During their lifetime, an individual can make three types of transfer which might be caught by IHT legislation:
Let’s look at each of these in more detail.
Exempt transfers fall into two categories: transfers which are exempt if made during lifetime or at death, and transfers which are exempt only if made during lifetime.
(a) Transfers made during lifetime or at death, which are tax free, are:
(b) Transfers made during lifetime only, which are tax free, are:
Chargeable lifetime transfers (CLTs)
The most common type of CLTs are gifts to a discretionary trust or gifts to other trusts made on or after 22 March 2006.
The value transferred for IHT purposes is the ‘loss to the donor’s estate’ as a result of the transfer, which is not always the same as the amount that the donee receives. This principle is particularly relevant if the donor gives shares in private or unlisted companies, as the value per share will increase depending on the number of shares owned by the shareholder. The value per share of a controlling shareholding is higher than the value per share if the shareholder does not have control.
The value of CLTs can be reduced by any available annual exemptions.
IHT is payable on CLTs on the amount exceeding the nil rate band (currently £325,000). The trustees will pay IHT at the lifetime rate of 20%. The nil rate band available on a CLT will be reduced by any CLTs which the donor has made in the preceding seven years.
Potentially exempt transfers (PETs)
All gifts between individuals are PETs.
A PET is treated as an exempt transfer while the donor is alive, and so PETs will not give rise to a lifetime IHT charge.
A PET becomes an exempt transfer if the donor survives for seven years from the date of the gift. If the donor dies within seven years, an IHT charge will arise and tax will be payable by the donee. Taper relief reduces the tax payable where there are more than three years between the date of the gift and the date of death. Further details regarding the tax due on PETs at the time of a donor’s death are given later in this article.
Unlike capital gains tax, where certain assets (for example, cars) are treated as exempt, there is no general concept of exempt assets for IHT purposes. However, certain assets are regarded as ‘excluded property’ and are outside the scope of IHT. An example of ‘excluded property’ is a non-UK asset owned by non-domiciled individual. Details of other assets which are regarded as ‘excluded property’ can be found in IHTA 1984 sections 6, 48 and 157.
Additional tax on death
On death, there are three types of transfer which are chargeable to IHT: ‘failed’ PETs (being PETs made by the deceased in the seven years prior to his/her death), CLTs made in the seven years prior to his/her death (additional tax may be payable on these transfers) and, finally, assets in the deceased person’s death estate.
The rate of IHT on death is always 40%.
Death tax on PETs
If a donor dies within seven years of making the gift, IHT is due on any amount above the nil rate band in force at the date of death. However, the nil rate band is reduced by any CLTs made by the donor in the seven years before the PET. Accordingly, it is necessary not only to look back seven years from death, but also seven years from the date of the PET, in order to identify the balance of the nil rate band available.
IHT is due at 40% on a ‘failed’ PET on any amount above the nil rate band.
However, if there are more than three years from the date of the gift until the date of death, taper relief is available at the following rates:
|Length of time between date of gift and date of death
|Taper relief percentage
Where there are more than seven years from the date of the gift until the date of death, the PET becomes completely exempt and so, in effect, the tax is reduced by 100%.
Death tax on CLTs
As stated previously, when an individual makes a lifetime CLT, IHT is payable at the rate of 20% on the amount of the CLT which exceeds the nil rate band available.
If the donor dies within seven years of the CLT, additional tax is due on death (payable by the trustees) on any amount in excess of the unused nil rate band, charged at 40%.
However, as with PETs, if there are more than three years between the date of CLT and the date of death, taper relief is available to reduce the tax. The trustees receive credit for any lifetime tax paid on the CLT.
Business property relief (BPR)
BPR is available if a donor makes a transfer of a relevant business property. BPR reduces the transfer of value for IHT purposes.
The definition of a relevant business property is given in Section 105 IHTA 1984.
The transfer of any number of shares in an unlisted trading company owned by the donor for at least two years qualifies for 100% BPR. The transfer of shares in a quoted trading company, if the donor has voting control of the company, qualifies for 50% BPR. The 50% rate also applies to gifts of land and buildings and plant and machinery, where those assets are used by the donor’s partnership or by a company which he/she controls.
BPR is restricted on a transfer of shares if the company holds ‘excepted assets’ in the balance sheet. An ‘excepted asset’ is one which is not used wholly or mainly for trading purposes, or is not required at the time for future use in the business.
BPR is given before annual exemptions, and is available to reduce the value of transfer for lifetime gifts. BPR is also available to reduce the value of business assets in a death estate. The relief is given automatically if the qualifying conditions are met.
Agricultural property relief (APR)
APR works in a similar way to BPR.
APR reduces the transfer of value for IHT purposes by 50% or 100%.
APR is available at 100% to a farmer who owns farmland and farm buildings and uses these assets in his business.
APR is available at 50% where the property is tenanted and let prior to 1 September 1995 and the lease has more than two years to run at the date of transfer. Otherwise, APR is given at 100%.