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Inheritance Tax, a tax on the wealthy? Urban myth or fact?

Inheritance tax has been around in some form since 1796. Estate duty dates back to 1894 and over the years this tax has evolved into the inheritance tax (IHT) we know and love today which was introduced in 1986 as a replacement for Capital Transfer Tax (CTT).


When Harold Wilson’s government introduced CTT, in 1975, it was intended that it would be more difficult to avoid paying the tax. Introduced was a lifetime charge to tax on gifts whenever they were made, certain exemptions and reliefs as well as a set of complicated rules for taxing property settled on trusts.


But everyone likes a challenge and the industry got busy trying to devise schemes to avoid paying the tax. A number of insurance-based mitigation packages were launched in the early 1980s that exploited the facility of giving an asset away and retaining an annual benefit from the gifted property while at the same time removing it from the estate for CTT purposes.


Enter modern day IHT and the gift with a reservation of benefits rule.


In this series of articles we will consider what is included in an estate, how it is calculated and the various exemptions and reliefs. We will also consider ways of mitigating IHT.

There is more to an estate than you might expect. An estate can include the family home, its contents, cars, bank and building society accounts, investments (for example, shares and investment bonds) and a share of any assets owned jointly. It can also include certain gifts made during the deceased’s lifetime.


However, from the estate certain debts and liabilities can be deducted, such as funeral costs and relevant outstanding bills, like credit card debts.


When arriving at the net value of the estate there are also exemptions and tax reliefs to be considered.

The rules surrounding tax reliefs, deductions and gifts can be complex but do play an important part of estate planning for clients.


Valuing an Estate


All assets that the deceased owned absolutely at the date of their death need to be valued and included in the IHT400 or IHT205 forms. But sometimes it can be difficult to establish whether an asset needs to be included and the value attached to that asset.

When valuing a gift, most of the time the market value (realistic selling price) is used. But remember if the gift was part of assets that were worth more combined than split the value of the gift is the loss to the estate. For example, two vases together are worth £100,000 but separately they are worth £30,000. If the deceased gifted one of the vases the loss to the estate is actually £70,000 - the value of the vases together less the value of the vase that the estate retained.

Jointly owned property

Where the deceased owned an asset with another person the whole asset must firstly be valued. Then the deceased’s share needs to be calculated and added to their estate.


Where the asset is a house and the other owner was not the deceased’s spouse or civil partner 10% is taken off the other owner’s share if the house was situated in England, Wales or Northern Ireland. However, if the house is situated in Scotland £4,000 is taken off the whole asset before working out the deceased’s share.


The deceased may also have held a joint bank or building society account with another person. Even though the surviving owner will automatically inherit the whole of the money, the value of the deceased’s share is included in their estate. If all the money in the joint account was provided by the deceased then the total value of the account should be included. For example some elderly people hold their bank accounts jointly with their children to ensure that the children can access the account on their behalf. As the children did not provide any of the money in the account on their parent’s death the full balance should be included in their parent’s estate as it was their money initially.


What lifetime gifts are chargeable to IHT on death?


Also, when valuing the estate all gifts the deceased made in the seven years before death need to be considered.

There are some exemptions and reliefs available for lifetime gifts, meaning that often no IHT liability arises during the lifetime of the donor (the person making the gift). Some gifts, known as potentially exempt transfers (PETs), may become chargeable to IHT when the donor dies, if the donor dies within seven years of making the gift, as it is then no longer potentially exempt.


In addition, gifts known as chargeable lifetime transfers (CLTs), which can create an IHT liability during the lifetime of the donor, may also be chargeable to IHT when the donor dies. CLTs are normally gifts made into trusts, rather than gifts made outright to individuals and the tax can depend on what other gifts the settlor made in the seven years before.

Looking at an example:

  • In January 2013 Ned had set up a discretionary trust with a gift of £318,000. He hadn’t made any previous CLTs so no tax was payable, but regularly used his £3,000 annual gift exemption.
  • He made a further gift of £125,000 in July 2013, outright, to his daughter, Maud.
  • Ned, sadly, died in August 2016.
  • Gifts made within seven years before death are included in the estate and are looked at in chronological order.
  • The CLT uses up some of his nil rate band (£318,000).
  • No tax is paid on the gift but there is only £7,000 available of his nil rate band of £325,000, to use against the rest of the estate.
  • Next the PET made in July 2013 has “failed” and becomes a chargeable transfer.
  • As Ned only has £7,000 of his nil rate band available to offset against this failed PET, the excess [£125,000 - £7,000 = £118,000] is above the nil rate band and therefore taxable at 40% along with the estate he owned at the time of his death. Taper relief would be available on the tax on the failed PET, but that is for another day!


The order in which a person gifts can impact the amount of tax payable on their estate and this will be covered later in the series of articles.


Gift with a reservation of benefits (GWR)

Also within a person’s estate are gifts which fall foul of the GWR legislation (s102 Finance Act 1986).

A GWR is, broadly, a gift of property made by an individual on or after 18 March 1986, where the individual continues to receive some form of benefit or enjoyment from the gift. If there is a reserved benefit the effect is that the gifted property is treated as part of the individual’s estate for IHT purposes. Even though they no longer own the property, they are enjoying the benefit of it.


The term 'gift' in the context of a GWR can include a sale deliberately made below market value. For example an individual sells his home for £750,000, when it has been valued at £1million. As the transfer is part sale part gift, even though the individual does not retain a benefit after the transfer on his death the loss to his estate will be £250,000. The £250,000 would be treated as a potentially exempt transfer and would be included within the deceased’s estate if death occurs within seven years of the sale.


When looking at the GWR rules you need to remember that it has only been around for 30 years. A client that gifted property, for example, placing an investment bond into a trust in which they are named as a potential beneficiary before 18 March 1986, will not be caught unless further gifts are settled on or after that date.

In the next in this series of estate planning articles we will consider what exemptions are available.

This article, written by Kim Jarvis from Canada Life's Techncial Services Team, first appeared on Professional Paraplanner's website.


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