INHERITANCE TAX

Scope Of The Tax

Inheritance tax (IHT) is a tax on the transfers of wealth made by individuals.

The main feature of IHT is that the individual may avoid it entirely by disposing of his/her property more than 7 years prior to his/her death; it is the property transferred in the 7 years before death and on death which may-subject to exemptions and reliefs-be chargeable.

The rate of tax on death is 40% and 20% on lifetime chargeable transfers. The first £250,000 is not chargeable.

IHT On Lifetime Gifts

Lifetime gifts fall into one of three categories.

1. A transfer to a company or a discretionary trust is immediately chargeable.
2. Exempt gifts will be ignored both when they are made and also on the subsequent death of the donor.
3. Any other transfers will be potentially exempt transfers (PETs) and IHT is only due if the donor dies within seven years. It might therefore be more accurate to regard them as potentially chargeable transfers.

IHT On Death

trust property where the deceased had a right to income from, or use of, the property. Furthermore:

• Potentially exempt transfers (PETs) made within seven years become chargeable.
• There may be an additional liability because of chargeable transfers made within the previous seven years.

Estate Planning

Much estate planning involves making lifetime transfers to utilise exemptions and reliefs or to benefit from a lower rate of tax on lifetime transfers.

Careful consideration needs to be given to other factors. For example a gift that saves IHT may unnecessarily create a capital gains tax (CGT) liability. Furthermore the prospect of saving IHT should not be allowed to jeopardise the financial security of those involved.

Use Of PETs

Wherever possible gifts should be made as PETs rather than as chargeable transfers. This is because the gift will be exempt from IHT if the donor survives for seven years.

Nil Rate Band And Seven Year Cumulation

Chargeable transfers covered by the nil rate band can be made without incurring any IHT liability. Once seven years have elapsed a gift is no longer taken into account in determining IHT on subsequent transfers. Therefore every seven years a full nil rate band will be available to pass assets out of the estate. This is important where PETs are not appropriate.

The Principal Exemptions (Wholly And Partial) Are:

• Annual exemption of £3,000 per annum may be given by an individual without an IHT charge. An annual exemption may be carried forward to the next year but not thereafter.
• Gifts between husband and wife. It may be desirable to use the spouse exemption to transfer assets to ensure that both spouses can make full use of lifetime exemptions, the nil rate band and PETs.
• Small gifts to individuals not exceeding £250 in total per tax year per recipient are exempt. The exemption cannot be used to cover part of a larger gift.
• Gifts which are normal expenditure out of income which are typical and habitual and do not result in a fall in the standard of living of the donor. Payments under deed of covenant and the payment of annual premiums on life insurance policies would usually fall within this exemption.
• A gift for family maintenance does not give rise to an IHT charge. This would include the transfer of property made on divorce under a court order, gifts for the education of children or maintenance of a dependent relative.
• Gifts in consideration of marriage are exempt up to £5,000 if made by a parent with lower limits for other donors.
• Gifts to registered charities are exempt provided that the gift becomes the property of the charity or is held for charitable purposes.
• Gifts to political parties.
• Gifts to employee trusts.
• Gifts for national purposes and gifts for the public benefit.

Business Property Relief

When 'business property' is transferred there is a percentage reduction in the value of the transfer. Often this provides full relief. In cases where full relief is available there is little incentive, from a tax point of view, to transfer such assets in lifetime. Additionally no CGT will be payable where the asset is included in the estate on death. However the reliefs may not be so generous in the future and therefore gifts now may be advisable.

Use Of Trusts

Trusts can provide an effective means of transferring assets out of an estate whilst still allowing flexibility in the ultimate destination and/or permitting the donor to retain some control over the assets. Provided that the donor does not obtain any benefit or enjoyment from the trust, the property is removed from the estate.

Life Assurance

Life assurance arrangements can be used as a means of removing value from an estate and also as a method of funding IHT liabilities.

A policy can also be arranged to cover IHT due on death. It is particularly useful in providing funds to meet an IHT liability where the assets are not easily realised, eg family company shares.

Wills

As the main IHT liability is likely to arise on death, a sensible and up to date Will is important.

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