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Chapter 23
INHERITANCE TAX
1 Introduction
The majority of UK taxpayers will only experience chargeability to Inheritance Tax (IHT) on one occasion – when they die! If their Chargeable Estate exceeds the nil rate band, currently £325,000, the excess will be taxed at 40%. If only the assets still owned at the time of death were to be taxable, “deathbed gifting”, giving assets away just prior to death, would effectively avoid this tax. This means that certain lifetime gifts, those made within 7 years of death, will also become chargeable on the death of the taxpayer. In addition there are also some transfers made in lifetime, transfers into trusts that will generate immediate chargeability to IHT as well as chargeability on death.
2 Transfer of Value
IHT is a cumulative donor based tax and for it to arise an individual must make a transfer of value i.e. a gift, computed as the loss to the estate of the donor. This is calculated as the difference in estate value before and after the gift of the asset. The amount of tax that may be payable on a transfer of value is based on the cumulative amount of transfers made by the donor over a 7 year period. For most assets the transfer of value will be the same as the open market value of the asset e.g. gifting a property worth £250, or cash of £100,000, but for some assets, notably shares in unquoted companies the transfer of value may be considerably higher than the market value of the asset being gifted.
Illustration 1 A owns 60% of the shares in A Ltd. A Ltd has 100,000 £1 ordinary shares in issue.
Share valuations have been agreed as follows: 20% £10 per share 40% £15 per share 60% £25 per share 80% £40 per share
Compute the transfer of value if A were to die leaving his shares to his daughter, or alternatively if he were to make a lifetime gift of 20,000 shares to his daughter.
If A died owning his 60,000 shares, a 60% shareholding, they would be valued at £25 per share i.e. 60,000 @ £25 = £1,500,000.
If, however, he were to give 20,000 shares in lifetime the transfer of value would not be based on the value of a 20% interest i.e. £ per share, but would be computed as the difference between the value of his estate before and after the transfer:
Before 60,000 shares (60%) @ £25 = 1,500, After 40,000 shares (40%) @ £15 = 600, Transfer of Value 900,
A transfer of value will arise by the gift of an asset either in lifetime and / or on death. For most taxpayers, as stated above, their only transfers of value will arise as a result of their death.
3 The Death Estate
On death the assets owned by the deceased are valued and included in the death estate. If the deceased was UK domiciled, all assets owned are included in the death estate. If non UK domiciled, only assets situated in the UK are included. If a property held in the estate is mortgaged, the mortgage will reduce the property value if it is a repayment or interest only mortgage. Endowment mortgages are not deducted as they are repaid on death by the life assurance part of that mortgage. The estate should also include the proceeds of any separate life assurance policy on the deceased’s life, not the market value of the policy at the date of death. The value of the estate will be reduced by any legally enforceable debts due at that date e.g. credit card bills, plus funeral expenses and by exempt bequests. Bequests are exempt IHT if made to:
• Spouse / Civil Partner
The “available” nil rate band is deducted from the value of the chargeable estate. The nil rate band is £325,000 in 2014/15. The “available” nil rate band is the £325,000 reduced by the value of any lifetime chargeable transfers made by the deceased in the 7 years before death. The balance of the estate is then taxed at 40%. This IHT liability has to be paid by the Personal Representatives before they get letters of probate allowing the estate to be distributed, but is anyway due 6 months after the end of the month in which the taxpayer died. The IHT is suffered by the beneficiaries, usually the residuary legatee of the estate – the person receiving the balance of the estate after any specific legacies have been paid out.
Illustration 2 Dee Parted, a spinster (never married), died on 1 st^ February, 2015 leaving an estate valued at £0..75M. She had made no chargeable transfers of value in her lifetime and now bequeathed her estate to be split equally between her nieces and nephews. Compute the IHT liability arising as a result of Dee’s death and state the date by which the liability should be paid.
Dee Parted Chargeable Estate at Death – February 1, 2015 £’ Net Assets 750
Chargeable Estate 750 IHT 325,000 @ Nil = Nil 425,000 @ 40% = 170, 750,
The Personal Representatives will be required to pay the IHT liability of £170,000 by 31 August 2015. The tax will come out of the estate and hence is borne by the nieces and nephews.
Illustration 3 As in Illustration 2 but Dee had made a lifetime chargeable transfer of value of £200,000 in June 2012. Compute the IHT liability arising as a result of Dee’s death
As the chargeable transfer made in lifetime falls within the 7 years before the date of death it will become chargeable as a result of Dee’s death. It will however fall within the nil rate band of £325,000 in force at the date of death so no IHT will be payable thereon. This will however mean that only £125,000 of nil rate band will now be available in taxing the estate at death. The IHT payable on the Chargeable Estate at Death will now be computed as follows: IHT 125,000 @ Nil = Nil 625,000 @ 40% = 250, 750,
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5 Taper relief
If a taxpayer does not survive for 7 years following the PET but does survive for at least 3 years any IHT payable on the transfer is reduced by taper relief. The relief is applied to the tax charge as follows: Time from transfer to date of death Relief 3 – 4 years 20% 4 – 5 years 40% 5 – 6 years 60% 6 – 7 years 80% (This table is provided in the examination)
Illustration 7 As in Illustration 5 but the 2 lifetime transfers of £200,000 occurred in January 2009 and June 2011 respectively.
Compute the amount of IHT payable as a result of Dee’s death.
Lifetime Transfers Chargeable on Death Gross Transfers IHT January 2009 PET 200,000 nil
June 2011 PET 200,000 30, 125,000 @ Nil = Nil 400, 75,000 @ 40% = 30,
As the PET falls between 3-4 years from the date of death The tax charge may be reduced by taper relief of 20% Less; Taper Relief (20%) (6,000) 24,
As in Illustration 5 the nil rate band has been fully utilised on the lifetime transfers made in the 7 years before death so the entire chargeable estate of £750,000 is taxed at 40% giving an IHT liability of £300,000.
It can now be seen that the amount of tax that arises on either transfers made in lifetime or on death cannot be computed in isolation and is nothing to do with the circumstances of the donee. IHT is a cumulative donor based tax.
6 chargeable Lifetime Transfers (cLT)
A CLT is a transfer made in lifetime into a trust. With a CLT, IHT is chargeable at the date of the gift using the nil rate band in force at that date. For transfers made before 2014/ the relevant nil rate band limit will be provided by the examiner. If IHT is payable it should be paid 6 months after the end of the month in which the transfer was made, but earliest the 30th^ April following the end of the tax year in which the transfer took place. For example tax payable on a CLT made in December 2014 will be payable by June 30, 2015, whereas if the CLT was made in June 2014 then the IHT would not be payable until April 30, 2015. The gross rate of IHT on transfers above the nil rate band is 20% and is applied if the tax is being paid by the donee (i.e. the trustees of the trust). If the tax is paid by the donor the transfer is said to be a net transfer and the gift has to be “grossed up” as the IHT payable by the donor effectively becomes part of the gift. The simple solution to this problem is to apply a net IHT rate of 25% to any part of the net gift in excess of the available nil rate band at that date. The gross amount of this transfer is then computed by adding the amount of IHT to the net transfer.
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Illustration 8 Kay Babb made a chargeable transfer into a trust of £400,000 in June 2010. She has made no previous lifetime transfers. The nil rate band in the 2010/11 tax year was £325,000.
Compute the amount of IHT payable, assuming firstly the trustees paid any IHT due, and then that Kay paid any IHT due.
Lifetime Transfers Chargeable When Made £ Gross Transfers IHT CLT 400,000 400,000 15, 325,000 @ Nil = Nil 75,000 @ 20% = 15,
If Kay paid the tax the first £325,000 is still within the nil rate band but the excess £75,000 is now taxed at 25%. This tax is then added to the £400,000 to establish the gross amount of the gift: CLT 400,000 418,750 18,
As a CLT is immediately chargeable to IHT, it goes into the donor’s IHT cumulation, using up his nil band for the next 7 years. If the donor dies within 7 years of a CLT, additional death tax may be due to top up the lifetime tax paid. The IHT liability is calculated in the same way as the tax on a PET, with credit given for taper relief and then any lifetime tax paid.
Illustration 9 Having made the chargeable transfer of £400,000 into the trust in June 2010 Kay then died in December 2014 leaving a chargeable estate of £1M.
Compute the IHT payable as a result of Kay’s death. Assume that the trustees paid the tax payable in lifetime as shown in Illustration 8. Lifetime Transfers Chargeable on Death Gross Transfers IHT June 2010 CLT 400,000 30, 325,000 @ Nil = Nil 75,000 @ 40% = 30,
(The tax charge is now reduced by any available taper relief as with PET’s but also by any lifetime tax that was paid)
Less: Taper Relief (40%) (4-5 years) (12,000) 18, Less: Lifetime Tax Paid (15,000) Additional Tax Due on Death 3,
If the lifetime tax paid exceeded the amount of tax now due, no additional tax would be payable, but equally there would be no repayment of lifetime tax paid.
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8 approach to Exam Questions
In an examination question the following approach should be adopted: (1) Compute the chargeable transfer for each lifetime gift (as per illustration 10) (2) If any CLT’s have been made the computation for Lifetime Transfers Chargeable When Made must be prepared ( as per illustration 8). To compute any tax payable it must be ascertained who paid the tax, donor or donees, to determine the tax rate to apply above the nil rate band (3) Any lifetime transfers, CLT’s or PET’s within the 7 years of death are now included in the computation for Lifetime Transfers Chargeable On Death (as per illustrations 7 and 9). (4) The Chargeable Estate is now established and the tax thereon computed. In short exam questions not all of the above steps may be necessary and hence the steps should be applied as applicable to the question set. It may also be required to state by whom and by when the IHT should be paid.
E xamplE 1
Joe Kerr died on April 1 2015, leaving £250,000 to his wife and the remainder of his estate to his son.
At the date of his death Joe owned the following assets: (1) His principal private residence valued at £300,000 upon which the outstanding repayment mortgage at the date of death was £80, (2) A holiday home valued at £140, (3) Bank and Building Society Deposits amounting to £230, (4) ISA’s with a market value of £50, (5) 12,000 Shares in Joe Ltd valued at £20 per share (6) A life assurance policy with an open market value at April 1 2015 of £125,000 from which proceeds of £140,000 were received following Joe’s death.
Joe had outstanding credit card bills of £6,000 at the date of his death and had also verbally promised to pay the medical expenses of £1,000 of a friend. Funeral expenses amounted to £6,000.
During his lifetime he had made the following lifetime transfers: (1) On 20 November 2008 a cash gift of £40,000 to his son on the occasion of his wedding. (2) On 15 July 2009 he transferred £405,000 into a trust and paid the IHT due thereon (3) On 8 December 2013 he gave 4,000 shares in Joe Ltd to his son. Prior to the gift Joe owned 16,000 of the 20,000 shares in Joe Ltd. Share valuations agreed with HMRC at this date were as follows: 20% shareholding - £8 per share 40% ,, - £12 ,, 60% ,, - £18 ,, 80% ,, - £25 ,,
The nil rate band for the tax year 08/09 was £312,000 and £325,000 for 09/10.
Compute the amount of IHT payable during Joe’s lifetime and upon his death.
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10 IhT Planning
As the Chargeable Estate of the taxpayer is charged at 40% above the nil rate band, making lifetime transfers is the easiest way an individual may reduce the IHT liability that would otherwise arise upon his death. This of course assumes that the individual has both the capacity and willingness to make such gifts. If an individual makes regular lifetime gifts to others out of his income these transfers will be exempt as normal expenditure out of income. Other gifts to individuals will be PET’s:
• these will only become chargeable if the donor dies within 7 years of having made them
• if the individual dies within 7 years the value of the transfer is “frozen” at the time of the transfer. It is therefore beneficial to
gift in lifetime those assets that are likely to increase in value over time
• if the donor survives for at least 3 years then any IHT payable thereon is reduced by taper relief
You should now review the following technical article written by the F6 examining team
-IHT parts 1 and 2, plus the Finance Act 2014 article - Inheritance Tax section
You may now attempt Practice Question 38
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