COURSE: ACCA – TAXATION (TX)

Lecture Topic: Inheritance Tax (IHT)

1. The Scope of Inheritance Tax

Inheritance tax (IHT) is paid on the value of a person’s estate when they die (this is called the death estate), but also
applies to certain lifetime transfers of assets.

During a person’s lifetime, IHT can only arise if a transfer of value is made.

Definitions:

(i) A transfer of value is defined as ‘any gratuitous disposition made by a person that results in a diminution
(decrease) in value of that person’s estate’.

(ii) Gratuitous: Poor business deals, for example, are not normally transfers of value because there is no gratuitous
intent.

(iii) Diminution in value: Normally there will be no difference between the diminution (decrease) in value of the
donor’s estate and the increase in value of the donee’s estate. However, in some cases it may be necessary to
compare the value of the donor’s estate before the transfer, and the value after the transfer in order to compute the
diminution in value. Typically, this is the situation where unquoted shares are gifted.

For exam purposes, the terms ‘transfer’ and ‘gift’ can be taken to mean the same thing. The person making a transfer is
known as the donor, while the person receiving the transfer is known as the donee.

2. Basic Calculation of Inheritance Tax

o Each tax year, an individual is entitled to one nil rate band.

Inheritance Tax (IHT) is calculated on the value of transfers/gifts in excess of the nil rate band for the tax year.

The nil rate band for the tax year 2022-23 is £325,000.

Where nil rate bands are required for previous years then these will be given to you within the question.

o The tax rates information that will be given in the tax rates and allowances section of the exam paper is as follows:

Nil rate band £325,000

Residence nil rate band £175,000

Rates of tax on excess

- Lifetime rate 20%
- Death rate 40%

o The rate of IHT payable as a result of a person’s death is 40%. This is the rate that is charged on a person’s estate
at death, on PETs that become chargeable as a result of death within seven years, and is also the rate used to see if any
additional tax is payable on CLTs made within seven years of death.

o The rate of IHT payable on CLTs at the time they are made is 20%. This is the lifetime rate.

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o In addition to the normal nil rate band, an additional nil rate band (called the residence nil rate band) is available
where a main residence is inherited on death by direct descendants (children and grandchildren). For the tax year 2022-
23, the residence nil rate band is £175,000.

The residence nil rate band is only relevant where an individual dies on or after 6 April 2017, their estate exceeds the
normal nil rate band of £325,000 and their estate includes a main residence. Note that any other type of property, such
as a property which has been let out, does not qualify for the residence nil rate band.

The value of the main residence is after deducting any repayment mortgage or interest-only mortgage secured on that
property.

If the main residence is valued at less than the available residence nil rate band, then the residence nil rate band is
reduced to the value of the residence.

3. Exempt Transfers

There are various exemptions available to eliminate or reduce the chargeable amount of a transfer for IHT purposes.

3.1 Transfers between spouses/ civil partners

All gifts to spouses (and registered civil partners) are exempt from IHT. This includes all lifetime transfers and transfers on
death (e.g., the death estate).

3.2 Small gifts exemption

Gifts to individuals totaling £250 or less per recipient (donee) in any one tax year are exempt from IHT. If the total amount
gifted to one person is more than £250 the whole amount is chargeable.

3.3 Normal expenditure out of income

IHT is a tax on transfers of capital, not income. Therefore, a gift is exempt from IHT if it is made as part of a person’s
normal expenditure out of income, provided the gift does not affect that person’s standard of living. To count as normal,
gifts must be habitual.

3.4 Gifts in consideration of marriage

This exemption covers gifts made in consideration of a couple getting married or registering a civil partnership. The
amount of the exemption depends on the relationship of the donor to the donee (who must be one of the two persons getting
married):

(a) £5,000 if the gift is made by a parent.

(b) £2,500 if the gift is made by a grandparent or by one of the couple getting married to the other.
(c) £1,000 if the gift is made by anyone else.

4. The Annual Exemption

Each tax year a person has an annual exemption of £3,000. The annual exemption is used after all other exemptions. If
several gifts are made in a year, the £3,000 exemption is applied to earlier gifts before later gifts. The annual exemption is
applied to both PETs as well as CLTs (see note 5), even though the PETs might never become chargeable.

Any of the annual exemption not used in a tax year can be carried forward to the following year. The brought forward
exemption is used after the exemption for the current year. Any unused brought forward exemption cannot be carried
forward a second time.

Note that the annual exemption is only applied to lifetime transfers, i.e., it is not used against the death estate.

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5. Lifetime transfers

A transfer/ gift made during a person’s lifetime will fall into one of these categories:

(a) Exempt lifetime transfers (see note 3 for exempt transfers)

(b) Potentially Exempt lifetime transfers (PETs)
(c) Chargeable lifetime transfers (CLTs)

5.1 Potentially Exempt lifetime transfers (PET)

o Any lifetime transfer that is made to an individual is a potentially exempt transfer (PET).

o A PET is exempt from IHT when made. This means that there is no lifetime IHT on PETs.

o If the donor survives for at least seven years after making a PET, it will remain exempt from IHT, which means that
there will also be no death tax on that PET.

o However, if the donor dies within seven years of making the PET, the transfer will become chargeable to IHT on
death.

o IHT will be charged according to the rates and allowances applicable to the tax year in which the donor dies. However,
the value of a PET is fixed at the time that the gift is made.

5.2 Chargeable lifetime transfers (CLT)

o Any lifetime transfer that is made to a trust is a chargeable lifetime transfer (CLT).

o A chargeable lifetime transfer (CLT) is immediately chargeable to IHT when made. This means that CLTs are subject
to lifetime IHT.

o The lifetime IHT on a CLT is calculated at the rate of 20%.

o An additional tax liability (the death tax) may then arise if the donor dies within seven years of making the gift.

o Just as for a PET, the value of a CLT is fixed at the time that the gift is made, but the additional tax liability (the death
tax) is calculated using the rates and allowances applicable to the tax year in which the donor dies.

o The death tax calculated on a CLT is reduced by the value of any lifetime IHT paid on that same CLT. However, if the
lifetime IHT is more than the death tax calculated, the difference cannot be refunded.

5.3 Taper relief

When calculating the death tax on a PET or CLT, taper relief may be applicable.

Taper relief reduces the amount of tax payable where a donor lives for more than three years, but less than seven years,
after making a gift. The reduction is as follows:

Years before death % reduction

Over 3 but less than 4 years 20
Over 4 but less than 5 years 40
Over 5 but less than 6 years 60
Over 6 but less than 7 years 80

Taper relief applies to both PETs and CLTs.

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5.4 Seven-year cumulation period

When calculating IHT on a transfer it is necessary to take account of any other chargeable transfers made within the
previous seven years of that (current) transfer.

If there were any chargeable transfers made in the seven years before the current transfer, the value of those previous
chargeable transfers reduces the amount of nil rate band available for the current transfer.

Therefore, whenever you are calculating IHT, apply the seven-year cumulation rule to determine how much of the nil rate
band is available for use against the current transfer.

5.5 Donor pays the tax

If the donor pays the lifetime tax due on a CLT, the total reduction in the value of his estate is the amount of the gift plus
the related lifetime IHT liability.

The result of this is that two (2) adjustments have to be made to the IHT calculation:

(i) The lifetime IHT will now be calculated as follows:

Lifetime IHT = Chargeable amount (i.e., not covered by nil rate band) × 20/80

(This means that 20/80 is used to calculate the lifetime IHT instead of 20%).

(ii) The gross amount of the transfer will be the actual value of the CLT plus the IHT paid by the donor.

Once the gross transfer has been calculated then this figure is used in all subsequent calculations (e.g., to calculate any
death tax that may be due).

5.6 Advantages of lifetime transfers

There are a number of inheritance tax advantages of making lifetime transfers:

(a) A PET will be completely exempt if the donor survives for seven years after making the transfer.

(b) A CLT will not incur any additional IHT liability if the donor survives for seven years after making the transfer.

(c) Even if the donor does not survive for seven years, taper relief will reduce the amount of IHT payable after three years.

(d) The value of lifetime transfers (both PETs and CLTs) is fixed at the time they are made, so it can be beneficial to make
gifts of assets that are expected to increase in value such as property or shares.

6. Transfer of a spouse’s unused nil rate band

Any unused nil rate band on a person’s death can be transferred to their surviving spouse (or registered civil partner).

The approach is to calculate the proportion (percentage) of the nil rate band not used when the first spouse died. The nil
rate band available when the second spouse dies is then increased by this percentage.

In the same way in which any unused normal nil rate band can be transferred to a surviving spouse (or registered civil
partner), the residence nil rate band is also transferable. It does not matter when the first spouse dies.

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7. Death Estate

An individual’s death estate consists of all the property which they owned at the date of death less debts and funeral
expenses.

Examples of such property are land, buildings, shares, motor vehicles, cash and other investments. The death estate also
includes the proceeds from life assurance policies even though these proceeds will not be received until after the date of
death. The value of the policy immediately before the date of death is not relevant.

The following debts are allowed as deductions:

(a) Reasonable funeral expenses.

(b) Debts due by the deceased provided they were incurred for valuable consideration. Therefore, gambling debts cannot
be deducted.

(c) Mortgages on property. This does not include endowment mortgages as these are repaid upon death by the life
assurance element of the mortgage. Repayment mortgages and interest-only mortgages are deductible.

8. Payment of IHT

8.1 Liability for IHT

The donor is primarily responsible for any lifetime tax due in respect of a CLT. However, the donee may agree to pay the
tax instead.

On death, liability for payment is as follows:

(a) Any additional IHT on a CLT is paid by the donee.

(b) Tax on a PET that has become chargeable is paid by the donee.

(c) Tax on the death estate is paid by the deceased’s personal representatives (PRs).

8.2 Due dates for IHT

(a) For the lifetime tax on CLTs, the due date is the later of:

(i) 30 April following the end of the tax year in which the gift is made.
(ii) Six months after the end of the month in which the gift was made.

(b) Tax arising on death in respect of PETs and CLTs: the due date is six months after the end of the month of death.

(c) Tax arising on the death estate: the due date is six months after the end of the month of death. However, if the
personal representatives submit an account of the death estate to HMRC within the six month period, they must
pay the IHT due on the death estate on the submission of the account.

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Questions

1. On 4 May 2022 Daniel made a gift to his son of 15,000 £1 ordinary shares in ABC Ltd, an unquoted investment
company. Before the transfer Daniel owned 60,000 shares out of ABC Ltd’s issued share capital of 100,000 £1
ordinary shares. ABC Ltd’s shares are worth £8 each for a holding of 15%, £10 each for a holding of 45%, and £18
each for a holding of 60%.

What is the value of the transfer for IHT purposes?

2. Amy died on 2 June 2022 leaving an estate valued at £600,000.

What is the IHT liability?

3. Sophie died on 26 May 2022 leaving an estate valued at £850,000. Under the terms of her will, Sophie’s estate was left
to her children. The estate included a main residence valued at £425,000.

What is the IHT liability?

4. Ming died on 22 April 2022 leaving an estate valued at £300,000.

On 7 September 2013 she had made a gift of £416,000 to her daughter.

On 30 April 2020 she had made a gift of £356,000 to her son.

The nil rate band remained unchanged at £325,000.

What is the IHT liability?

5. Rose died on 23 January 2023. She had made the following lifetime gifts:

8 November 2014 A gift of £456,000 to her son.

12 August 2020 A gift of a property valued at £616,000 to her daughter. By 23 January 2023 the value
of the property had increased to £655,000.

The nil rate band remained unchanged at £325,000 for each tax year.

What is the IHT liability?

6. Joe died on 13 October 2022.

On 12 November 2019 he had made a gift of £400,000 to a trust. This figure is after deducting available exemptions.
The trust paid the IHT arising from the gift.

The nil rate band for 2019-20 was £325,000.

What is the IHT liability?

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7. Tim died on 19 September 2022.

On 14 October 2019 he had made a gift of £281,000 to his son.

On 1 November 2020 he had made a gift of £453,000 to a trust.

The trust paid the IHT arising from the gift.

The nil rate band was unchanged at £325,000 for each tax year.

What is the IHT liability?

8. Ali died on 3 March 2023.

On 21 November 2019, he had made a gift of £425,000 to a trust. The trust paid the IHT arising from this gift.

This figure is after deducting all available exemptions.

The nil rate band for the tax year 2019-20 is £325,000.

What is the IHT liability?

9. Winnie died on 9 January 2023. She had made the following lifetime gifts:

2 November 2017 A gift of £466,000 to a trust. The trust paid the IHT arising from this gift.

23 May 2018 A gift of £2,000 to her son

16 August 2019 A gift of £324,000 to her son.

The nil rate band remained unchanged at £325,000 in each tax year.

What is the IHT liability?

10. Ja died on 18 March 2023. She had made the following lifetime gifts:

1 August 2014 A gift of £200,000 to a trust.

1 November 2020 A gift of £280,000 to a trust.

These figures are after deducting all available exemptions. In each case the trust paid the IHT arising from this gift.

The nil rate band was £325,000 for each tax year.

What is the IHT liability?

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11. Trevor makes a gross chargeable transfer of value of £180,000 in December 2012. He then makes a gift to a trust of
shares worth £200,000 on 15 November 2018. The trustees pay the lifetime tax due. There are no exemptions available.
Trevor dies in February 2023. The shares held by the trustees were then worth £500,000.

The nil rate band remained unchanged at £325,000.

(a) What is the lifetime tax payable by the trustees on the November 2017 lifetime transfer?

(b) What is the death tax (if any) payable on the November 2017 lifetime transfer?

12. On 2 November 2019 James made a gift of £485,000 to a trust. No exemptions were available. James paid the lifetime
IHT arising from the gift. James died on 11 October 2022.

The nil rate band is unchanged at £325,000.

(a) What is the lifetime tax payable by James?

(b) What is the death tax (if any)?

13. On 17 June 2019 Annie made a gift of £425,000 to a trust. No exemptions were available. She paid the IHT arising
from the gift.

The nil rate band remained unchanged at £325,000.

(a) What is the lifetime tax payable by Annie?

(b) Assuming that Annie died on 12 March 2023, what is the death tax (if any)?

14. Jenna and Rebecca were civil partners until the death of Jenna on 19 August 2019.

Jenna made no lifetime transfers. Her death estate was £260,000 and she left it to her mother. The nil rate band at
Jenna’s death was £325,000.

Rebecca died on 24 February 2023. Her death estate was £550,000 and she left her entire estate to her brother. She had
made no lifetime transfers. The nil rate band at Rebecca’s death was £325,000.

Calculate the inheritance tax payable on the death of Rebecca, assuming that any beneficial claims are made.

15. Andy died on 31 December 2022. At the date of his death, he owned the following assets:

- A main residence valued at £425,000. This had an outstanding interest-only mortgage of £180,000.
- Ordinary shares in Herbert plc valued at £54,000.
- Building society deposits of £25,000.
- A life assurance policy on his own life. On 31 December 2022 the policy had an open market value of £85,000,
and proceeds of £100,000 were received following Andy’s death.

On 31 December 2022 Andy owed £700 in respect of credit card debts, and he had also verbally promised to pay the
£800 legal fee of a friend. The cost of his funeral amounted to £4,300.

What is the value of Andy’s Death Estate?