Inheritance Tax

Inheritance tax (‘IHT’) was introduced in 1984. It replaced Capital Transfer Tax introduced in 1975, which had imposed a tax charge on the gift of assets during the taxpayer’s lifetime.

The basic principle of IHT is that a tax charge arises on the reduction in the value of an individual’s estate as a result of a transfer of an asset from the estate. Some transfers are referred to as ‘potentially exempt transfers’, since no IHT charge will arise providing the donor survives for seven years after making the gift.

There is a specific exemption from IHT where assets are given to charities. The legislation further defines ‘given to charities’ to mean assets that are given ‘if it becomes the property of charities or is held on trust for charitable purposes only’. The IHT exemption applies equally to lifetime gifts and gifts on death.

If an individual receives a legacy and chooses to pass this on to a charity, it may be appropriate to effect the transfer as a deed of variation within two years of the date of death. Under a deed of variation the gift is treated as if it had been made by the deceased person and can therefore benefit from the general charitable exemption.

A reduced rate of IHT applies where 10 per cent or more of a deceased’s net estate (after deducting IHT exemptions, reliefs and the nil-rate band) is left to charity. In those cases the current 40 per cent rate will be reduced to 36 per cent. The new rate came into effect on 6 April 2012.

The total amount left to charity by the testator is compared to a ‘baseline’ amount to decide whether or not the estate qualifies for the 36 per cent rate. The ‘baseline’ for the purposes of the test will be the value of the estate charged to IHT after deducting all available reliefs and exemptions and the nil-rate band but excluding the charitable legacy itself. The estate qualifies for the 36 per cent rate if the amount left to charity is equal to 10 per cent or more of the baseline.

A person’s estate for IHT purposes includes not only the assets that the deceased owned directly immediately before his or her death and may be disposed of under the terms of the will (the ‘free estate’) but also certain other assets and property. These include jointly-owned assets which pass automatically to the surviving joint owner, interests in certain types of trust (settled property), and some other assets which the individual gave away during his or her lifetime while continuing to derive a benefit (gifts with reservation of benefit). In these cases the estate will be divided into three components: the survivorship component (i.e. property which passes automatically to a surviving joint owner), the settled property component (eg life interests in trusts), and the general component (all property not included in one of the other components). The 10 per cent test will be applied to each component individually and the 36 per cent rate of IHT will apply to any of the components that pass the test. Note that it is possible to merge one or more components to gain the maximum benefit from the reduced rate.

In April 2012, HMRC produced new guidance and an IHT reduced rate calculator relating to this change. The reduced rate calculator will help to work out whether or not an estate will qualify to pay the reduced rate of tax.

IHT thresholds (or ‘nil rate bands’) from 1914, and changes to IHT interest rates from October 1988, can be found here.

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