Inheritance Tax (Advanced)

Scope:

• IHT is charged on the death estate and on certain lifetime transfers
• UK domicile/deemed domicile: worldwide assets subject to IHT
• Non-domiciled: only UK-situs assets (some exceptions for "excluded property")
• From April 2025: non-dom IHT rules replaced by RESIDENCE-based system (10 of last 20 years UK resident → worldwide assets in scope). Transition provisions apply.

Rates (2024/25):

• Nil rate band (NRB): £325,000 — effectively a tax-free threshold
• Residence nil rate band (RNRB): £175,000 — additional for qualifying residence left to direct descendants
• Main rate: 40% — on taxable estate above NRB (plus RNRB if applicable)
• Reduced rate: 36% — if 10% or more of the net estate left to charity
• Lifetime rate on CLTs: 20% (half the death rate) — charged when the transfer is made

Three types of transfer:

Cumulation (7-year principle):

• When calculating IHT on any chargeable transfer, you must CUMULATE all chargeable transfers made in the 7 years BEFORE
• This determines how much of the NRB is available against the current transfer
• The 7-year window "rolls forward" — earlier transfers eventually fall out of cumulation
• Chargeable transfers for cumulation include: CLTs (always) + failed PETs (on subsequent death)

Key exempt transfers:

• Between SPOUSES/CIVIL PARTNERS — unlimited (if both UK-domiciled; if one is non-dom spouse, limit applies)
• Annual exemption £3,000 (per tax year; can carry forward ONE year of unused = max £6,000)
• Small gifts exemption £250 per recipient per tax year (unlimited different recipients; cannot be combined with annual exemption)
• Normal expenditure out of income — regular gifts from INCOME (not capital) that don't affect standard of living
• Marriage/civil partnership gifts — £5,000 (parent), £2,500 (grandparent), £1,000 (others)
• Gifts to charities, political parties, national heritage — unlimited

Potentially Exempt Transfers (PETs):

• Outright gift to an INDIVIDUAL, or to an ABSOLUTE/BARE TRUST
• Also: gifts into certain disabled trusts, or IP trusts established BEFORE 22 March 2006
• Treated as EXEMPT when made — no immediate IHT
• Becomes chargeable ONLY if donor dies within 7 years (then rated at death rates with taper relief if donor survived 3+ years)

Chargeable Lifetime Transfers (CLTs):

• Transfers to most TRUSTS from 22 March 2006 (discretionary trusts and most interest-in-possession trusts)
• Transfers to COMPANIES (unless exempt — e.g., wholly owned)
• Chargeable IMMEDIATELY at 20% on amount exceeding NRB (after cumulating with previous 7 years)

Who pays the CLT lifetime IHT?

Worked example — CLT (donor pays):

Arnold, aged 60, transfers £600,000 in cash to his family discretionary trust in 2024/25. His wife previously transferred her unused NRB to him (£325k inherited). He has made no previous lifetime transfers. Arnold pays the IHT.

• Cumulation (7 years prior): nil
• Arnold's NRB available: £325,000 (his own — the transferred NRB from his late wife applies at HIS death, not on his own lifetime transfers)
• Gross value of transfer = £600,000 (the "loss to donor" includes any IHT he pays)
• Net chargeable (in excess of NRB): £600,000 − £325,000 = £275,000
• IHT at 25% (because donor pays) on net chargeable: £275,000 × 25/100 = £68,750
• Cumulative running total (for 7 years ahead): £600,000 + £68,750 = £668,750 — NO, actually: for cumulation of FUTURE transfers, the "gross" amount is £600,000 + £68,750 = £668,750
• Or alternatively: this is a net-based calculation as given. In an exam, read carefully whether "donor" or "trustee" pays.

Application of annual exemption:

• Always applied BEFORE calculating PET/CLT value
• Use the year's £3,000 first, then any brought-forward from previous year (limited to ONE year carry-forward)
• Apply in CHRONOLOGICAL ORDER to PETs/CLTs in a tax year

Worked example — annual exemption application:

Lisa makes TWO gifts in 2024/25: (1) June 2024: £50,000 to her son; (2) September 2024: £20,000 to her daughter. No previous years transfers.

• Annual exemption available: £3,000 (2024/25) + £3,000 (2023/24 b/f) = £6,000
• Allocated chronologically:
  • June gift: £50,000 − £6,000 = £44,000 chargeable value (PET)
  • September gift: £20,000 − £0 (all AE used) = £20,000 chargeable value (PET)
• Both are PETs — no immediate IHT
• If Lisa dies within 7 years: failed PETs cumulate. £44,000 then £20,000 (with NRB applied)

If the donor dies within 7 YEARS of any lifetime transfer, the position is REVISITED.

For PETs:

• The PET FAILS — becomes a chargeable transfer
• Charged at DEATH RATES (40%) on any amount above NRB available at the time of the PET
• NRB: the NRB available at the DATE OF DEATH (not date of PET) — but reduced by cumulation of earlier chargeable transfers
• TAPER RELIEF may reduce the IHT if donor survived 3+ years from the PET
• Donee (recipient) is liable for the IHT

For CLTs:

• Recalculate IHT using DEATH RATES (40%)
• ADDITIONAL IHT due = (Death rate tax) − (Lifetime tax already paid)
• Taper relief applies (see below)
• Trustees primarily liable

Taper relief:

Crucial point: Taper relief reduces the IHT, NOT the transfer value. So the transfer still cumulates at the original value for subsequent transfers.

Comprehensive example — failed PET with taper:

Robert made a PET of £450,000 to his son in June 2019. He died in September 2024 (5 years 3 months later). No annual exemptions (assume already used). No other lifetime transfers. NRB £325,000 (unchanged).

• Transfer value: £450,000 (PET now a failed PET)
• NRB available: £325,000 (no earlier cumulation)
• Chargeable amount: £450,000 − £325,000 = £125,000
• IHT at 40%: £125,000 × 40% = £50,000
• Taper relief: 5-6 year band → 60% relief on tax → IHT payable: £50,000 × 40% = £20,000
• IHT payable by son: £20,000

Note for the subsequent death estate: the £450,000 PET has now "used up" £325,000 of NRB — so none left for death estate (subject to RNRB).

Complex example — CLT with additional IHT on death:

Helen made a CLT of £500,000 (gross) to a discretionary trust in May 2020. Trustees paid the lifetime IHT. She died in August 2024 (4 years 3 months later).

• LIFETIME calculation (May 2020): £500,000 − £325,000 NRB = £175,000 × 20% = £35,000 lifetime IHT
• DEATH calculation (reopened):
  • Chargeable amount same: £175,000
  • Death rate tax: £175,000 × 40% = £70,000
  • Taper relief (4-5 years): 40% → £70,000 × 60% = £42,000
  • Less lifetime IHT already paid: £35,000
  • Additional IHT on death: £42,000 − £35,000 = £7,000
• Trustees pay the additional £7,000

Structure of death estate computation:

Tax on net chargeable estate:

• Above NRB (+ RNRB): 40% (or 36% if 10% left to charity)

Residence Nil Rate Band (RNRB):

• £175,000 (2024/25) — additional NRB for residence passed to direct descendants
• Direct descendants = children (including adopted, step, foster), grandchildren, and their spouses
• Only available for a RESIDENCE (not other property) that has been the deceased's residence at some point
• TAPERED by £1 for every £2 of estate value over £2m (fully lost at £2.35m + depending on RNRB amount)
• Unused RNRB can be transferred to spouse (same as main NRB)
• "Downsizing addition" — if you sold your home before death (e.g., moved to smaller or care home), can still claim RNRB if direct descendants inherit the cash or smaller home

Transferable NRB and RNRB:

• Any UNUSED NRB from a pre-deceased spouse/civil partner can be TRANSFERRED to the surviving spouse
• Claim made by the executors at the second death (IHT402)
• Transferred as a PERCENTAGE of the NRB at the first death — applied to the NRB at the second death
• Example: First spouse died in 2010 using 40% of NRB. On second death in 2024: surviving spouse has £325,000 + 60% × £325,000 = £325,000 + £195,000 = £520,000
• Same principle for RNRB (since its introduction in 2017)

Quick Succession Relief (QSR):

• Prevents DOUBLE IHT charges when assets pass through two deaths within 5 YEARS
• Relief = tax paid on first death × (value on second death / value on first death) × time-based %
• Time-based % tapers:
  • Within 1 year: 100%
  • 1-2 years: 80%
  • 2-3 years: 60%
  • 3-4 years: 40%
  • 4-5 years: 20%
• Claimed against IHT on second death

Charitable reduced rate (36%):

• If 10% or more of "net estate" passes to charity, the rate on the chargeable portion is reduced from 40% to 36%
• "Net estate" = gross estate less exemptions other than charitable legacies, less BPR/APR, less the NRB, less reliefs
• Often encourages individuals to leave at least 10% to charity — can be tax-efficient

Comprehensive example — death estate:

Maria died in January 2025. Her estate:

• Main residence: £700,000 (left to son)
• Investments: £200,000
• Cash: £150,000
• Private company shares: £400,000 (qualifying for BPR)
• Chattels: £50,000
• Debts: £20,000
• Funeral: £5,000
• Legacies: £50,000 to charity; residue to son
• No previous lifetime transfers. Husband died in 2015 using NO NRB (fully transferred).

Calculation:

Apply NRB and RNRB:

• Own NRB: £325,000
• Transferred NRB (100% of £325,000): £325,000
• Own RNRB: £175,000 (residence to son — direct descendant — qualifies)
• Transferred RNRB: £175,000 (husband died 2015 when RNRB didn't exist, but can still claim transfer)
• Total allowances: £325k + £325k + £175k + £175k = £1,000,000
• RNRB tapering: estate £1.5m < £2m — no taper

Taxable estate: £1,025,000 − £1,000,000 = £25,000
Is 10% left to charity? Test: charity £50,000 vs baseline amount. In this case £50,000/£1,050,000 (estate + BPR excluded value) — may or may not reach 10% threshold for the reduced rate. If not: IHT = £25,000 × 40% = £10,000. If yes: 36% = £9,000.

Note: RNRB taper starts at £2m — Maria's £1.5m gross estate is below the threshold, so full RNRB available. For estates over £2m, each £2 over reduces RNRB by £1.

Business Property Relief (BPR):

A MAJOR RELIEF allowing full or partial exemption of qualifying business assets from IHT.

Categories and rates:

Key conditions:

• Ownership: Transferor must have owned the property for at least 2 years (except replacement property — can combine ownership periods)
• Trading activity: The business must be WHOLLY OR MAINLY TRADING (not investment) — see next
• Exclusion: BPR not available for businesses "wholly or mainly" investment (e.g., property investment, investment companies, security/stock dealing, running cemeteries)

What counts as "investment"?

• Property investment (buy-to-let portfolios) — generally INVESTMENT, not trading
• Exception: furnished holiday lettings traditionally argued as trading (but case law mixed)
• Investment companies (passive holding of assets)
• Dealing in shares/securities (general investment)

"Wholly or mainly" test: Typically >50% of the company's activities must be trading. Investment activities can be incidental. For companies with mixed activities, case-by-case analysis.

Excepted assets:

• Even if the BUSINESS qualifies, SPECIFIC ASSETS within it may not
• "Excepted" assets = not used wholly or mainly for the business in the two years before death/transfer, AND not required for future use
• Example: investment property held by a trading company, excessive cash balances beyond trading needs
• BPR restricted — excepted assets NOT qualifying

Clawback on death within 7 years of lifetime gift:

• If a lifetime gift (PET) of business property failed due to donor's death within 7 years, BPR is RECONFIRMED only if:
  • The donee STILL OWNS the property at the date of donor's death (or has replaced it with other qualifying property), AND
  • The property still QUALIFIES for BPR at that date (still a trading business, etc.)
• If conditions not met: BPR on the failed PET is CLAWED BACK → full value charged

Planning implications of BPR:

• Holding trading business interests is highly tax-efficient at death — 100% BPR gives complete exemption
• Incorporating a property investment business does NOT turn it into a trading company for BPR purposes
• Quoted shares giving control (50% BPR) — useful for family-controlled listed companies
• Careful structuring of family companies to maintain trading status is important

Agricultural Property Relief (APR):

Similar relief for agricultural property.

Qualifying property:

• Agricultural land in UK (farmland used for agriculture)
• Farmhouses (of "character appropriate" to the property — judicial interpretation)
• Farm buildings
• Cottages occupied by farm workers
• Farmland leased to others (with special rules)

Rates:

• 100%:
  • Owner-occupied (used for farming by the owner or their spouse)
  • Let on tenancy granted on/after 1 September 1995 (modern tenancies)
• 50%:
  • Let on tenancy granted before 1 September 1995 (older tenancies — protected tenancies, harder to end)

Ownership conditions:

• Self-occupied (owner-farmed): held for at least 2 years
• Let (tenanted): held for at least 7 years

APR vs BPR interaction:

• Agricultural land used by a trading farming business: could qualify for APR on the agricultural value, with BPR on any excess (e.g., development value)
• Farmhouses and commercial activity parts separately analysed

CGT position on death:

• Death is NOT a disposal for CGT
• Beneficiaries acquire assets at MARKET VALUE at date of death — "uplifted" or "stepped-up" base cost
• Effect: all unrealised gains accumulated during lifetime are WASHED OUT at death (no CGT payable)
• But IHT is due on the full death estate value

CGT position on lifetime transfers:

• Gifts of assets to INDIVIDUALS: generally treated as disposals at MARKET VALUE for CGT (so CGT may apply to donor)
• Transfers to spouse/civil partner: no gain/no loss (covered in CGT topic)
• Gifts of BUSINESS ASSETS or qualifying unlisted trading company shares: GIFT RELIEF (s.165) available — elect to hold over gain
• Gifts to discretionary trusts or other trusts with IHT entry charge: automatic gift relief is available for any chargeable transfer for IHT purposes

Strategic implications:

• Holding appreciated assets UNTIL DEATH gives step-up in CGT base cost (saves CGT), but full IHT charge
• Lifetime transfers: may trigger CGT now but survive 7 years to escape IHT altogether
• Combined CGT and IHT planning is nuanced — maximum efficiency depends on asset type, holding period, donor's age/health, and recipient's circumstances

Deeds of variation:

• A legally binding document, signed by all beneficiaries affected, that REDIRECTS assets from the original beneficiaries to others
• Must be executed within 2 years of the death
• Must be in writing and elect for the retroactive treatment
• For IHT: the variation is treated AS IF the testator had made the provision (rewrites the will)
• For CGT: same retroactive treatment

Typical use case: A child inherits from a parent but passes the inheritance to their own children (grandchildren) via a deed of variation. This:

• Avoids the child's estate building up further (which might push them over thresholds at their death)
• Skips a generation for IHT purposes
• Does NOT count as a lifetime gift by the original beneficiary (so no 7-year wait)

Conditions for deed of variation:

• Signed by ALL beneficiaries adversely affected
• Executed within 2 years of death
• Specific election for tax purposes included in the deed
• Beneficiaries receive NO CONSIDERATION from the new beneficiaries (otherwise treated as a sale, not a variation)

Limitations:

• Cannot reduce stamp duty or other transaction taxes
• Cannot avoid settled property rules if assets go into trust
• HMRC scrutinises — must be clearly expressed

Practical example: Alan died leaving £500,000 to his adult daughter Beth. Beth is already wealthy and doesn't need the money. Within 18 months of Alan's death, Beth executes a deed of variation redirecting the £500,000 to her two children. For IHT and CGT: treated as if Alan had left the money to the grandchildren directly. No PET/CLT from Beth.

Reporting requirements:

Full IHT account (Form IHT400):

• Standard form for most estates — required unless "excepted estate" rules apply
• Detailed schedules for assets, liabilities, exemptions, reliefs, lifetime transfers
• Must be submitted to HMRC before obtaining probate (in England/Wales) or confirmation (Scotland)

Excepted estates — reduced reporting (no IHT400 needed):

• Gross estate below NRB, or fully exempt (e.g., all to spouse/charity), or "small" (under specific thresholds)
• For deaths from 1 January 2022, many estates exempt from IHT400 if they meet excepted estate conditions
• Thresholds updated periodically

Payment of IHT on death:

• Due date: 6 months after the END OF THE MONTH OF DEATH
• Example: death on 15 January 2025 → IHT due by 31 July 2025
• Interest runs from this date if late
• Typically personal representatives (PRs) pay from estate assets; PRs are liable for IHT

Payment on lifetime transfers:

• CLT lifetime IHT: due 6 months after the END OF THE MONTH of the transfer, OR 30 April after the tax year end (whichever LATER)
• Practical: use 30 April for transfers made between 6 April and 30 September; use 6 months after end of month of transfer for later periods
• Additional IHT on death (failed PETs, CLT recalculation): 6 months after end of month of death

Instalment option:

• IHT can be paid by TEN EQUAL ANNUAL INSTALMENTS (instead of a lump sum) for certain qualifying property:
  • Land and buildings (UK and overseas)
  • Unquoted shares (any amount) or quoted controlling shares
  • A BUSINESS or interest in a business (sole trader, partnership)
  • Timber (in certain circumstances)
• First instalment due at the normal due date (6 months after end of month of death)
• Interest-free for certain property (agricultural property and business property); other property at the statutory rate
• If the property is SOLD, the outstanding IHT becomes payable immediately from the sale proceeds

Personal Representatives (PRs) duties:

• Identify and value all assets
• Calculate IHT, submit IHT400 (or equivalent)
• Pay IHT before obtaining probate (usually via "direct payment scheme" from deceased's bank accounts)
• Distribute estate to beneficiaries
• PRs are JOINTLY AND SEVERALLY liable for IHT

Interest and penalties:

• Interest on late payment: statutory rate
• Penalties for late filing or incorrect returns — based on behaviour
• HMRC has 4-year investigation window (extended to 6 years for carelessness, 20 years for deliberate inaccuracies)

Valuation:

• Open market value at the date of death
• For properties: surveyor valuation typically required
• For quoted shares: "quarter-up" rule (lower + ¼ × (higher − lower) of the bid-offer quotes on the date of death)
• Private company shares: complex valuation — often disputed with HMRC
• "Related property" rules: spouse's property in same asset counted together for valuation (prevents discount for partial interests)