“In this world nothing can be said to be certain, except death and taxes,” said Benjamin Franklin, in 1789. Inheritance tax, somewhat unhappily, might be said to marry the two.
Taxation on death, like income tax, has existed since 1799. Originally, it applied only to personal property. It was extended to real estate in 1894 with the introduction of estate duty. Capital transfer tax replaced estate duty in the Finance Act 1975, applying not only to disposals on death but also to some lifetime transfers. The provisions relating to capital transfer tax were consolidated in the Capital Transfer Tax Act 1984. This has been subsequently amended, and may now be called the Inheritance Tax Act 1984. So, inheritance tax is both a death tax and a gift tax.
One of the more peculiar characteristics of inheritance tax is that it taxes gifts. Whereas a capital gains tax will tax a profit, inheritance tax imposes a liability on transfers which reduce a person’s wealth. It is as though the taxman, like Charon, will not be cheated of his fee by an attempt to dispose of all one’s wealth before death.
There are, of course, many exemptions from liability, which this article will address.
The charge
The charge is imposed on the value transferred whenever there is a transfer of value made by an individual which is not exempted: sections 1 and 2(1) Inheritance Tax Act 1984.
It applies to an individual who has assets in the United Kingdom and to persons who are resident and domiciled in the UK.
If, therefore, a person owns a house in the UK but lives abroad, inheritance tax will apply. If, on the other hand, a person buys a house abroad, perhaps with the object of retiring there, then liability to inheritance tax will depend on where that person is domiciled. While they remain domiciled in the UK then they are liable to inheritance tax on the property wherever it is situated. Once they retire, however, and move abroad then their domicile will change. It might be expected that it will change immediately; this is not, however, the case. While a person can have two residences, they may only have one domicile. If they retain a property in the UK, which is available for their use, then they will be deemed by the Inland Revenue to be resident. If the property is let and the tenants have exclusive possession then they will not be resident as there is no property available for their use. There are other grounds for residency; for example, regular trips to visit children.
Residence, therefore, is a question of fact. Domicile determines with which legal system of which territory a person is associated. Under the provisions of the inheritance tax legislation domicile has an extended meaning. There are two tests:
(1) If they were domiciled in the UK on or after December 10 1974 and within the three years preceding the time when the liability to inheritance tax is in question. So, when a person acquires a new domicile of choice by, for example, moving to their retirement home, their domicile will not change, for inheritance tax purposes, for three years.
(2) The second test looks to residency in a similar way. If the person was resident in the UK on or after December 10 1974 and for not less than 17 of the 20 years of assessment immediately preceding the relevant time, then they will be deemed to have a UK domicile.
Transfer of value
This is the basis of the charge to inheritance tax. It is a disposition made by a person as a result of which the value of his estate immediately after the disposition is less than it would be but for the disposition: section 3(1) Inheritance Tax Act 1984. So, if I give away property, that is a transfer of value. That is a straightforward example of a disposition. More complex dispositions, known as associated operations, (section 268), can also be caught.
Some dispositions are deemed not to be transfers of value. For example, dispositions:
- not intended to confer a gratuitous benefit;
- for the maintenance of the family;
- which are liable to income tax;
- which are contributions to a retirement benefit scheme;
- which constitute a waiver of remuneration or dividends of a grant of an agricultural tenancy.
Death
On death a transfer of value is deemed to have taken place. The amount transferred is the value of the estate immediately prior to the death. Different rates of tax apply according to when the transfer takes place; death incurs the highest rate.
So, what is included in a transfer on death for the purposes of computing liability to inheritance tax? Excluded property is not included, but property subject to a reservation and potentially exempt transfers made within seven years of death are.
Gifts with reservation?
This includes gifts of property made after March 17 1986 where either the donee does not assume possession within seven years before the donor’s death or the gift is not enjoyed to the entire exclusion of the donor at any time within seven years of the donor’s death.
So, a proper transfer of the property must take place. If the gift is of land, then a deed and the proper formalities must be observed.
A reservation would occur where a person gave away a freehold reversion on the condition that the recipient would, for example, lease it back to him or grant him shooting rights or a right of way. However, if full consideration in money or money’s worth were given for it then the reservation will be ignored: para 6(1)(a) of Schedule 20 to the Finance Act 1986.
Another ground on which a reservation will be ignored relates to the type of situation where the donor is elderly or infirm and his occupation results from an unforeseen change in his circumstances and the donee is a relative (para 6(1)(b)). So an elderly parent who has gifted the property to a child, but who now needs to live in it because he is unable to maintain himself, will not be deemed to have reserved a benefit in it thereby causing it to become liable to inheritance tax.
Exempt transfers
Not all transfers are caught by the inheritance tax legislation. Annual transfers up to £3,000 do not attract liability. Unused exemptions can be carried forward for one year only. In addition, small gifts up to £250 are exempt (but, in this case, there is no carry forward provision) and marriage gifts up to £5,000. These exemptions are available only on lifetime transfers.
Exemptions available on death as well as during lifetime include transfers between spouses, gifts to charities, qualifying political parties, registered housing associations, gifts for national purposes and the public benefit.
A political party, to qualify, must have either two Members of Parliament or one MP and not less than 150,000 votes cast for members of that party.
A gift for national purposes includes gifts to museums, government departments or local authorities, universities and some organisations such as the National Trust.
Gifts for the public benefit provide for property which might be considered as of historic or scientific or architectural interest to be given to non-profit-making bodies approved by the Treasury so that they can be preserved and public access granted. This provision protects such buildings and other treasures as might be considered part of the national heritage.
Potentially exempt transfers
Even if a transfer is not exempt it may escape liability if the donor survives for seven years after the transfer has taken place. This involves a waiting game; if the donor dies within seven years then the tax is payable on death. So if a mother decides to transfer her house to her child immediately, she must survive seven years to avoid payment of tax.
How much will it be?
The tax is charged on the value transferred, that is, the amount by which the donor’s estate is reduced. Expenses may be incurred as a result of the transfer, such as fees to estate agents, surveyors and solicitors. If these are borne by the donor they are left out of account for the purpose of calculating the amount of tax payable.
The value is “the price which the property might reasonably be expected to fetch if sold in the open market at that time” (section 160 Inheritance Tax Act 1984). Incumbrances will be taken into account; so a mortgage on a house, for example, will reduce the value of the transfer by the amount of the mortgage.
If the use of property is transferred then the normal rule will apply and the value transferred will be the reduction in the market value of the property resulting from the fact that someone other than the owner is now entitled to occupy it.
Agricultural property may be subject to relief. This includes woodland and buildings used for the intensive rearing of livestock or fish where that is occupied with agricultural land or pasture, farm buildings and cottages and stud farms. There are conditions which broadly relate to the fact that the property must have been occupied for agricultural purposes. The relief will amount to a reduction of up to 50% of the value transferred. Woodlands may also be subject to relief, but only on death.
Transfers of business property also carry relief up to 50% where the business is carried on in the exercise of a profession or vocation and is for gain.
Rate of tax
The rate chargeable depends on whether the transfer is made during the lifetime or on death. A cumulative record of all the transfers of value made up to a period of seven years before the death must be kept. As from March 15 1989 the rate of tax on cumulative lifetime transfers is 20% on all those exceeding £118,000. This will not include those transfers which are potentially exempt; it covers only those which are immediately payable. The death rate is twice that of the lifetime rate — 40%. Potentially exempt transfers made within seven years of death will become chargeable at the death rates.
