Principles of Inheritance Tax
| Author | Lesley King/Peter Gausden |
| Pages | 181-194 |
16.1 Importance of inheritance tax
Although inheritance tax can sometimes be payable on lifetime transfers at the time they are made, this is relatively unusual. Generally, taxpayers only encounter inheritance tax when someone dies. It is a very unpopular tax. In May 2018, the government’s Intergenerational Commission produced a report, Passing On: Options for reforming inheritance taxation, which said that the current system ‘manages the uniquely bad twin feat of being both wildly unpopular and raising very little revenue’.
Only 4% of estates actually pay inheritance tax. This is partly because of a generous system of exemptions and reliefs but also because lifetime giving can significantly reduce exposure to the tax.
This chapter considers the basics of the tax, and the implications for will drafting are looked at in Chapter 17.
16.2 Death estate
When a person dies, they are treated as making a transfer of value of all the assets to which they were beneficially entitled immediately before death less any debts and funeral expenses (section 5 of the IHTA 1984). Some property is excluded from inheritance tax but this statement is broadly correct.
Where a person is entitled to the income from a trust or has the right to occupy or enjoy settled property they are said to have an interest in possession. If the interest is a ‘qualifying’ interest in possession their estate will include the capital value of the trust assets.
EXAMPLE
Ted leaves £100,000 to Luna for life, remainder to Raoul absolutely. When Luna dies her estate includes the value of the settled property. While Luna’s interest continues, Raoul’s interest has no value for inheritance tax purposes so he can give away his right to inherit without any tax consequences.
182 Wills: A Practical Guide
Before 22 March 2006 it was possible to create a qualifying interest in possession by lifetime transfer. Since that date qualifying interests in possession can generally only be created on death and must take effect immediately. They are called ‘immediate post-death interests’.
EXAMPLE
Tom leaves £400,000 by will to his wife for life and then to his daughter for life. Tom’s wife has an immediate post-death interest and will be treated as the owner of the trust assets for the purpose of inheritance tax. When the wife dies, Tom’s daughter will not have an immediate post-death interest. Instead the trust will be classified as a relevant property trust and will be subject to a different tax regime (see Chapter 17).
Qualifying interests in possession created before 22 March 2006 retain that status regardless of the method of creation.
The only type of lifetime transfer to a trust which creates a qualifying interest in possession on or after 22 March 2006 is a lifetime transfer to a trust which qualifies as a disabled person’s trust (see sections 89–89C of the IHTA 1984). The details of these trusts are beyond the scope of this book.
Lifetime transfers to individuals do not attract any tax at the date they are made; they are treated as potentially exempt.
Lifetime transfers to most types of trust are initially chargeable to tax at half the death rates.
In both cases, if the transferor dies within 7 years of the transfer, it becomes chargeable at the full death rates (unless an exemption or relief applies). Credit is given for any tax paid at the date of a chargeable transfer and once the transferor has survived 3 years, tapering relief is available to reduce the amount of any tax payable.
An obvious way of saving tax is to make lifetime gifts but, of course, the moderately wealthy often have no surplus assets which they can spare.
A lifetime transfer to a trust which qualifies as a disabled person’s trust (see sections 89–89C of the IHTA 1984) is not an immediately chargeable transfer. It is a potentially exempt transfer. The details of these trusts are beyond the scope of this book.
16.3 Exemptions and reliefs
Some transfers are completely exempt from inheritance tax. These include:
(a) Transfers between spouses or civil partners: all transfers between spouses and civil partners are exempt from inheritance tax, provided the gift has immediate effect (section 18 of the IHTA 1984). Such gifts include gifts into trust for a spouse or civil partner for life made on death.
Since 2006 lifetime transfers into trust for a spouse or civil partner for life are not treated as a transfer to the spouse and so do not attract the spouse exemption. They are treated as a transfer to a relevant property trust and therefore are immediately chargeable at half the death rates.
There is a limitation on the spouse exemption where the transferring spouse or civil partner is domiciled in the United Kingdom but the recipient is not.
Section 18(2) then limits the amount of the exemption to the level of the nil rate band. It is possible for the surviving spouse or civil partner to elect to be treated as domiciled in the United Kingdom for inheritance tax purposes (see sections 267ZA and 267ZB of the IHTA 1984) but this has a significant drawback: the worldwide assets of the foreign spouse or civil partner become subject to UK inheritance tax. Normally, a person who is not domiciled in the United Kingdom is liable to inheritance tax only on his UK assets.
(b) Gifts to political parties: section 24 of the IHTA 1984, as amended by the Finance Act 1988, makes all gifts to political parties wholly exempt from inheritance tax.
(c) Gifts to charities and national institutions: gifts to charities are totally exempt from inheritance tax whenever made and regardless of amount (section 23 of the IHTA 1984). Gifts to certain named institutions, for example certain museums, the National Trust, government departments, local authorities and universities in the United Kingdom, are similarly exempt.
(d) Death on active service: under section 154 of the IHTA 1984, no inheritance tax is chargeable on the death of a person from a wound inflicted or a disease contracted while a member of the armed forces if that person was on active service at the time, or on service of a warlike nature or involving the same risks (see Barty-King v Ministry of Defence [1979] 2 All ER 80, QBD).
(e) Death of emergency service personnel: under section 153A of the IHTA 1984, no inheritance tax is chargeable on the death of a member of the emergency services from an injury sustained, accident occurring or disease...
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