Inheritance tax – exemptions and reliefs
Death duties have been with us for centuries, in the guise of Estate Duty, Capital Transfer Tax and now Inheritance Tax (IHT). The combination of frozen thresholds and rising property prices have meant more estates than ever are likely to face an IHT bill.
This briefing provides an overview on the main Inheritance Tax principles with an emphasis on looking at IHT Exemptions and Reliefs. Supporting calculations are included to show the learning points in practice.
IHT is a tax on the transfer of assets on certain lifetime gifts or on death.
- IHT is only charged on the part of an estate that is the above the tax-free allowance (called the nil rate band) of £325,000.
- There is also a Main Residence Nil Rate Band of £175,000 which is available to anyone who owns a main residence which is passed onto their direct descendants.
- The current rates of IHT on death are 0% up to the nil rate band and 40% on the excess (reduced to 36% if 10% or more of the deceased’s net estate is left to charity).
- UK domiciled individuals are liable to UK IHT on assets they own anywhere in the world. Non-UK domiciled individuals only pay UK IHT on assets that are situated in the UK.
- Most assets will be chargeable to IHT unless they are specifically exempt.
- There can be benefits to gifting to others during an individual’s lifetime. However, to have this effect, gifts need to comply with certain criteria.
- No IHT is payable on gifts between spouses/civil partners as long as both parties are domiciled in the UK.
- For those who have been married and their spouse/civil partner has died, they will be able to claim the Transferable Nil Rate Band.
- There are also exemptions for those that own a business or agricultural property.
- Inheritance Tax Exemptions
- Inheritance Tax Reliefs
Where an individual’s estate (including lifetime gifts in the previous seven years) is less than £325,000, there will be no IHT to pay. For estates that are valued over this amount there are some valuable exemptions and reliefs that can be used to reduce the amount of IHT liability.
Some gifts are completely exempt from IHT whether they are made during lifetime or on death and others are exempt only if made during lifetime.
Broadly speaking, for gifts made during lifetime, once the individual survives seven years after having made them, their value will not be counted as part of the estate on death and will be exempt from IHT. This is provided the donor has given up all rights to the gifted asset, otherwise this will be considered as a Gift With Reservation of Benefit and will fall back into their estate for IHT purposes.
These lifetime transfers to individuals are called Potentially Exempt Transfers (PETs) and become totally exempt once the donor has survived for seven years from the date of the gift.
If any gift is exempt from IHT, it will not be included in the estate when working out whether any IHT is due. The main IHT exemptions are as follows.
Gifts between Spouses and Civil Partners
Gifts made between spouses/civil partners, during their lifetime or on death, are exempt from IHT, provided both of them are UK domiciled or deemed domiciled. Where the recipient is non-UK domiciled, the amount that can be transferred without it being assessable to IHT is £325,000. Any value over this amount will be subject to IHT. Gifts made from a non UK spouse/civil partner to a UK domicile spouse/civil partner, will benefit from the full spouse/civil partner exemption.
This exemption is not available to individuals who are co-habiting or who may be co-parenting but not married or civil partnered.
Gift to Charities
The gift to charities exemption is available where an individual makes a gift either during their lifetime or on their death. The charity must be UK registered. In some cases this exemption can also apply to gifts made to certain EU charities.
The IHT rate of tax reduces to 36% where at least 10% of an individual’s net estate is left to charity.
The small gift exemption allows an individual to gift up to £250 per person (to an unlimited number of recipients) each tax year. The small gift exemption cannot be used when making a gift to an individual that has already benefitted from another IHT exemption (e.g. it cannot be used in addition to the annual exemption).This exemption applies during an individual’s lifetime. It cannot be claimed to reduce the value of the estate on death.
This covers gifts to the value of £3,000 each tax year, made during an individual’s lifetime – all or some of which can be rolled over to the following tax year, making it possible to gift up to £6,000 in one tax year. This means a couple could make gifts of up to £6,000 in one year; or £12,000 if they have rolled over the previous year’s exemption.
Gifts out of Normal Expenditure
Regular gifts of income can be made provided that the individual is left with sufficient income to maintain their usual standard of living. For example, the payment of school fees or premiums on a life policy for someone else’s benefit.
For the exemption to apply, it must be shown that the transfer of value/gift meets three conditions:
- It formed part of the donor’s normal expenditure – normal includes standard, regular, typical, habitual, or usual. All relevant factors must be considered (ie frequency and amount, the nature of the gifts, the identity of the recipients and the reasons for the gifts).
- It was made from income (taking one year with another). Common sources of income are employment and self–employment, rents from property, pensions, interest and dividends.
HMRC will initially look at the income of the year in which gifts were made to establish whether there was enough income available to make the gifts, before considering earlier years.
Payments received regularly may appear to be income but are in fact capital in nature. An example would be withdrawals from an investment bond, which are considered a return of capital and would not qualify as income for this exemption.
- It left the transferor with enough income to maintain their normal standard of living. Gifts out of income will not qualify for exemption if the transferor had to resort to capital to meet their income needs. To claim this exemption, details of the deceased’s income and expenditure should be provided to HMRC using page 8 of form IHT403.
Gifts in consideration of marriage
An individual can gift up to the following amounts to someone who is getting married or entering a Civil Partnership. The amount that can be gifted depends on the donor’s relationship with the recipient. Gifts can be made up to:
- £5,000 to a child
- £2,500 to a grandchild or great-grandchild
- £1,000 to any other person
The gift must be made on or shortly before the marriage or the registration of the civil partnership, it must be made in contemplation of the marriage or civil partnership, and the gift must be conditional on the marriage or civil partnership taking place.
The gift can be combined with another exemption, such as the annual exemption (but not the small gift exemption). This means a parent could gift their child up to £8,000 (a £5,000 gift made in consideration of marriage plus the £3,000 annual exemption), or possibly up to £11,000 if they can carry forward a full unused annual exemption from the previous tax year. This also means both parents could jointly gift up to £22,000.
The excess of any gift over the available exemptions is chargeable to IHT.
Gifts to Political Parties
Gifts can be made to any UK political party as long as at the last general election it had either at least two MPs in the House of Commons, or one MP and received at least 150,000 votes.
Gifts for National Purposes
These are national institutions (e.g. the National Gallery and British Museum) that exist for the purposes of preserving for the public benefit collections of scientific, historic or artistic interest.
Gifts to Housing Associations
Gifts of land to registered housing associations are exempt. A registered housing association is a non-profit making body established for the provision or encouragement of housing.
Quick Succession Relief
Quick Succession Relief may be available on the death of an individual who had previously benefited from a Will or intestacy. It gives some credit for the IHT that was paid on the estate of the person they inherited from. The amount of the relief is tiered and depends on the length of time between the first and second person’s death. The relief is deducted from the IHT liability on the estate of the second person to die.
For relief to apply, there must have been IHT paid on the first death and, there must be an IHT liability on second death, and the second death must occur within five years of the first death.
Quick Succession Relief is calculated on the first death using this formula:
net estate (after IHT is paid) x IHT paid on the first death
gross estate (before IHT is paid)
The credit given on second death will always be less than the IHT paid on first death and is tapered as follows.
Period between the transfer and the death of the transferee
|1 year or less
|Over 5 years
If the period is precisely two years, 80% relief is given and so on.
Business Relief (formerly Business Property Relief)
Any ownership of a business, or share of a business, is included in the estate for Inheritance Tax purposes. However, Business Relief is on certain assets after an ownership period of two years. Business Relief is applied to the value of relevant business property and is available for transfers during lifetime and on death.
Relevant business property that will qualify for this relief is defined as:
a) Property consisting of a business or an interest in a business (such as a partnership share)
b) Securities of a trading company which are unquoted and which (alone or with other securities or unquoted shares) gave the transferor control of the company immediately before the transfer
c) Any unquoted shares (not securities) in a trading company
d) Shares in, or securities of, a company which are quoted and which (alone or with other such shares/securities) gave the transferor control of the company immediately before the transfer
e) Any land or building, machinery or plant which, immediately before the transfer, was used wholly or mainly for the purposes of a business carried on by a company of which the transferor then had control, or by a partnership of which they were then a partner
f) As in e) where the asset was used in a business carried on by the transferor and was settled property in which they were then beneficially entitled to an interest in possession
For the purpose of Business Relief, shares or securities on the Alternative Investment Market (AIM) are treated as unquoted.
Business Relief is only available if the relevant business property, as described previously:
- was owned by the transferor for at least the two years preceding the transfer, or
- replaced other relevant business property where the combined period of ownership was at least two out of the last five years. In this situation, relief is given on the lower of the values of the two sets of property.
This gives an individual up to three years to reinvest the sale proceeds of a qualifying business into a new qualifying business without any loss of Business Relief.
Business Relief is still available even if the transferor cannot fulfil either of the two-year ownership criteria if:
- they acquired it by gift, and
- when they acquired the property, it was eligible for Business Relief and
- either the previous or current transfer was made on death.
It is important to note that even though business property may qualify for 100% relief from IHT, the value of the business property must be included in the estate total for the purposes of determining eligibility for the Residence Nil Rate Band (RNRB). If the total estate value, including the value of any business property, exceeds £2m, the RNRB will be restricted (this is covered in a separate IHT briefing).
Business Relief is not available if the business consists wholly or mainly of:
- dealing in securities, stocks and shares,
- dealing in land or buildings, or
- making or holding investments (including land which is let).
Business Relief a complex specialised area, the detail of which is outside the scope of this document. In most scenarios, specialist advice will be required.
Agricultural Relief (formerly Agricultural Property Relief)
Agricultural Relief is available on gifts of land occupied for the purposes of agriculture, together with appropriate buildings and farmhouses used in conjunction with the land. It enables agricultural property to be passed on free of Inheritance Tax, either during lifetime or on death.
The relief is available where agricultural property is situated in the UK or the European Economic Area, however from 6 April 2024, it will be restricted to agricultural property in UK. Agricultural property that qualifies for Agricultural Relief is land or pasture that is used to grow crops or to rear animals intensively. It also includes:
- Growing crops.
- Stud farms for breeding and rearing horses and grazing.
- Trees that are planted and harvested at least every 10 years (short-rotation coppice).
- Land not currently being farmed.
- Some agricultural shares and securities.
- Farm buildings, farm cottages and farmhouses:
- Buildings must be of a nature and size appropriate to the farming activity that is taking place. The property is valued as if it could only be used for agricultural purposes. Any value over and above this agricultural value, such as the market price of a country residence, does not qualify for Agricultural Relief.
- A cottage or farmhouse must be occupied by someone employed in farming or a retired farm employee, or the spouse or civil partner of a deceased farm employee.
- The property must have been owned and occupied for agricultural purposes immediately before its transfer for:
Two years if occupied by the owner, a company controlled by them, or their spouse or civil partner.
Seven years if occupied by someone else.
Agricultural Relief is available in respect of the agricultural value of property and cannot be claimed on any enhanced value attributable to development potential of the land.
Agricultural Relief is available at 100% if:
- The person who owned the land farmed it themselves.
- The land was used by someone else on a short-term grazing licence.
- It was let on a tenancy that began on or after 1 September 1995.
Relief will be due at a lower rate of 50% in any other case.
Similar to Business Relief, this is a complex specialised area, the detail of which is outside the scope of this document. In most scenarios, specialist advice will be required.