FA - 19 F6: IHT

Chapter # 01
OUTLINE OF INHERITANCE TAX

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FA - 19 F6: IHT

1. Introduction
IHT is primarily a tax that is levied upon the value of an individual’s estate at the date of their
death.
As it would be easy to avoid IHT by making a gift of property just before the date of death. IHT
also taxes certain gifts made during a person’s lifetime.

The rates of tax

For deaths occurring on or after 6 April 2019, the tax rates are:
(i) Nil% on the first £325,000 of a person’s estate
(ii) 40% thereafter.

Chargeable persons
An individual domiciled in the UK is chargeable to IHT in respect of their worldwide assets.
For individuals not domiciled in the UK only their UK assets are chargeable to IHT.
An individual is domiciled in the country where they have their permanent home.

Husband and wives

Husband and wives and civil partners are separate persons as regards IHT just as they are for
other taxes. They therefore each have a nil rate band of £325,000 which is charged to IHT at nil%.
If one spouse or civil partner does not use up the whole nil rate band, the percentage of unused
NRB will be transferred to the surviving spouse/civil partner.

Chargeable property
Chargeable property consists of all property to which a person is beneficially entitled prior to
death.
 The value of a person’s estate at death therefore consists of the aggregate value of all
property to which the deceased was beneficially entitled immediately prior to death.
 The estate also includes any property acquired as a result of death. The most important
example of this is the proceeds of a life assurance policy which matures upon death. When
the deceased has a life insurance policy on their own life, the proceeds of that policy are
included in the death estate, rather than the market value of the policy at the date of their
death.

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2. The estate at death

To compile an individual’s death estate computation, the chargeable assets to which that
individual is beneficially entitled is aggregated and then allowable deductions and exempt
legacies are deducted to calculate the gross chargeable estate value.
‘Assets’ to be included comprise all forms of property, cash and other assets.
Pro forma death estate computation
£ £
Business assets X
Stocks and shares X
Leasehold property X
Motor cars X
Personal chattels X
Debts due to the deceased X
Insurance policy proceeds X
Cash and bank and on deposit (including ISA) X
Freehold property X
Less: Repayment mortgage (X) X
X
Less: Allowable deductions:
Funeral expenses X
Other allowable debts X (X)
X
Less: Exempt legacies
(e.g. legacy to wife, charity,) (X)
Chargeable estate X

Responsibility for payment of the IHT liability

The personal representatives (executors or administrators) pay the IHT due on the free estate.
Allocation of estate

 After the death, estate of the deceased is distributed amongst the beneficiaries according
to the will of deceased.
 Estate is allocated between beneficiaries after the payment of IHT by the personal
representatives.

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FA - 19 F6: IHT

Funeral expenses and other deductible debts

a) Debts are deductible if they were outstanding at the date of death and if they had been
incurred for valuable consideration or imposed by law.
This will include all outstanding taxes such as income tax and CGT, although not the IHT
due on death itself.
Note that a 'promise' to pay a friend is not legally enforceable and therefore not deductible.
Gambling debts are not incurred for valuable consideration and cannot be deducted.
b) The cost of administering the estate or establishing the value of the estate at death is not
allowable as it is for professional services carried out after the death. By contrast, unpaid
accountants fees for work prior to death (e.g. for preparing the annual tax return) would
be allowed.
c) If a debt is secured against specific property it is deducted from that property. This will be
the case with a mortgage secured against freehold property.
A repayment mortgage is a straightforward loan, and will be a liability in the deceased’s
estate.
An endowment mortgage is different in that it includes an element of life assurance. The
life assurance will repay the mortgage upon death, and therefore an endowment
mortgage-is not deducted as a liability.
d) The costs of a reasonable funeral (including the tombstone) are allowable, even though
the cost is incurred after the date of death.

3. Exempt transfers
1. Husband and wives
Transfers between spouses or civil partners are normally wholly exempt from IHT.
For example, if upon her death a wife leaves her estate entirely to her husband, then regardless
of the value of her estate there will be no IHT liability.
The inter-spouse exemption is the one most often met in practice, and is therefore the most likely
exemption to be examined.

Example 1
Ace died on 31 December 2019 leaving a widow and two children. He left an estate valued at
£600,000. Under the terms of his will he left £175,000 to his widow, and the balance to his children
in equal shares.
Calculate the IHT arising upon Ace’s death.

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FA - 19 F6: IHT

2. Gifts to charities
Gifts to registered charities are totally exempt.

Example 2
Simon died on 31 December 2019. At the date of his death Simon owned the following assets:
(i) Freehold property worth £230,000.
(ii) Leasehold property worth £58,000.
(iii) 10,000 shares in a quoted company valued at. £50,000.
(iv) Four paintings worth £25,000.
(v) A loan of £16,500 due to Simon by his uncle.
(vi) A motor car worth £3,000.
(vii) Bank deposits of £2,200,
(viii) UK government stocks valued at £9,500.
At the date of his death Simon owed £800 for gambling debts, His funeral expenses amounted
to£1,200.
All of Simon’s estate was left to his daughter. He had made no lifetime gifts.
Calculate the IHT arising upon Simon’s death.

4. Valuation rules

The basic rule for valuing property for IHT purposes is that of open market value.
Open market value is the price which property might reasonably be expected to fetch if sold in
the open market at that time.
The following points must be considered when establishing a sale in the open of open market
value.
i. The valuation assumes that there has been adequate publicity prior to the sale.
ii. The price is not reduced to take account of the fact that the whole property is placed on
the market at once.
iii. The opinion of a suitably qualified expert will normally suffice in order to establish what
constitutes open market value.
iv. For example, an estate agent’s opinion will be accepted on the value of land and buildings.
HMRC can set aside any valuation that they consider to be unreasonable.

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FA - 19 F6: IHT

5. Residence Nil Rate Band

An additional nil rate band has been introduced where a main residence is inherited on death
by direct descendants (children and grandchildren). For the tax year 19/20, the residence nil
rate band is £125,000.

 The residence nil rate band is only relevant where an individual dies on or after 6 April
2017, their estate exceeds the normal nil rate band of £325,000 and their estate includes
a main residence. Any other type of property, such as a property which has been let out,
does not qualify for the residence nil rate band.
 In the same way in which any unused normal nil rate band can be transferred to a surviving
spouse (or registered civil partner), the percentage of unused residence nil rate band is
also transferable. It does not matter when the first spouse died.
 The value of the main residence is after deducting any repayment mortgage or interest-
only mortgage secured on that property.
 If a main residence is valued at less than the available residence nil rate band, then the
residence nil rate band is reduced to the value of the residence.
 The executors of the surviving spouse or civil partner must claim the transferred
NRB/RNRB by submitting the IHT return by the later of:
2 years from the second death, or
3 months from the executor starting to act.

Example 3

Una died on 10 July 2019 leaving an estate valued at £600,000. Under the terms of her will, Una’s
estate was left to her children. The estate included a main residence valued at £200,000 on which
there was an outstanding interest-only mortgage of £130,000. Una’s IHT liability is:
£
600,000
Chargeable estate
_______

IHT liability
0
395,000 (325,000 + 70,000) at nil%
82,000
205,000 at 40%
_______
82,000
_______

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FA - 19 F6: IHT
The value of Una’s main residence is £70,000 (200,000 – 130,000), so the residence nil rate band
is restricted to this amount.

 The residence nil rate band does not apply to lifetime transfers becoming chargeable as
a result of the donor’s death within seven years.
 Given that the residence nil rate band is only available where inheritance is by direct
descendants, rearranging the terms of a will can save IHT.

Example 4

Victor has an estate valued at £1,200,000, including a main residence valued at £400,000. He
has not made any lifetime gifts. Victor’s wife died on 17 May 2007 and all of her estate was left to
Victor. Under the terms of his will, Victor has left his main residence to his brother, with the residue
of the estate left to his children.

Currently, Victor’s estate will benefit from a nil rate band of £650,000 (325,000 + 325,000). The
residence nil rate band is not available because the main residence will not be inherited by a
direct descendant.

Victor could amend the terms of his will so that his brother inherited £400,000 of other assets,
with the main residence being included within the residue. A residence nil rate band of £200,000
(125000 + 125,000) would then be available, saving IHT of £100,000 (250,000 at 40%).

There is no reason why Victor’s brother could not purchase the main residence from the children
following Victor’s death.

A question will make it clear if the residence nil rate band is available. Therefore, you should
assume that the residence nil rate band is not available if there is no mention of a main residence.

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FA - 19 F6: IHT

Chapter # 02

LIFETIME GIFTS

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FA - 19 F6: IHT
IHT extends to a transfer of value of chargeable property by a chargeable person during a person
lifetime, although it generally only applies to those gifts made within seven years of death. For
IHT purposes there are three types of lifetime gifts:

 Exempt transfers,

 Potentially exempt transfers (PETs), and

 Charge lifetime transfers (CLTs).

1. Transfers of value

During a person’s lifetime, IHT only arises if a transfer of value is made. Put simply, a transfer of
value is a gift of any capital asset which reduces the value of a person’s estate. However the term
‘disposition’ is somewhat wider than a ‘gift’, since it covers any act which reduces the value of a
person’s estate.
Diminution in value
a) In calculating a transfer of value, it is the diminution in value of a person’s estate that is
relevant.
b) In many cases, the diminution in value of a person’s estate will be straightforward.
For example, a parent gives a son £20,000 in cash. The parent’s estate has diminished in
value by £20,000, and this is therefore the transfer of value.
c) However, in other cases it is necessary to compare:
i. The value of the donor’s estate before the gift, and
ii. The value of the donor’s estate after the gift.

Example 1
Adam owns 51,000 shares (a 51% holding) in GHI Ltd.
On 30 April 2019 he gave 2,000 of the shares (a 2% holding) to his son.
The relevant values of GHI Ltd’s shares are as follows:
Shareholding Value per share
£
51% 15
49% 11
2% 4
Calculate the transfer of value made by Adam on 30 April 2019.

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FA - 19 F6: IHT

2. Exempt transfers

 Transfers between spouses or civil partners are normally exempt from IHT.
 Gifts to approved charities

3. Potentially exempt transfers (PETs)

The majority of lifetime transfers are PETs.

A PET is a lifetime transfer which is made by an individual to another individual.
Transfers made on death are never PETs.

The implications of the donor dying within seven years of making a PET

a) If the donor lives for more than seven years after making a PET, then the transfer is
completely exempt from IHT.

Therefore, at the time that such a transfer is made, it has the potential to be exempt. Hence
the terms ‘potentially exempt transfer’.

b) It would be impractical if IHT was due at the time that a PET was made, with a refund
being made once the donor has lived for seven years.

Therefore, IHT in respect of PETs is not due until they become chargeable, which will only
be when the donor dies within seven years of making the gift.

c) A PET made more than seven years before the donor dies thus has no IHT implications
whatsoever.

Example 2
Daniel made the following gifts during his lifetime:
a) £20,000 on 31 October 2008 to his son.
b) £40,000 on 31 August 2013 to a discretionary trust.
c) £25,000 on 30 September 2015 to his daughter.
Daniel died on 30 June 2019.
Which of Daniels lifetime gifts would have been PETs, and which of these will be chargeable as
a result of his death.

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FA - 19 F6: IHT

PETs becoming chargeable

a) Even though the IHT on a PET is not due until it becomes chargeable, the value of the
transfer is fixed at the time that the gift is made.
b) The nil rate band of £325,000 is available in respect of transfers which become
chargeable. Only one nil rate band of £325,000 is available, and it will be utilised according
to the order that transfers are made.
c) The availability of the £325,000 nil rate band will sometimes mean that no IHT is due on
PETs which become chargeable. However, the utilisation of the nil rate band will result in
a correspondingly higher charge to IHT for the estate at death.
d) The IHT liability that arises on PETs becoming chargeable is always the responsibility of
the donee.

Example 3
Fred died on 30 June 2019 leaving an estate valued at £350,000. Fred had made the following
lifetime transfers:
a) £65,000 on 31 July 2014 to his son.
b) £140,000 on 30 November 2016 to his daughter.
c) £250,000 on 30 April 2017 to his son.
Calculate the IHT arising as a result of Fred’s death on 30 June 2019. You should ignore
any reliefs and exemptions that might be available.

4. Chargeable lifetime transfers (CLTs)

Chargeable lifetime transfers (CLTs) are lifetime gifts which are not exempt and not PETs.
Therefore, CLTs are lifetime transfers made by an individual to a trust.

A trust is an arrangement whereby a person (known as the settlor) transfers assets to trustees to
hold for the benefit of one or more persons (the beneficiaries).

The rates of tax

a) Chargeable lifetime transfers are immediately charged to IHT at half of the full rate of IHT,
so the rate of tax will be either 0% or 20% as appropriate.

b) An additional charge to IHT arises if the donor dies within seven years of making a
chargeable lifetime transfer. This charge is at the full rate of IHT (0% or 40% as
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FA - 19 F6: IHT
appropriate), although credit is given for any IHT already paid. However, any IHT paid
during lifetime at the rate of 20% is never refunded.

c) Should the donor live for more than seven years after making a chargeable lifetime
transfer, then an additional charge to IHT does not arise.

Example 4

Zoe died on 30 September 2019 leaving an estate valued at £550,000.

On 15 July 2015 Zoe had made a transfer of £350,000 into a discretionary trust. The IHT due in
respect of this gift was paid by the discretionary trust.
Calculate the IHT arising as a result of Zoe’s gift on 15 July 2015, and her death on 30
September 2019. You should ignore any reliefs mid exemptions that might be available.

Grossing up of chargeable lifetime transfers

a) In the above example, the IHT was paid by the donee (the trust). The diminution in value of
Zoe’s estate was therefore £350,000, being the amount of the gift.
If the IHT was instead paid by Zoe (the donor) then the diminution in value of her estate would
be the gift plus the IHT payable.
b) Where the IHT is paid by the donor, the gift is considered to be the net figure, and this must
be grossed up in order to find the gross amount of the transfer. Since the rate of IHT on lifetime
transfers is 20%, grossing up is done using the fraction 100/80.
c) Grossing up is straightforward where the £325,000 nil rate band has already been utilised.
For example, a net gift of £100,000 would be grossed up to £125,000 (100,000 x 100/80). The
IHT due is £25,000 (125,000 x 20%).
d) The calculation is slightly more complicated where the £325,000 nil rate band has not been
fully utilised.

Example 5

On 31 July 2019 Kevin made a gift of £180,000 into discretionary trust ‘A’. His only previous gift
was one of £200,000 into discretionary trust ‘B’ on 1 January 2015. In both cases Kevin paid any
IHT that was due.

Calculate the IHT liability in respect of Kevin’s gifts. You should ignore any reliefs and
exemptions that might be available.
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Responsibility for the payment of the IHT liability

a) The donor is primarily responsible for the IHT on chargeable lifetime transfers. Grossing up
will then be necessary.
b) The donor can, however, agree with the donee that the donee is to pay any tax due.
c) If a question is silent as to whether the donor or the donee is to pay the IHT, then it should be
assumed that it will be paid by the donor.
d) Where an additional charge to IHT arises as a result of the donor dying within seven years of
making the chargeable lifetime transfer, then the additional IHT liability is always the
responsibility of the donee. Whether the donor or the donee paid the IHT during lifetime is
irrelevant.
e) The additional charge to IHT is calculated using the previously calculated gross transfer.

The seven-year cumulation period

a) Whereas PETs are completely ignored once the donor has lived for seven years, this is not
the case with chargeable lifetime transfers.
b) Each time a chargeable lifetime transfer is made, it is necessary to take into account all other
chargeable lifetime transfers made within the previous seven years in order to calculate the
IHT liability.
c) There is thus the seven year cumulation period.
d) After seven years, a chargeable lifetime transfer will drop out of the cumulative total.
e) The seven year cumulation principle is probably the most difficult aspect of IHT to grasp, but
it is important.

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FA - 19 F6: IHT

Chapter # 03

LIFETIME exemptions and reliefs

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FA - 19 F6: IHT

1. Exemptions specific to lifetime transfers

Tapering relief

a) It would be somewhat unfair if a gift made seven years and one month before the date of
the donor’s death was exempt, whilst a gift made six years and eleven months before the
date of the donor’s death was fully chargeable.
b) Therefore gifts made between three years and seven years of the date of the donor’s
death qualify for tapering relief.
c) The relief applies to both PETs and CLTs.
d) Tapering relief reduces the IHT otherwise payable by a percentage reduction.
e) The percentages are as follows: The IHT liability is calculated as normal, and this is then
reduced by a percentage according to the length of time between the date of the gift and
the date of the donor’s death.

Years between the Percentage

gift and death reduction

3 to 4 20%
4 to 5 40%
5 to 6 60%
6 to 7 80%

f) For chargeable lifetime transfers, any IHT already paid is deducted after tapper relief.
g) No refund is made if the tax already paid is higher than the amount now due.

Example 1
Brian dies on 31 December 2019. He had made the following lifetime gifts:

£340,000 to his son on 31 October 2014.

£350,000 into a discretionary trust on 30 November 2015.

Brian paid the IHT liability arising on this transfer.

Calculate the IHT arising on Brian’s lifetime gifts. With the exception of tapering relief, you
should ignore any exemptions and reliefs that might be available.

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The annual exemption

a) The first £3,000 of value transferred in each tax year is exempt.

Note that this is one of the few situations where the tax year has any relevance to IHT.
b) The annual exemption is used up by PETs as well as by chargeable lifetime transfers.
This is despite the fact that a PET might become completely exempt.
c) The annual exemption is allocated on a strict chronological basis.
For example, a gift of £10,000 is made on 30 April 2019, with a further gift of £7,000 being
made on 15 May 2019. The annual exemption for 19/20 of £3,000 will be allocated to the
£10,000 gift made on 30 April 2019.
d) If an annual exemption is not fully used in a tax year, it can be carried forward to the next
tax year. It is only possible to carry the annual exemption forward for one year.
The annual exemption for the current year is used before the annual exemption brought
forward.
e) The annual exemption is only used after other relevant exemptions and reliefs have been
applied.
For example, business property relief is applied before the annual exemption. This
ensures that the annual exemption is not wasted if 100% relief would otherwise be
available.
f) Where a chargeable lifetime transfer is to be grossed up, then the annual exemption is
applied to the net transfer. The net transfer, after the deduction of the annual exemption,
is then grossed up.
g) Other exemptions or reliefs, if available, are given before the AE.
h) Note that as the AE is used up by PETs as well as by CLTs, where more than one
transfer is to be made during a tax year, CLTs should be made before PETs to ensure
that the optimum use is made of the AE.

Example 2
Julie has made the following gifts:
a) £600 on 31 August 2017 to her son
b) £800 on 31 October 2017 to a discretionary trust
c) £2,100 on 31 May 2018 to a discretionary trust
d) £1,100 on 30 November 2018 to a discretionary trust
e) £5,000 on 30 April 2019 to her daughter.
You are to show how Julie’s annual exemptions will be utilised.
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The small gifts exemption

a) Outright gifts to individuals are exempt if the total gifted to that individual in any one tax
year is £250 or less.
b) The small gift exemption does not apply if the gift is in excess of £250.
c) Unlike the annual exemption, if the limit of £250 is exceeded then no relief is given.
d) A donor can give up to £250 each tax year to as many individuals as he or she wishes.
e) There is no small gift exemption available for gifts into trusts.

Example 3
Simon made the following gifts during 19/20:
a) £120 to his son Alex
b) £450 to his son Bertie
c) £245 to his son Charles
d) £70 to his friend Diana
e) £650 to his friend Eric
f) £60 to his son Alex
g) £320 to his friend Diana.
Which of the gifts qualify for the small gifts exemption?

Gifts in consideration of marriage

a) Gifts in consideration of marriage are exempt up to the following limits:
i. £5,000 if made by a parent of either party to the marriage.
ii. £2,500 if made by a grandparent or a remoter ancestor of either party to the
marriage.
iii. £2,500 by a party to the marriage or civil partnership (e.g. groom to bride)
iv. £1,000 if made by anybody else, such as a brother or a sister.
b) The marriage must actually take place for the exemption to be available.
Both the marriage exemption and the annual exemption can be claimed for the same
gift if it is large enough.
The marriage exemption should be used first, since its use is more restricted.

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Normal expenditure out of income

IHT only taxes transfers of capital, not dispositions of income.
Therefore, a transfer of value is exempt if:
i. it is made as part of a person’s normal expenditure out of income, and
ii. that person’s standard of living is not affected as a result of the gift.
A typical situation where this exemption can be used is where premiums on a life assurance policy
are paid on behalf of someone else.
Each year, the premiums will be regarded as coming out of income, and will therefore have no
IHT implications. When the policy matures it will not form part of the donor’s estate.

2. Administration of IHT

Due dates for the payment of IHT

a) For chargeable lifetime transfers, the due date is the later of:
i. six months from the end of the month in which the transfer is made, and
ii. 30 April following the end of the tax year in which the transfer is made.
b) For IHT arising on:
i. PETs becoming chargeable as a result of the donor’s death, and
ii. Additional IHT arising on chargeable lifetime transfers as a result of the donor’s death.
the due date is six months from the end of the month in which death occurred.
c) For IHT arising on an estate at death the due date is the earlier of:
i. six months from the end of the month in which death occurred, and
ii. when the personal representatives deliver their account.
Note that the due date is generally earlier than the date that an account has to be delivered.

Interest on overdue IHT

Interest on overdue IHT runs from the due date to the date that the tax is paid.

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