Inheritance tax - chapter 4 PDF

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Inheritance tax - chapter 4...

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TAXATION Chapter 4 – Inheritance tax  Inheritance Tax Act 1984 (IHTA 1984).  Taxed on:  on death;  on lifetime gifts made to individuals within seven years prior to death; and  on lifetime gifts to a company or into a trust.  Inheritance tax is charged on ‘the value transferred by a chargeable transfer’.  ‘chargeable transfer’ is defined as ‘a transfer of value which is made by an individual but is not an exempt transfer’ (IHTA 1984, ss 1, 2).  General calculation  Step 1: Identify the transfer of value  Any disposition which reduces the value of the transferor’s estate. On death, tax is charged as if the deceased had made a transfer of value of his estate.  Step 2: Find the value transferred  Lifetime transfer, this is the amount of the reduction in the transferor’s estate.  Death, it is the value of the estate.  Step 3: Apply any relevant exemptions and reliefs  Various exemptions and reliefs exist for public policy reasons.  Step 4: Calculate tax at the appropriate rate  zero per cent. - ‘nil rate band’ (currently £325,000).  Rate in excess of the nil rate band varies according to the type of transfer.  The nil rate band will not neccessarily be available in full (or at all) for any given transfer.  Cumulation – Any chargeable transfers made by transferor during that period must be taken into account to determine how much of the nil rate band remains available.  TRANSFERS ON DEATH  Step 1: Identify the transfer of value  The value transferred is  The value of the deceased’s ‘estate’ immediately before his death.  Definition of ‘estate’  IHTA 1984, s 5(1) - all property to which he was beneficially entitled immediately before his death, with the exception of ‘excluded property’.  (a) Property which passes under the deceased’s will or on intestacy.  The deceased was ‘beneficially entitled’ to all such property immediately before he died.  (b) Property to which the deceased was ‘beneficially entitled’ immediately before his death but which does not pass under his will or on intestacy.

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 Deceased’s interest in any joint property passing on his death by survivorship to the surviving joint tenant(s). The deceased will be taken to have owned an equal share in the property with the other joint tenant(s). (c) Property included because of special statutory provisions.  (i) certain trust property; and  (ii) property given away by the deceased in his lifetime but which is ‘subject to a reservation’ at the time of death.

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Trust property included in the estate for IHT purposes  If entitled to the income from a trust - ‘beneficially entitled’ to the capital which produces that income - trust fund taxed as if it were part of the beneficiary’s estate.  ‘qualifying interest in possession’.  must be an interest under which the beneficiary is entitled to claim the income from the trust property (or enjoy trust property) with no power on the part of the trustees to decide whether or not he should receive it.  On/after 22 March 2006, qualifying interest in possession in limited circumstances.  ‘immediate post-death interest’ (IPDI) - an interest in possession arising on the death of the settlor under his will or intestacy. Property subject to a reservation  The Finance Act 1986 - give property away more than 7 years before death but continuing to enjoy the benefit of the property.  Deceased gave away property during lifetime but did not transfer ‘possession and enjoyment’ of the property/was not entirely excluded from enjoying the property.  If property reserved - ‘beneficially entitled’. Property outside the estate for IHT purposes  life assurance policy once it is written in trust for a named beneficiary.  discretionary lump sum payment made from pension fund to the deceased’s family. Excluded property  Certain property which would otherwise be included in the estate for IHT purposes  Excluded property is not part of the estate for IHT purposes.  ‘reversionary interest’- a future interest under a settlement (an interest in remainder under a trust).  EXAMPLE - In 2000, Faith created a settlement placing £500,000 on trust for Guy for life, remainder to Hazel absolutely. Whilst both Guy and Hazel are alive, Guy has a qualifying interest in possession and Hazel has a reversionary interest (that is excluded property).

 Step 2: Find the value transferred  Basic valuation principle  ‘the price which the property might reasonably be expected to fetch if sold in the open market’ immediately before the death (IHTA 1984, s 160).  The value of an asset agreed for IHT purposes is known as the ‘probate value’.  Modification of the basic valuation principle: s 171  IHTA 1984, s 171 - where the death causes the value of an asset in the estate to increase or decrease, that change in value should be taken into account.  Valuing quoted shares  The value of quoted shares is taken from the Stock Exchange Daily Official List for the date of death (or the nearest trading day).  The list quotes two prices. To value the shares for IHT, take one-quarter of the difference between the lower and higher price and add it to the lower price.  Debts and expenses  Liabilities owed at the time of death are deductible (IHTA 1984, s 505).  Reasonable funeral expenses are also deductible (IHTA 1984, s 162).

 Step 3: Apply any relevant exemptions and reliefs  Spouse or civil partner exemption  S18 IHTA 1984 exempt if it passes to the deceased’s spouse or civil partner under the deceased’s will or intestacy or, in the case of joint property, by survivorship.  s 18(2), if the transferor is domiciled in the UK but the transferee is not, the level of the exemption is currently limited to £55,000.  Trusts - IHT is charged as if the person with the right to income owned the capital.  Charity exemption  S 23 (1) IHTA 1984, s 23(1) passes on death to charity is exempt.  life interest in trust property which passes under the terms of the trust to charity.  gifts to certain national bodies and bodies providing a public benefit.  Business and agricultural property relief  Reduce the value transferred by a transfer of ‘relevant business property’ by a certain percentage  Must be a trading concern  Must have owned for at least 2 years before death  The reduction is 100% for:  (a) a business, or an interest in a business (such as a share in a partnership); and  (b) unquoted shares.  The reduction is 50% for:  (a) quoted shares which gave the transferor control of the company; and  (b) certain land, buildings and machinery owned by the transferor but used in his company or partnership.  Agricultural property relief applies in a similar manner to reduce the agricultural value of agricultural property  Step 4: Calculate tax at the appropriate rate  first £325,000 of his estate (the ‘nil rate band’) is 0%.  excess at 40  Finance Bill 2012 may apply. aimed at increasing charitable giving and will apply a 36% tax rate in place of the normal 40% rate when at least 10% of a defined ‘component’ of a person’s net estate passes to charity.  If the deceased died on or after 9 October 2007 having survived a spouse or civil partner, the nil rate band increased by whatever percentage of the nil rate band of the first to die was unused by them subject to a maximum increase of 100%).  cumulation principle - lifetime transfers use up the deceased’s nil rate band first.  LIFETIME TRANSFERS: POTENTIALLY EXEMPT TRANSFERS  Any gift made by an individual to another individual or into disabled trust - IHTA 1984, s 3A(1A)) - to the extent in either case that the gift would otherwise be chargeable.  All lifetime gifts to an individual are ‘potentially exempt’ to the extent that no immediate exemption applies.  Step 1: Identify the ‘transfer of value’  Any lifetime disposition reduces the value of his estate (IHTA 1984, s 3(1)) - lifetime gift.

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Become chargeable because the transferor died within 7 years of making the transfer. Exclusion: such as a transfer for the maintenance, education or training of the transferor’s child under 18, or over that age if still undergoingfull-time education or training, or for the maintenance of a dependent relative (IHTA 1984, s 11).  Step 2: Find the value transferred  Value of transferor’s estate ‘less than it would be but for’ the transfer (IHTA 1984,s 3(1)).  Loss to the estate is market value of the property transferred.  Step 3: Apply any relevant exemptions and reliefs  Spouse or civil partner and charity exemptions  Business and agricultural property relief  if transferor dies within 7 years after transfer, relief available only if the transferee still owns the property or qualifying replacement when the transferor dies.  Order of application of exemptions and reliefs  Spouse or civil partner and charity exemptions are applied before reliefs.  The ‘lifetime only’ exemptions may apply to only part of a transfer - applied before such exemptions are considered.  Lifetime only exemptions  The annual exemption (IHTA 1984, s 19)  first £3,000 transferred by lifetime transfers in each tax year.  Any unused annual exemption may be carried forward for one year only.  Small gifts (IHTA 1984, s 20)  Lifetime gifts in any one tax year of £250 or less to any one person are exempt.  Normal expenditure out of income (IHTA 1984, s 21)  A lifetime transfer is exempt if it can be shown that:  (a) it was made as part of the transferor’s normal expenditure; and  (b) it was made out of the transferor’s income; and  (c) after allowing for all such payments, the transferor was left with sufficient income to maintain his usual standard of living.  Gifts in consideration of marriage (IHTA 1984, s 22)  Lifetime gifts on marriage are exempt up to:  (a) £5,000 by a parent of a party to the marriage;  (b) £2,500 by a remoter ancestor of a party to the marriage; and  (c) £1,000 in any other case.  Potentially exempt status  As long as the lifetime transfer is not immediately chargeable, chargeable only if the transferor dies within seven years.  OTHER LIFETIME TRANSFERS: LIFETIME CHARGEABLE TRANSFERS  Any lifetime transfer which does not fall within the definition of a PET is immediately chargeable as a ‘lifetime chargeable transfer’ (LCT).  Steps 1-3 are the same.  the balance is chargeable to IHT and tax must be calculated by applying step 4.  The rates of tax applicable to LCTs are:  (a) 0% on the first £325,000 (the nil rate band); and  (b) 20% on the balance of the chargeable transfer.

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Cumulation must occur

 EFFECT OF DEATH ON LIFETIME TRANSFERS  Effect of death on PETs  A PET is chargeable only if the transferor dies within seven years of making the transfer.  Steps 1-3 are the same  cumulative total will be made up of:  (a) any LCTs made in the seven years before the PET being assessed (even if the LCT was made more than seven years before the transferor’s death); and  (b) any other PETs made during the seven years before the PET being assessed which have become chargeable as a result of the transferor’s death.  Tax rates to chargeable transfers within seven years of death of the transferor are:  (a) 0% on the available nil rate band; and  (b) 40% on the balance (the lower 36% charity rate is not applicable).  Tapering relief  Where a PET has become chargeable, tapering relief is available if the transferor survives for more than three years after the transfer.  The relief works by reducing any tax payable on the PET.  (a) transfers within 3 to 4 years before death: 80% of death charge  (b) transfers within 4 to 5 years before death: 60% of death charge  (c) transfers within 5 to 6 years before death: 40% of death charge  (d) transfers within 6 to 7 years before death: 20% of death charge  Effect of death on LCTs  Steps 1-3 are the same  the lower 36% charity rate is not applicable.  The cumulative total is made up of:  (a) any other LCTs made in seven years before the LCT being assessed (even if such earlier LCTs were made more than seven years before the transferor’s death); and  (b) any PETs made during the seven years before the LCT being assessed which have become chargeable as a result of the transferor’s death.  tapering relief applies to reduce the recalculated tax.  Credit is then given for any IHT paid on the LCT at the time it was made but if the recalculated bill is lower than the original amount paid no tax is refunded.  LIABILITY AND BURDEN OF PAYMENT  Meaning of ‘liability’ and ‘burden’  Payment will usually be obtained from people who are not beneficially entitled to the property but who hold property in a representative capacity (ie PRs and trustees).  Those who ultimately receive the property are concurrently liable.  The estate rate  average rate of tax applicable to each item of property in the estate for IHT.  The principle is that tax is divided between the various assets in the estate proportionately, according to their value.  Liability for IHT on death  The PRs: tax on the non-settled estate

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The PRs are liable to pay the IHT attributable to any property which ‘was not immediately before the death comprised in a settlement’ (IHTA 1984, s 200).  This includes:  (a) property which vests in the PRs; and  (b) property not pass to the PRs but in the because beneficially entitled.  Thus the PRs are liable to pay the IHT on joint property even though that property does not vest in them.  IHTA 1984, s 200(1)(c)) tax on property passing by will or intestacy may be claimed by HMRC from a beneficiary who has received that property.  HMRC may claim tax on joint property from the surviving joint tenant – unusual.  The trustees: tax on settled property  Part of estate that is ‘comprised in a settlement’ the trustees of the settlement are liable for IHT attributable to that property.  relevant where the deceased had a qualifying interest in possession under a trust.  Additional liability of PRs  If reserved a benefit in the property - donee liable to pay tax  if unpaid 12 months after the end of the month of death, the PRs become liable.  Liability for IHT on PETs  Transferee liable but PRs liable if the tax unpaid 12 months after end of month of death.  Liability of PRs limited to assets received/would have received but for neglect/default.  PRs cannot escape liability on the grounds that they have distributed the estate and so they should ideally delay distribution until IHT on any such lifetime gifts has been paid.  Liability for IHT on LCTs  Transferor liable for IHT, although HMRC may also claim the tax from the trustees.  If transferor pays, the amount of tax will be more than it would be if the trustees paid.  Because IHT charged on value transferred, ie loss to transferor’s estate due to the gift.  Burden of IHT  Unlike liability, question where burden of tax should fall is for the transferor to decide.  TIME FOR PAYMENT  Death estates  The basic rule  6 months after end of month of death if not paid on time, interest on amount.  The instalment option  10 equal yearly instalments, 1st due six months after the end of the month of death.  Tax is apportioned using estate rate to find tax for instalment option property.  The instalment option applies to:  (a) land of any description;  (b) a business or an interest in a business;  (c) shares gave control of the company to the deceased;  (d) unquoted shares which do not give control if either:  (i) the holding is sufficiently large (a holding of at least 10% of the nominal value of the company’s shares and worth more than £20,000); or  (ii) HMRC satisfied tax can’t be paid in one sum without undue hardship; or

 (iii) the IHT attributable to the shares and any other instalment option property in the estate amounts to at least 20% of the IHT payable on the estate. 

Interest  Instalment option for tax on shares or any other business property or agricultural land, interest only from the date when each instalment is payable.  other land interest is payable with each instalment (apart from the first) on the amount of IHT which was outstanding for the previous year.  Sale  Instalment option property is sold, all outstanding tax and interest becomes payable.  PETs  six months after the end of the month of death.  Instalment option may be available depending on the circumstances (IHTA 1984, s 227).  LCTs  LCTs made after 5 April before 1 October in any year due on 30 April the following year.  not made between those dates - due 6 months after end of month in which LCT is made.  Any additional IHT on the reassessment of a LCT following the transferor’s death is due six months after the end of the month of death.  Again, the instalment option may be available (IHTA 1964, s 227)....