Inheritance Tax (United Kingdom)

History

Prior to the introduction of Estate Duty by the Finance Act 1894, there was a complex system of different taxes relating to the inheritance of property, that applied to either realty (land) or personalty (other personal property):

1. From 1694, Probate Duty, introduced as a stamp duty on wills entered in probate in 1694, applying to personalty.
2. From 1780, Legacy Duty, an inheritance duty paid by the receiver of personalty, graduated according to consanguinity
3. From 1853, Succession Duty, a duty introduced by the Succession Duty Act 1853 applying to realty settlements, taking effect on the death of the settlor
4. From 1881, Account Duty applied as an anti-avoidance duty on lifetime gifts made to avoid paying Legacy Duty
5. From 1885, Corporation Duty applied to the annual value of certain property vested in corporate and unincorporated bodies that would otherwise have avoided any of the above duties
6. From 1889 (scheduled for expiry in 1896), Estate Duty, being an additional stamp duty on estates and successions greater than £10,000 in value

In 1894, estate duty replaced probate duty, account duty, certain additional succession duties, and temporary estate duty.

Legacy duty and succession duty were later abolished by the Finance Act 1949, followed by the abolition of corporation duty by the Finance Act 1959. The three-year period for gifts made prior to death was extended to five years by the Finance Act 1946, and then to seven years by the Finance Act 1969.

Estate duty became more progressive in scale, eventually peaking in 1969 with the highest marginal rate fixed at 85% of amounts in excess of £750,000, provided that total duty did not exceed 80% of the value of the total estate.

Estate duty was abolished with the passage of the Finance Act 1975, which created the Capital Transfer Tax, with the following characteristics:

CTT was reduced in scope during the Thatcher years, with most lifetime gifts removed by the Finance Act 1986. The tax was renamed as Inheritance Tax.

Estate on death

For IHT purposes, a person's estate includes:

1. the aggregate of all the property, other than excluded property and specified interests in possession, to which he is beneficially entitled;
2. beneficial entitlement includes the general power to dispose or charge money on any property;
3. except where otherwise provided, the person's liabilities must be taken into account, but it does not include liability with respect to any other tax that may arise on the transfer, and a liability incurred by a transferor shall be taken into account only to the extent that it was incurred for a consideration in money or money’s worth.

Excluded property comprises:

1. property situated outside the United Kingdom, where the person beneficially entitled to it is an individual domiciled outside the United Kingdom;
2. decorations and awards granted for valour or gallant conduct, and which have never been the subject of a disposition for a consideration in money or money's worth; and
3. certain specified securities.

Relief is also granted, where the value of the estate is reduced with respect to specified business property, agricultural property, woodlands, certain transfers made within three years of death made at a diminished value, and certain other cases.

Chargeable transfers prior to death

Deductions will be made from an estate's nil rate band with respect to transfers of value made in excess of specified limits, other than "potentially exempt transfers" made more than seven years before the transferor's death. Transfers of value made within specified limits are known as "exempt transfers".

Transfers of value will also include gifts arising from the amount by which an asset is sold for less than it could have been sold on the open market, as for a sale from a parent to a child. Gifts can also arise where:

Where the value of such transfers exhausts the amount available to the nil rate band, IHT is assessed on the excess amount, to which the recipients of such transfers bear the liability to pay.

Types of estates exempt from IHT

For deaths occurring on or after 1 September 2006, the following estates are effectively excepted from liability for IHT:

Rate of tax

Tax is assessed at 40% of the net value of the estate, after application of the nil rate band. The applicable nil rate band will depend on the date of death: if the date falls at any time from 6 August to 5 April in a given tax year, the current year's band will apply; but, where the date is after 5 April but before 6 August, and application for a grant is filed before 6 August, the prior year's band will apply.

For deaths occurring after 5 April 2012, the tax is assessed at 36%, where at least 10% of a specified baseline amount of the estate has been bequeathed as charitable gifts. For purposes of calculation, the property of the estate is separated into three components, each of which is tested to see if the charitable gifts are sufficient to qualify for the lesser rate:

If applicable gifts meet the 10% threshold for a given component, in certain circumstances, upon election, the 36% rate applies to the whole estate. There are several options available for estates to be able to achieve that threshold, such as having the will specifying relevant gifts in terms of percentages of assets, or successors executing a deed of variation to attain the desired result.

Nil-rate band

The Chancellor of the Exchequer's Autumn Statement on 9 October 2007 announced that with immediate effect inheritance tax allowances (often referred to as the nil-rate band) were to be transferrable between married couples and between civil partners. Thus, for the 2007/8 tax year, a married couple will in effect have an allowance of £600,000 against inheritance tax, whilst a single person's allowance remains at £300,000. The mechanism for this enhanced allowance is that on the death of the second spouse to die, the nil rate band for the second spouse is increased by the percentage of the nil-rate band which was not used on the death of the first spouse to die.

For example, if in 2007/08 the first married spouse (or civil partner) to die were to leave £120,000 to their children and the rest of their estate to their spouse, there would be no inheritance tax due at that time and £180,000 or 60% of the nil-rate band would be unused. Later, upon the second death the nil-rate band would be 160% of the allowance for a single person, so that if the surviving spouse also died in 2007/08 the first £480,000 (160% of £300,000) of the surviving spouse's estate would be exempt from inheritance tax. If the surviving spouse died in a later year when the nil-rate band had reached £350,000, the first £560,000 (160% of £350,000) of the estate would be tax exempt.

This measure was also extended to existing widows, widowers and bereaved civil partners on 9 October 2007. If their late spouse or partner had not used all of their inheritance tax allowance at the time of the spouse's death, then the unused percentage of that allowance can now be added to the single person's allowance when the surviving spouse or partner dies. This applies irrespective of the date on which the first spouse died, but special rules apply if the surviving spouse remarries.

In a judgement following an unsuccessful appeal to a 2006 decision by the European Court of Human Rights, it was held that the above does not apply to siblings living together. The crucial factor in such cases was determined to be the existence of a public undertaking, carrying with it a body of rights and obligations of a contractual nature, rather than the length or supportive nature of the relationship.

Prior to this legislative change, the most common means of ensuring that both nil-rate bands were used was called a nil band discretionary trust (now more properly known as NRB Relevant Property Trust*). This is an arrangement in both wills which says that whoever is the first to die leaves their nil band to a discretionary trust for the family, and not to the survivor. The survivor can still benefit from those assets if needed, but they are not part of that survivor's estate.

It is worth noting that as the Government seeks not to profit from the death of those who a) gave their lives in military service, or b) died from the results of a wound, injury, or disease associated with that military service, that the estates of such servicemen and women are exempt, totally, from any Inheritance Tax regardless of the value of the estate even if it amounts to millions of pounds as long as a) or b) apply....and that that exemption is then transferable to the serviceman's or servicewoman's widow or widower. That they do qualify as at a) or b) may be certified by application to the British MOD "Joint Casualty and Compassionate Centre" (JCCC). The JCCC then inform the HMRC of that decision. The exemption does not apply to ex-servicemen or servicewomen who die from other causes unrelated to their military service.

Additional nil rate band on main residence

In the summer budget of 2015 a new measure was outlined to reduce the burden of IHT for most families by making it easier to pass on the family home to direct descendants without a tax charge. It came into effect upon the passage of the Finance (No. 2) Act 2015, and provided for the following scheduled amounts:

The Finance Act 2016 provided further relief in cases where all or part of the additional band could be lost, where a person had downsized to a less valuable residence or had ceased to own a residence after 8 July 2015 (and before the person has died). This is conditional upon the deceased having left that smaller residence, or assets of equivalent value, to direct descendants. These are defined as lineal descendants, spouses or civil partners of such lineal descendants, or former spouses or civil partners who have not become anyone else's spouse or civil partner.

Pre-owned assets

Effective with the 2005-06 tax year, the Finance Act 2004 introduced a retrospective income tax regime known as pre-owned asset tax (POAT) which covers transactions not made at arm's length, where a person either:

and then subsequently benefits from its use.

The person liable for POAT may, while he is still alive, elect on a timely basis to have such transactions treated as gifts with reservations (thus subject to IHT) with respect to such transactions made in a given tax year.

Controversy

In 2002, Queen Elizabeth The Queen Mother is understood to have left her entire estate (estimated at £50 million) to her daughter Elizabeth II, including works of art, jewels, antiques and her thoroughbred racehorses. A deal made back in 1993 ensures that The Queen is spared inheritance tax of an estimated £20 million on her mother's estate.

In 2016, there have been calls to reform the UK's system of trusts. Pressure groups have called for trusts to publish annual accounts, like private companies, and also for a central register of trusts. This follows the recent death of the Duke of Westminster, whose significant assets, which are to be passed down to his children, are thought to be largely free from inheritance tax.