduction in 2017 and it doesn’t even matter if the deceased never owned residential property. Only where the estate of the first death was greater than £2 million may the ability to transfer the allowance be lost.

6) High value estates above £2 million will see the Residence Nil Rate Band reduced by £1 for every £2 above the threshold – so for 2020/21 year onwards it will be lost where the estate is greater than £2.35 million (in this context only, the estate excludes gifts made within 7 years of death but includes business/agricultural property relief).

7) There are downsizing provisions so that those who move to a smaller property in later life or who no longer own a property (eg in residential care) are not disadvantaged provided the disposal occurred after 8 July 2015. There is a downsizing addition which will mean that you would be no worse off than if you still owned the property.

8) The Residence Nil Rate Band is available on death only and does not apply to lifetime gifts.

OTHER EXEMPTIONS AND RELIEFS

There are other exemptions from IHT:- 

• Gifts of an unlimited amount between UK-domiciled spouses/civil partners are exempt, whether made on death or during your lifetime.
• Gifts made to a “qualifying” charity during lifetime or on death.
• Annual exemption: you can give up to £3,000 per tax year without any liability to Inheritance Tax, and if not used in the previous year can be brought forward to the current tax year giving a maximum of £6,000. This is per donor, so up to £12,000 for a married couple/civil partnership.
• Small gift exemption – you can make as many gifts of £250 to as many individuals as you like.
• Gifts on marriage of up to £5,000 from a parent, £2,500 from a grandparent and £1,000 by other relatives are exempt.
• Normal expenditure out of income: gifts of any amount are exempt if they are made on a regular basis, are made out of income and do not affect your standard of living. Accurate records would be required here.
• Business Property Relief of 100% can apply to business property owned for two years or more (eg a shareholding in a non-quoted trading company). 50% relief is available on assets owned by a controlling director that are used in the company’s trading business. Agricultural Property Relief at 100% may apply to owner occupied farms/farm tenancies, with 50% relief in many other cases.

OTHER GIFTS 

A frequent question is: how much can I give away without having to pay Inheritance Tax? The answer is anything as long as you live for 7 years following the date of the gift. 

Outright gifts of any amount made during your lifetime fall outside of your estate for Inheritance Tax purposes after 7 years. Care is needed as gifts of property for example can be subject to immediate Capital Gains Tax at the time the gift is made. Gifts of cash are not subject to Capital Gains Tax. 

Such gifts need to be made “without reservation” ie when you make the gift, if you retain a benefit (such as enjoy the    income generated by such a gift, or if you give your home to your children but continue to live in it) then the gift will be deemed to remain as part of your estate. 

These gifts are known as “Potentially Exempt Transfers” or PETs, and are subject to IHT only where they exceed the nil rate band and where death occurs within 7 years. Effective lower rates than 40% apply depending on the number of complete years between the date of the gift and the donor's date of death (40% IHT on gifts above the Nil Rate Band if death occurs within 3 years, 32% if death occurs in year 3-4, 24% in years 4-5, 16% year 5-6, 8% year 6-7, nil 7 years +).

GIFTS INTO TRUST

The problem with outright gifts is one of control as often the donor would like to have some control over who receives the benefit and when. This can often be overcome by the use of trusts. 

Gifts into most trusts (up to the amount of the nil rate band) will fall outside of your estate after 7 years and the growth in value on the gifts falls outside of the estate immediately. It is important that gifts into such trusts be limited to the Nil Rate Band (£325,000) otherwise the excess will give rise to an immediate Inheritance Tax charge at 20%. An income can often be retained by the donor in respect of the amounts paid into such trusts without affecting the usual gift with reservation rules. Such lifetime gifts into trust are known as “chargeable lifetime transfers” (CLTs). 

A trust is established by someone (the “Settlor”) for the benefit of his/her beneficiaries, the main types of trust (there are other variations) being:- 

There are certain taxation issues relating to trusts which are not covered here.

WILLS & INTESTACY 

Making a Will is important so that you can direct who you wish to benefit on your death.

If a person dies without a valid will, they are said to have died intestate, and the estate is distributed according to intestacy rules. These rules changed in 2014 and a summary of the new rules follows. The new intestacy rules are a fall back provision but it is always advisable to take control – make a Will setting out your wishes and review it regularly. 

PENSION PLANS

Most pension plans (occupational schemes, personal pensions, SIPPs etc) are written under a trust automatically so that the benefits payable on death are not included in your estate for Inheritance Tax purposes. The taxation of benefits on death depends on the age of death – if under age 75 then benefits (such as a fund value) are payable to your beneficiaries tax free, but if death occurs after age 75 then benefits arising are subject to income tax on the beneficiary (although the beneficiary may have options other than taking a taxable lump sum, such as a beneficiary drawdown plan to maintain the tax efficiency of the pension arrangement). Not all pension arrangements have the full flexibilities available, and some old style retirement annuities have not been written under trust, so you may wish to consider this.  

THE FUTURE

The Office of Tax Simplification has made a series of recommendations aimed at removing some of the complexities in IHT rules. These are suggestions only, but the main recommendations were (a) the introduction of a single annual personal gift allowance to replace some of the other exemptions, (b) a reduction in the lifetime gift period from 7 years to 5 years, (c) removing the taper relief available on gifts within 7 years of death, and (d) clarifying who is liable for payment of IHT (eg IHT may be payable on a lifetime gift and the recipient is primarily responsible for paying it, even if it has been spent. Settlors can remove this problem by stating in their Wills that any IHT on lifetime gifts is to be paid by their estate).

The Conservative Party have stated that they will review IHT but without any timetable.

The Labour Party have openly stated that they would make swingeing changes to IHT and in their document “Land For The Many” the suggestion is to sweep away the current IHT thresholds, exemptions and reliefs and introduce a “lifetime gifts tax” so that anyone inheriting more than the report’s £125,000 would pay income tax on the surplus. Given that the average home in the UK is valued about £230,000 then IHT could be expected to increase dramatically.

Contact John Perry should you wish to discuss any aspect covered in this Newsletter