Benjamin Franklin said in 1789 “In this world nothing can be said to be certain, except death and taxes.” Inheritance tax is the meeting point of these two certainties of life! When you die leaving your estate and property to your loved ones, government will take 40% of it from your loved ones (with some exceptions & reliefs).
Although it is generally true that inheritance tax arises at the point of death, there are some situations where it arises during lifetime of a person which we will explain later.
Good news is that you can avoid all of inheritance tax by good tax planning well ahead of your death. Actually, government encourages you to do proper tax planning. Contact UK Property Accountants to find out how you can reduce or eliminate potential inheritance tax bill.
Individuals who are domiciled in the UK are liable to inheritance tax on transfers of all assets anywhere in the world. On the other hand, individuals, who are not domiciled in the UK, are liable to inheritance tax on transfers of their UK assets only.
Domicile of origin
At birth, an individual acquires domicile of his/her father when they are born. For example, a child of UK parents will be UK domiciled.
Domicile of dependency
Until the age of 16, your domicile status depends on your parents or guardians. If your parents’ domicile status changes, the domicile status of the child automatically changes with the parent.
Domicile of choice (Emigration)
Although the name implies, you don’t have any choice under this method! However, you can change your personal circumstances proving your intention to reside permanently in your new home country. However, you have to work really hard to be able to prove HMRC that you have acquired a domicile status somewhere else outside the UK.
From April 2017, if you have been tax resident in the UK for at least 15 tax years out of 20, you will be deemed to be UK domiciled. Before April 2017, it was 17 tax years out of 20.
On death, inheritance tax is collected at single rate of 40%. So, if you have taxable value of £2.5 million, inheritance tax of £1 million is payable.
On lifetime transfers, the rate immediate inheritance tax is 20%. Extra tax is payable if taxpayer dies with 7 years of transfer.
Nil rate band is £325,000 until tax year 2020/21. Also, for deaths occurring after 5 April 2017, there is additional residence nil rate band. This new additional exemption limit is available on qualifying residential property as shown in the table below:
Residence Nil Rate Band
A property must have been the deceased’s private residence at some point during their ownership to qualify for the additional nil rate band.
Certain transfer of value are completely exempt from Inheritance tax as detailed below:
A potentially exempt transfers will not give rise to inheritance tax during lifetime of the donor. These transfers will be fully exempt if donor survives for 7 years from the date of the gift.If donor dies within 7 years of the gift, inheritance is payable on the transfer subject to taper relief we will discuss below.
All gifts by donor to any individuals are potentially exempt transfers. This means any gifts to trusts (except bare trusts & disabled trusts) are not potentially exempt.
Any transfers that are neither exempt nor potentially exempt are chargeable to inheritance tax and so are chargeable lifetime transfers. The most common type of chargeable transfer are transfer to discretionary trusts and interest in possession trusts. These transfers are taxed at 20% at the time of transfer with additional tax of 20% if donor dies within 7 years.
The gifts to company is also chargeable lifetime transfer. However, in most of the cases, the donor receives share or loan capital in return of the transfer and so there is no loss to the donor. As a result, in majority of the cases, there will not be any charge on transfer to the company. However, if donor gifts assets to the company and receives nothing in return, this will be chargeable.
If the donor dies within 7 years of the transfer, both potentially exempt transfers and chargeable lifetime transfers will taxed at the death at 40% subject to tapering relief. In case of chargeable lifetime transfer, as 20% inheritance tax would have been already paid, there is only additional 20% tax to be paid to get to total 40% tax.
Good news is that if the transfer was made more than 3 years before the death, there is reduction in the normal rates of inheritance tax. This is called ‘Taper Relief’.
No of years after transfer, before death
% of death rate of 40%
Effective rate of IHT
Not more than 3 years
3 years to 4 years
4 years to 5 years
5 years to 6 years
6 years to 7 years
More than 7 years
To encourage continuity to of the existing businesses, there is special relief for the businesses called ‘Business Property Relief (BPR)” which is either 50% or 100% depending upon the situation as shown below:
In any case, to qualify for business property relief, business needs to be qualifying business which is quite restrictive for property investors. Usually, this relief is not available to property investors as described below:
Further details on BPR can be found on HMRC guide.
Similar as BPR, agricultural property relief is also given at the rate 50% or 100% depending upon the situation. 100% APR is available to a farmer who owns the land and buildings and uses these assets in his own business. In case of tenanted land, either 50% or 100% APR is available depending upon the case. For further details on this, please refer to HMRC guide on this.
As you can see, Inheritance tax is quite complicated tax, and substantial tax saving can be achieved with property tax planning well in advance of the death. As property tax specialists, we will provide you holistic tax advice considering the implication on inheritance tax together with other taxes such as capital gains & income tax.
Contact us now to discuss how we can help you.