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Inheritance tax

Taper Relief

Taper relief causes a lot of confusion over when it applies and how it works.

To start with, although it is called taper ‘relief’, it is not strictly a relief as defined elsewhere in the Inheritance Tax Act 1984 (IHTA). It is actually a percentage reduction in the tax payable. Another aspect that can cause confusion is that taper relief does not reduce the capital value of the transfer – it only reduces the actual tax payable. Therefore, if there is no tax payable on death on a specific gift, you cannot claim taper relief to reduce the value of that gift. Consequently, any gift which sits inside the nil rate band (NRB) – currently £325,000 – cannot benefit from taper relief.

Taper relief (under IHTA/S7(4)) applies where:

  1. the transfer was made more than three years but less than seven years before the transferor’s death, and
  2. tax is due on the transfer in its own right.

Time Between date of Gift
and date of Donor's Death
 
Taper Relief Applied
to tax Due
 
Effective Rate on Gift
 0 to 3 Years
0%
 40%
 3 to 4 Years
20%
 32%
 4 to 5 Years
40%
 24%
 5 to 6 Years
60%
 16%
 6 to 7 Years
80%
 8%

Here are some examples, all of which assume that lifetime exemptions have already been used elsewhere and no other gifts have been made:

Example 1:

Jack makes a gift of £360,000 simultaneously between his four sons in December 2012. He dies in May 2014.

The gift was made within 18 months of Jack’s death and it is above the NRB at the date of death.  Therefore, there is IHT to pay. Unfortunately, as Jack died within three years of making the gifts there is 0% taper relief available. The IHT calculation is:
£360,000 (value of gifts) – £325,000 (NRB) = £35,000 x 40% (rate of IHT on death) = £14,000 tax payable.

Example 2:

Jon makes a gift of £300,000 to his son on 1 March 2011. He dies on 20 October 2014.

The gift was made over three years before death, but its value is below the IHT NRB at date of death. As there is no tax directly attributable to the gift there is no taper relief available.

Remember that gifts made in the seven years prior to death are offset against the NRB in chronological order and, once the NRB has been fully used up, any excess gift(s) will potentially be subject to IHT.

Example 3:

Peter makes a gift of £350,000 to his son on 1 July 2011. He dies on 5 November 2014. 

The gift was made over three years before death and the value is above the IHT nil rate band at date of death.  Therefore, IHT is due. The calculation is: £350,000 (value of gift) - £325,000 (NRB) = £25,000 x 40% = £10,000. As the gift was made between 3 and 4 years before the date of death, taper relief applies to the tax payable. £10,000 x 20% taper relief = £2,000; therefore tax of £8,000 (£10,000 - £2,000) is payable.

Example 4:

Emily makes a gift of £200,000 into a discretionary trust on 10 June 2010. Emily had given her daughter £200,000 in November 2008. Emily died on 24 February 2015.

The gift into the trust was made over four years before death and its value, when added to the failed potentially exempt transfer (PET) made in November 2008 of £200,000, is over the IHT NRB at the date of death (£325,000). Therefore, IHT is due. The calculation is:
£325,000 (NRB) - £200,000 (failed PET) = £125,000 (available NRB). £200,000 (gift to trust) - £125,000 (available NRB) = £75,000. IHT @ 40% x £75,000 = £30,000 tax. Taper relief applies against the £30,000 tax payable and, as the gift was made between 4 and 5 years before the date of death, the percentage relief is 40%. £30,000 x 40% taper relief = £12,000 therefore tax of £18,000 (£30,000 - £12,000) is payable. 

Taper relief and relevant property trusts. If you are recalculating the tax due on discretionary trusts on death, where there was a lifetime tax charge at inception, you do get credit for the lifetime tax paid and this may mean that no further tax is payable –but no refund of tax paid at inception is available if the tax due on death is a lower amount. Non-exempt gifts into discretionary trusts are chargeable lifetime transfers (CLTs).

Example 5:

Michael created a discretionary trust in March 2007 for £285,000. He then created a further discretionary trust in September 2011 for £315,000. At this point, the trustees paid a lifetime tax charge (20%) on the excess over the cumulative seven year total: £285,000 + £315,000 = £600,000 - £325,000 (NRB) = £275,000 x 20% = £55,000 tax payable. Michael died on 13 December 2014.

The first discretionary trust (£285,000) had run more than seven years and is therefore not included in Michael’s death calculation for IHT payable on his estate. However, when we look at the calculation for the second discretionary trust (£315,000), we have to look back seven years from inception of this trust and the first discretionary trust has to be included as it was created in the seven years prior to this one. Therefore the calculation is:

£600,000 (total of all CLTs within seven years of inception of second trust) minus £325,000 (NRB) = £275,000 x 40% (IHT rate on death) = £110,000.  Michael died between 3 and 4 years from inception; therefore taper relief applies at 20%. £110,000 x 20% = £22,000. Tax payable is £110,000 - £22,000 (taper relief) = £88,000 - £55,000 (tax paid at outset) = £33,000 further tax payable.

Example 6:

If we take the above example but change Michael’s date of death to 13 December 2017, the calculation would be:

£600,000 (total of all CLTs) minus £325,000 (NRB assumed to remain at £325,000) = £275,000 x 40% (IHT rate on death) = £110,000. Michael now died between 6 and 7 years from inception; therefore taper relief applies at 80%. £110,000 x 80% = £88,000.  Tax payable is £110,000 - £88,000 (taper relief) = £22,000 - £55,000 (tax paid at outset) = £0. The taper relief has reduced the tax payable to less than the tax that was paid at inception (£55,000), so no tax is payable on death - but no refund of tax paid at inception is available.

Planning points

  1. Taper relief only applies to gifts made more than three years but less than seven years before death.
  2. It is the value of the gift at the date the gift was made that is used in the calculation – not the value of the gifted property at the date of death.
  3. Every individual has a “nil rate band” (currently £325,000) on which IHT is payable at 0%.  Therefore, IHT only applies to gifts when the cumulative value of chargable gifts made within the seven years prior to death exceeds the NRB.
  4. The NRB is applied in chronological order, so any gifts (within the seven years prior to death) will claim the nil rate band before it can apply to any other assets or property that the deceased leaves on death.
  5. Certain gifts made up to 14 years before death could be included when calculating tax due on gifts within seven years of death, as any chargeable transfers (which includes failed PETs) made in the seven-year period prior to a gift, made within seven years of death, will be included.
  6. For CLTs, the IHT liability on death is first calculated at the full death rate (40%) then any applicable taper relief is deducted and finally any lifetime IHT (20%) paid at inception is deducted. If this produces a negative amount, no refund is due.
  7. Where multiple lifetime gifts have been made, you must work out the amount of NRB available to each gift separately and then apply taper relief to each gift separately where applicable.
  8. The application of taper relief to the tax payable on individual gifts does not reduce the value of those gifts when looking at subsequent gifts or the estate on death.
  9. If the settlor paid the lifetime tax on a gift then you must include the tax paid when calculating the value of the gift at inception. For example: settlor gifts £350,000 to a discretionary trust (assume all exemptions have been used) and the settlor then pays the £6,250 lifetime tax charge. (£350,000 - £325,000 = £25,000 x 20% = £5,000; plus grossed-up £6,250 x 20% = £1,250; £5,000 + £1,250 = £6,250) Value of gift for IHT purposes is grossed up to £356,250. (Lifetime tax = £356,250 - £325,000 x 20% = £6,250).
  10. Individual gifts are removed from the IHT death calculation on the estate seven years from the date they were made.

This briefing note has been prepared for professional adviser use only.

This briefing note can also be viewed as a PDF

 

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