Basic principles of inheritance tax


Inheritance tax (IHT) was introduced by the Finance Act 1986 to replace capital transfer tax and applies for transfers made on or after 18 March 1986.

Consequently, the codifying Act was renamed the Inheritance Tax Act (IHTA) 1984. Between 26 March 1974 and 18 March 1986 capital transfer tax (CTT) applied. Prior to that date estate duty applied, which can be relevant when dealing with trusts created, or estates of persons who died, before 1986.

Transfers of value

IHT applies to ‘transfers of value’ whether made during lifetime or on death. These are transfers that reduce the value of the donor’s estate. IHT is usually charged on the donor, according to the ‘loss to the estate’ principle, rather than by reference to the benefit received by the donee.

Broadly, there are three types of lifetime transfer that can be made. Exempt transfers are not subject to tax, nor are they included in the donor’s future cumulation. Transfers that are exempt are set out in IHTA 1984. The Act also sets out a number of reliefs from tax, such as business relief. These reliefs are not to be confused with exemptions. A relief reduces the value of a chargeable transfer but does not remove that transfer from the tax regime.

Lifetime gifts which are outright gifts between individuals and gifts by an individual into bare or absolute trusts and into trusts for the disabled become exempt from tax provided the donor survives seven years from the date of the gift. Such transfers are called potentially exempt transfers (PETs). A liability could however arise on the death of the donor within seven years of the transfer, in which case the PET ‘fails’ and becomes a chargeable transfer.

Also falling into the PET category is a transfer into a bereaved minor’s trust on the coming to an end of an immediate post-death interest (IPDI).

All other transfers, including lifetime transfers made by an individual into interest in possession trusts and accumulation and maintenance trusts from 22 March 2006, are chargeable. When a chargeable lifetime transfer (CLT) is made an IHT charge may become payable at the time of the transfer.

In general, IHT applies only to transfers by individuals, although there are special provisions for close companies.

Tax rates and nil rate bands

The rates of tax are 20% for a CLT and 40% (with an effective reduction to 36% if a certain proportion of one’s estate is left to charity) for a transfer on death. The first £325,000 (the nil rate band (NRB)) of cumulative chargeable transfers made by an individual are charged at a nil rate of tax.

In addition, a residence nil rate band (RNRB) now applies for deaths occurring on or after 6 April 2017 where all or part of a qualifying residential interest is left to direct descendants of the deceased (or their spouses/civil partners). Full RNRB applies if the estate of the deceased does not exceed £2m. If the estate value exceeds £2m, the RNRB is tapered, or reduced, by £1 for every £2 over that limit.

The RNRB was initially set at £100,000 for the 2017/18 tax year and has been phased in gradually in annual increments of £25,000 until it has reached £175,000 by the 2020/21 tax year. This means that an individual, whose estate (valued at not more than £2m) includes a qualifying residence that is being left to direct descendants, for example to children, will be able to pass on up to £500,000 free of IHT. In recognition of the fact that the new rules could act as a disincentive to older people wishing to either downsize to a less valuable residence or sell a residence prior to death to move into residential accommodation, legislation protects the RNRB where the sale or downsizing occurs after 8 April 2015 – provided (broadly) that assets of a value equivalent to the lost RNRB are left to persons fulfilling the extended definition of direct descendants.

Cumulation principle

IHT is a cumulative tax. So, all chargeable transfers made in the seven calendar years preceding a transfer are taken into account in determining whether IHT is payable and if so at what rate. Once the cumulative total exceeds the NRB, tax is payable at 40% on death and 20% on lifetime transfers. A CLT remains on the donor’s “IHT clock” for seven years. After seven years the transfer is no longer taken into account but may continue to be relevant should subsequent PETs be made and fail.


The IHT on death on an estate of £325,000 if there were no chargeable transfers in the previous seven years is currently nil as £325,000 is the amount of NRB (until 2020/21). If, however, there had been previous chargeable transfers (or PETs which have now become chargeable by virtue of the donor’s death) of say £100,000, there would only be £225,000 of the NRB remaining. Ignoring the possibility of a RNRB, this would mean IHT of £40,000 would be payable.

Excluded property

Certain property, known as excluded property, is excluded from the scope of IHT. The prime example of such property is property owned by an individual who is not UK domiciled that is situated outside the UK (although special rules now apply to former UK domiciles who are UK resident at the time of their death as well as for foreign property that derives its value from UK residential property).

Spouses and civil partners

In the case of a married couple or civil partners, each spouse’s/civil partner’s transfers are separately taxed and each spouse/civil partner is entitled to his/her own exemptions and reliefs. Transfers between UK domiciled spouses and registered civil partners are exempt. There is a limited exemption for transfers to non-domiciled spouses/civil partners (see Domicile below).

If one spouse/civil partner does not use their NRB on death, it can be transferred to the other spouse/civil partner so that the surviving spouse’s/civil partner’s estate would benefit from two NRBs (and two RNRBs if relevant).

Gifts with reservation of benefit

Special rules apply where a gift is made and the donor can continue to enjoy a benefit from the gift. These are called ‘Gifts With Reservation’ (GWRs). If the benefit enjoyed by the donor (i.e. the reservation) ends during the donor’s lifetime, the gift is treated as a PET made by the donor on that date. If the reservation continues until the donor’s death, the then value of the property comprising the gift is treated as remaining part of his or her estate. The pre-owned asset tax (POAT) provisions supplement the GWR provisions in respect of gifts from which the donor can continue to enjoy a benefit.

Domicile and deemed domicile

The primary determinant of an individual’s liability to IHT is that individual’s domicile. If the donor is domiciled in the United Kingdom, the tax applies to all that donor’s property wherever it is situated in the world. If the donor is domiciled abroad, the tax usually applies only to property situated in the United Kingdom.

The domicile of a person is generally the country which he or she regards as their permanent and ultimate home (i.e. where they permanently reside or have their permanent home and where they intend to remain for the foreseeable future). A person starts with a domicile of origin that he or she takes from their father. This can be replaced by a domicile of choice, which can be secured by physically taking up residence abroad with the intention of permanently residing there. Domicile must not be confused with a person’s residence status, which may be the same as domicile but need not be. Whilst the residence status of a person is relevant for the purpose of income tax and capital gains tax, it is domicile which is most relevant for IHT.

By virtue of S267 IHTA 1984 domicile is given an extended meaning (the so-called deemed domicile). Before 6 April 2017 a person who was resident in the UK for 17 of the 20 years of assessment ending with the year in which the relevant time fell was deemed to be UK domiciled for IHT purposes only. For tax years 2017/18 onwards the deemed domicile rules have been extended to income tax and capital gains tax.

For IHT purposes, under the current rules a person who is not domiciled in the UK under the general law will nevertheless be deemed to be UK domiciled for IHT purposes if at the time of the transfer he/she:

  • Was domiciled in the UK within the three years immediately preceding the transfer;
  • Is a formerly domiciled resident in the tax year in which the transfer falls; or
  • Was resident in the UK for at least 15 out of the 20 tax years immediately prior to the tax year of the transfer, and for at least one of the four years ending with the tax year of the transfer.

A formerly domiciled resident is a person who:

  • Was born in the UK with a UK domicile of origin;
  • Has subsequently become domiciled abroad; and
  • Is UK resident for at least the tax year in which the transfer falls as well as for one out of the two tax years preceding tax years.

Since 6 April 2013, it has been possible for a non-UK domiciled spouse or civil partner of a UK domiciled person to elect to be treated as UK domiciled for IHT purposes. By making such an election, worldwide assets would be subject to UK IHT so advice should be sought prior to making a decision. However, unlimited spouse/civil partner exemption will then apply if gifts are made to the non-domiciled spouse/civil partner (otherwise the spouse/civil partner exemption in such a case is limited, currently, to £325,000).

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Source: Techlink


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