UK Inheritance Tax

Scope

UK Inheritance Tax applies to the worldwide assets of individuals who are domiciled or are deemed to be domiciled in the UK. In the case of non-UK domiciled individuals, such as Republic of Ireland residents, UK inheritance tax will only apply to assets situated in the UK.

UK  Inheritance tax will generally only apply to an Irish domiciled individual who has assets in the UK which exceed £325,000.00 in value. There are special UK rules on domicile for the purpose of UK inheritance tax.

Transfers to spouses are exempt provided that the the donee spouse is UK domiciled. if the donee spouse is not UK domiciled there is an exemption of £325,000. Thereafter transfers are treated as potentially exempt transfers subject to tax if the donor spouse does not survive seven years in the usual way. Prior to 6th April 2013,  the exemption in respect of transfers to non-UK domiciled spouse was £55,000 only.

The  non-UK domiciled spouse may make an election to be treated as UK domiciled. This means that he or she is is  treated the way a UK domiciled spouse to that inter- spouse transfers are thereby exempt. However, the spouse becomes subject to UK inheritance tax on his or here worldwide assets as a deemed UK domiciled person.

The £325,000 can be increased to up to £650,000 where the individual’s spouse has not used up the full £325,000 allowance on his or here earlier death.

Potentially Exempt Transfers

UK Inheritance arises principally on assets which pass to others on an individual’s death.  However, Inheritance Tax can also arise on transfers of assets made during an individual’s lifetime. To some extent, therefore, it is also a tax on lifetime gifts. There are two categories of lifetime transfer.

Most outright gifts of assets made by an individual during his lifetime are potentially exempt from Inheritance Tax.  This means that as long as the person making the gifts survive seven years there will be no tax.  Therefore there is no tax in the UK on an outright gift where the person making it survives seven years.

The first category is where the person making the gift dies within seven years.  Where an individual makes an outright unconditional gift and survives by seven years, there is no UK inheritance tax.

There is no tax at all on an outright gift unless the donor dies within seven years. In that case, the tax is payable at the time of the donor’s death. This is different to the case in most countries (including Ireland) where lifetime gifts are taxed in much the same way as benefits inherited on death.

Effectively, UK Inheritance tax “looks back” at lifetime gifts made by an individual in the seven years before his death and adds them back into his total assets for the purpose of calculating the tax. The first £325,000 of value is not taxed and the balance is taxed at death at the rate of 40%.

Tapering Rates

Where a person makes a lifetime gift and dies more than three years after the transfer, the full death rate (40%) is reduced in so far as it applies to that transfer.  The reductions are as follows:-

Transfers 3 /4 years before death – 80% of death charge

4 /5 years before death – 60% of death charge

5 /6 years before death – 40% of death charge

6 /7 years before death – 20% of death charge

The above transfers alter the rate of tax payable so do not make any difference if the amount transferred was within the nil amount; it remains untaxed. However, the gift may use up the nil band so that it is reduced or not available in respect of inheritances on death.

The second type of lifetime transfer is subject to inheritance tax immediately. This arises on transfers to certain trusts.   The tax on these transfers is at half the normal (40%) tax rate. In the case of lifetime transfers to trusts. The tax rate is therefore 0% on the first £325,000 and  20% on the balance of the value of the assets transferred.

Where a person dies within seven years of making a lifetime gift into trust the effect of the above reductions may that no tax may be payable.  For example, if a person died 4 to 5 years after making a lifetime transfer, the tax is reduced to 40% of the death charge. The death rate is 40% of 40% (16%), so that no additional tax would be payable.  The trustees, however, are not entitled to a refund of the 20% tax already paid.

Transfers to Trusts

Prior to 22nd March 2006, it was possible to set up so-called “accumulation and maintenance trusts” which had many of the advantages of a trust and which were exempt from Inheritance Tax provided that the person creating the trust survived by seven years.  Many such trusts still exist but it is not possible to create new trusts which qualify for this special treatment.   It is still possible to create trusts for certain disabled persons and bereaved minors which receive the favourable treatment.

Transfers between husband and wife

Transfers and inheritances between husband and wife are generally exempt from Inheritance Tax provided both are UK domiciled or both are not UK domiciled.  An individual has an Inheritance Tax free allowance of £325,000.

Prior to 2008 husbands and wives had separate Inheritance Tax allowances. Since that date unused, thresholds are freely transferable. This means potentially that a threshold of £650,000 is available on the death of a second spouse.

Formerly techniques were used to try to ensure that as many assets as possible passed through each spouses estate. This would typically involve parties putting properties in two names as  tenants in common so that (say) half the value transferred down to children on the death of the first spouse and the other (say) half pass down on the death of the second spouse so as to maximise the nil rate in each of the estate.  These planning techniques are no longer required.

There is an important exception to the exemption for gifts and inheritances passing between spouses. There is a nil rate / allowance of only £55,000 if the recipient spouse is non-UK domiciled but the transferor spouse is UK domiciled.

Other Exemptions

Gifts not exceeding £250 to any one person in any one year are exempt.   Transfers of £3,000 per person per year are exempt. Any unused annual exemption can be carried forward for one year.   Gifts up to £5,000 per parent are exempt on marriage.

Normal expenditure out of income is exempt.  It would have to be part of normal expenditure of the donor paid out of income to maintain the usual standard of living of another.  This is a question of fact in each individual case.  This exemption is often used to fund payment of premiums on an insurance policy written by a parent in favour of a child on which the parent pays the premium.

The exemption can be also used to pay premiums on insurance to fund potential Inheritance Tax liabilities should the donor die within seven years of a gift.  Because these policies are funded by monies exempt from Inheritance Tax, the proceeds are owned by the named beneficiary free from Inheritance Tax.