Inheritance Tax 2

BAA Tax: Lecture 18Spring 2015

Finance Act 2014

Robert Berrybob@bobberry.co.uk

Inheritance Tax

Introduction

• In the last lecture we looked at the charge to IHT and applied this to lifetime transfers into relevant property trusts, and also the “death” rate charge on lifetime transfers within 7 years of death.

Inheritance Tax

IHT payable on death• This comprises:• additional tax on chargeable lifetime

transfers made by the deceased during the 7 years ending on the date of his death

• tax on any PETs made by the deceased during the 7 years ending on the date of his death

• tax on the estate at death (unless transfers are exempt)

Inheritance Tax

Chargeable Lifetime transfers and PETs

• When calculating IHT on chargeable lifetime transfers, PETs are initially ignored. If the donor then dies within 7 years, PETs that become chargeable will have to be taken into account when calculating the extra IHT due on the chargeable transfers because of the death. This may mean that a chargeable lifetime transfer may lose all or some of the nil rate band. However once a chargeable lifetime transfer has been grossed up it is not altered.

• Transfers are taken in chronological order• • PETs are completely ignored once the donor has lived for 7 years but for

chargeable lifetime transfers it is necessary to take into account all other chargeable lifetime transfers made within the previous 7 years to calculate the IHT liability. After 7 years a chargeable lifetime transfer drops out of the cumulative total – i.e. there is a 7 year cumulation period. The tax rates used are those applicable to transfers on death not those used for chargeable lifetime transfers.

Inheritance Tax

Taper relief

• The tax calculated above will then be reduced by taper relief depending on the number of years between the date of the transfer and the date of death. Taper relief is given as follows:

• Period between transfer and death % reduction in tax

• 3 years or less 0• Over 3 but no more than 4 years 20 • Over 4 but no more than 5 years 40 • Over 5 but no more than 6 years 60 • Over 6 but no more than 7 years 80

Inheritance Tax

Final steps in calculation

• On each transfer, any tax paid during the lifetime of the transferor is subtracted leaving a balance of tax due on the transfer.

• This tax is the responsibility of the transferee.• If the lifetime tax paid exceeds the liability on

death, there is no further tax due but neither will any repayment be given.

Inheritance Tax

Tax on the deceased person’s estate

• IHT on the deceased’s estate (unless exempt) is calculated using the rates of tax applicable on death.

• The 0% band is reduced by any gross chargeable transfers made in the 7 years ending on the date of death including any PETs made in the period.

• Any remaining 0% band is then set against the value of the estate and tax at 40% is calculated on the balance.

Inheritance Tax

Example 1 – IHT on death

• T dies on 2/3/15 leaving an estate of £400,000. • Calculate the IHT on the estate on three

scenarios. • Assume that gross chargeable transfers made by

T in the 7 years preceding his death were:

• nil• £125,000• £370,000

Inheritance Tax

Example 1 - Answer• a) No lifetime transfers

•• 325,000 x 0% 0• 75,000 x 40% 30,000• 400,000 30,000•• IHT paid by PRs of the estate in all 3 cases

•• b) £125,000 gross chargeable transfers

•• 200,000 x 0% 0• (325,000 - 125,000)

• 200,000 x 40% 80,000• 400,000 80,000•• c) £370,000 gross chargeable transfers

•• 400,000 x 40% 160,000• (nil band fully used)

Inheritance Tax

Example 2• L gave £339,000 (her first transfer for IHT) to her son

on 1/2/2011. On 10/10/2014 she gave £369,000 to a trust, the trustees paying the lifetime tax due. On 11/01/2015 L died.

• • Calculate:1. The lifetime tax payable by the trustees on the

lifetime transfer made in 2014.2. The death tax payable on the lifetime transfer made

in 2011.3. The death tax payable on the lifetime transfer made

in 2014.

Inheritance Tax

Example 2 – Answer (part 1)

• Value AE for AE for Value• before AE CY PYafter AE• £ £ £ £•2010/11 Gift to son PET 339,000 -3,000 -3,000 333,000•2014/15 Gift to trust CLT 369,000 -3,000 -3,000 363,000•

•Tax due during lifetime Net Gross Tax

•2014/15 Gift to trust - nil CLT 325,000 325,000 0

•Balance (not grossed up - Trustees paid tax) 38,000 38,000 7600

• 363,000 363,000 7600

Inheritance Tax

Example 2 – Answer (part 2)• Tax on death - 7 year review back from 11/01/2015 11/01/2008

• The PET on 1/02/2011 is within the 7 years (between 3 to 4 years from death) and is taxed

• at death rate (40%) - the nil band is used against this (now) chargeable transfer:

• 325,000 x 0% 0• 8,000 x 40% 3200• 333,000•• Less: Taper Relief (3 to 4 years) 20% -640

• 2560• Less: Lifetime tax paid 0• IHT due from son 2560

Inheritance Tax

Example 2 – Answer (part 3)• The CLT of 10/10/2014 is within the 7 years (between 0 to 1

years from death) and is re-taxed at death rates -

• No nil rate remains as the transfer to the son (above) used it all up:

• 363,000 x 40% 145200

• Less: Taper Relief (0 to 1 years) 0% 0

• 145200

• Less: Lifetime tax paid (above) -7600

• Additional tax due from the Trustees 137600

Inheritance Tax

Transfer of unused part of nil rate band

• This arises when a spouse or civil partner dies and not all of the nil rate band is used up on his/her death.

• The unused part of the nil rate band can be transferred to the surviving spouse / civil partner to be used on his/ her death.

• • The amount that can be transferred is the proportion

of the nil rate band which was unused on the death of the first spouse/ civil partner.

• This proportion is then applied to the amount of the nil rate band which is in force on the date of the survivor’s death.

Inheritance Tax

Nil rate band• Tax Year Nil band LR DR DR*• 6/4/03 – 5/4/04 0 - £255,000 20% 40%• 6/4/04 – 5/4/05 0 - £263,000 20% 40%• 6/4/05 – 5/4/06 0 - £275,000 20% 40%• 6/4/06 – 5/4/07 0 - £285,000 20% 40%• 6/4/07 – 5/4/08 0 - £300,000 20% 40%• 6/4/08 – 5/4/09 0 - £312,000 20% 40%• 6/4/09 – 5/4/10 0 - £325,000 20% 40%• 6/4/10 – 5/4/11 0 - £325,000 20% 40%• 6/4/11 – 5/4/12 0 - £325,000 20% 40% • 6/4/12 – 5/4/13 0 - £325,000 20% 40% 36%• 6/4/13 – 5/4/14 0 - £325,000 20% 40% 36%• 6/4/14 – 5/4/15 0 - £325,000 20% 40% 36%

Inheritance Tax

Example 3 – Transfer of unused nil rate band

• W died on 21/10/14. Her husband had died previously and his estate on death (including transfers made within 7 years of death) had absorbed £100,000 of the nil rate band at the time.

• • Calculate the nil rate band available on W’s death

assuming her husband had died in:• • May 2007• July 2009

Inheritance Tax

Example 3 - Answer

•1 Nil rate band for 2007/08 was £300,000

•H had used £100,000 leaving 66.6666% available to W (£200,000/£300,000) •W has £325,000 + (£325,000 x 0.6666666) = £541,666 available.

••2 Nil rate band for 2009/10 was £325,000

•H had used £100,000 leaving 69.230769 % available to W (£225,000/£325,000)

•W has £325,000 + (£325,000 x 0.69230769) = £550,000 available.

Inheritance Tax

Due date for payment of IHT •1. for chargeable lifetime transfers, due date is the later of:-• - 6 months from the end of the month in which the transfer is made• - 30 April following the end of the tax year in which the transfer is made• •2. For IHT on PETs becoming chargeable and additional IHT on chargeable lifetime transfers (because of donor’s death); the due date is 6 months from the end of the month in which death occurred.• •3. For IHT on an estate at death, due date is the earlier of • - 6 months from the end of the month in which death occurred•And • - When the PRs deliver their account

Inheritance Tax

Example 10• State the due dates in respect of chargeable

lifetime transfers made on the following dates:

• a) 25/3/14• 30-Sep-14• b) 20/7/14• 30-Apr-15• c) 30/10/14• 30-Apr-15

Inheritance Tax

VALUATIONS FOR IHT – QUOTED SHARES AND SECURITIES

• Valuation of assets for IHT• The value of any property is the price which the asset might be

expected to fetch if sold on the open market.• • • Quoted shares and securities• • These are valued (as for CGT) taking the lower of:• • lower quoted price + ¼ of (higher quoted price – lower quoted

price)• the average of the highest and lowest marked bargains (ignoring

bargains marked at special prices)

Inheritance Tax

Valuation of Unit Trusts• Unit trusts • • Unit trusts are valued at the managers’ bid price (lower of the two

published prices).

Inheritance Tax

Valuation of Life Assurance Policies

• Where a person’s estate includes a life assurance policy which matures on his death the proceeds payable to his PRs must be included in his estate for IHT.

• • Where a person’s estate includes a life policy which matures

on the death of someone else, the open market value must be included in his estate.

• • If the individual writes a policy in trust or assigns a policy,

the proceeds will not be paid to his estate and are therefore not included as part of his free estate at death.

Inheritance Tax

Valuation of Overseas Property

• Overseas property• • Property situated outside the UK is valued in the currency of

the property’s location, converted to sterling at the date of transfer (using the lowest sterling daily rate).

Inheritance Tax

Valuation on Death - ExpensesDebts and funeral expenses•Only bona fide debts and for full consideration may be deducted. Gambling debts would, therefore, not be deductible.•A debt charged on a specific property is deductible from that property.•Debts contracted abroad must be deducted first from foreign property but any excess can be deducted from UK property if the debts would be recoverable in the UK.•Reasonable funeral expenses may be deducted including a tombstone.

Inheritance Tax

Example 5 – Estate on death• Z died on 19/6/14. His estate comprised:• 10,000 shares in A plc. quoted at 84-89 with bargains

marked at 85p, 87p and 90p• 8,000 shares in B Ltd with a market value of £9,280. • Freehold property valued at £150,000 subject to a

mortgage of £45,040.• Liabilities and funeral expenses were £2,700 (£250

consisted of gambling debts).• Z had made a chargeable lifetime transfer of £340,000

in July 2009.• Calculate the IHT on the estate at death.

Inheritance Tax

Example 5 – Answer – Estate on death 1

• Estate at death• • Aplc shares - lower of: £ £• • 10,000 x 85.25p (¼ up) 8,525 8,525• 10,000 x 85p + 90p (average basis) 8,750 2 __________• • Bplc shares• • Market value 9,280• c/f 17,805

Inheritance Tax

Example 5 – Answer – Estate on death 1

• b/f 17,805• Freehold property• • Value 150,000• (Mortgage) (45,040) 104,960• _______________• 122,765• Liabilities and funeral expenses (2,450)• (Gambling debt of £250 not deductible)

__________• 120,315• ==========• Nil rate band used up by CLT within 7 years•• Inheritance tax due £120,315 x 40% £ 48,126

Inheritance Tax

Comprehensive– Melville Q31.7• 31.7 – Tony died on 11 July 2014, leaving an estate valued at £500,000.

None of the transfers made on his death were exempt from IHT, He had made the following transfers during his lifetime:

• £• 3 May 2006 Gift to RP Trust (tax paid by trustees) 100,000• 1 July 2007 Gift to daughter 250,000• 1 August 2007 Gift to son 250,000• 10 June 2009 Gift to RP Trust (tax paid by Tony) 450,000

• Calculate the tax payable as a result of Tony’s death (Assume there is no unused nil-rate band to be transferred from a previously deceased spouse or civil partner).

Inheritance Tax

Melville Q31.7 – Answer 1

• Tony died on 11 July 2014 – means that lifetime transfers going back 7 years to 11 July 2007 need to be “reviewed”.

• The transfers were:

• 3 May 2006 Gift to RP Trust (tax paid by trustees) 100,000 OUT • 1 July 2007 Gift to daughter 250,000 OUT/GONE!• 1 August 2007 Gift to son 250,000• 10 June 2009 Gift to RP Trust (tax paid by Tony) 450,000

Inheritance Tax

Melville Q31.7 – Answer 2

• The transfers were:

• 3 May 2006 Gift to RP Trust (tax paid by trustees) 100,000 CLT• 1 August 2007 Gift to son 250,000 Recalculate• 10 June 2009 Gift to RP Trust (tax paid by Tony) 450,000 Recalculate

• To calculate tax to be paid as a result of Tony’s death we need to calculate what tax was paid on these gifts during Tony’s lifetime.

• The gift on 1 August 2007 had been a PET but is not reduced by Annual Exemptions for 2007/08 or 2006/07 as these are used by other gifts.

• The gift on 1 June 2009 was a CLT and is reduced by Annual Exemptions for 2009/10 and 2008/09 (£3K each). Net value of transfer is £444,000.

Inheritance Tax

Melville Q31.7 – Answer 3

• Values after Annual Exemptions

• Value AE for AE for Value• before current previous after• AE year year AE• £ £ £ £• 2006-07 Trust 100,000 3,000 3,000 94,000• 2007-08 Gift (D) 250,000 3,000 247,000• Gift (S) 250,000 - - 250,000• 2009-10 Trust 450,000 3,000 3,000 444,000

Inheritance Tax

Melville Q31.7 – Answer 4

• Step One - IHT paid during lifetime• IHT paid on gift to trust on 10 June 2009 for 2009/10 would have

been:• £444,000 less available nil rate band in 2009/10 • Nil rate band part used by CLT in 2006/07 (within 7 years of

2009/10). How much used? £100,000 – AE for 2006/07 and 2005/06 = £94,000.

• Nil rate band for 2009/10 was £325,000 less £94,000 = £231,000.• Tax due on £213,000 (£444,000 - £231,000) x 25% as Tony paid

tax = £53,250.• Gross value of transfer £497,250 (£444,000 + £53,250)

Inheritance Tax

Melville Q31.7 – Answer 5

• Step Two - IHT due on transfers within 7 years of death

• 1 August 2007 Gift to son 250,000• Less available nil rate band • (£325,000 – less CLT in previous 7 years - £94,000) - 231,000• Chargeable at 40% 19,000• 19,000 x 40% 7,600• Less: taper relief (6-7 years from death) 80% -6,080• IHT payable by son on or before 31 January 2015 1,520

Inheritance Tax

Melville Q31.7 – Answer 6

• Step Two - IHT due on transfers within 7 years of death• 10 June 2009 Gift to RP Trust (tax paid by Tony) 497,250• Less available nil rate band • (£325,000 – all used) 0• Chargeable at 40% 497,250• 497,250 x 40% 198,900• Less: taper relief (5-6 years from death) 60% 119,340• 79,560• Less: Lifetime IHT paid (see previously) -53,250 • IHT payable by trustees on or before 31 Jan 2015 26,310

Inheritance Tax

Melville Q31.7 – Answer 7

• Step Three – IHT on Estate at death• Tony died on 11 July 2014, leaving an estate valued at

£500,000. None of the transfers made on his death were exempt from IHT.

• Nil rate band used – IHT is 40% x £500,000 = £200,000• Payable by PRs on application for probate or by 31 January

2015 whichever is the sooner.

• What transfers on death could be “exempt”?• Transfers to Spouse, Charities, Political Parties, etc

Inheritance Tax

Next time…..

•Important IHT reliefs exist for Business Property, Agricultural property and Quick Succession. •We will look at these reliefs in IHT lecture 3. •We will also look at the anti-avoidance measure on “gifts with reservation”.

Inheritance Tax

Reading and exercises

• Reading and Exercises• • Reading: Melville Chapter 31 (pages 502 –

504, 506 and 509)• • Attempt exercises from Melville – questions

31.5 & 31.6.

Inheritance Tax

Seminar Question 1 (1)

• Melanie made the following lifetime transfers:• • 8 July 2003 • Gift of house to her daughter - £200,000 • 13 June 2009 • Unquoted shares gifted to her son. The gift consisted of

6,000 shares which were valued at £50,000. Before the gift Melanie owned 9,000 shares valued at £160,000 and after the gift the remaining 3,000 shares were valued at £22,500. Assume that Business Property Relief is not available on these shares.

Inheritance Tax

Seminar Question 1 (2)• Melanie died on 23 October 2014 and her assets and debts at death

were as follows:• Assets £• Shares in Tesco plc 320,000• Life assurance policy See note• House in UK 175,000• Villa in France 80,000• Household furniture and jewelry 20,000• Car 5,000• Cash in bank 14,750 • Debts• Mortgage secured on house - £10,000, Credit card bills - £7,000, Income tax - £2,500,

Gas bill - £250. • Note: the value of the insurance policy immediately before Melanie’s death was £60,000.

The proceeds payable as a result of her death were £250,000.

Inheritance Tax

Seminar Question 1 (3)• The personal representatives of Melanie’s estate paid funeral expenses of

£2,500.• Melanie was widowed in August 2010. Her husband left £20,000 to his

sister and the rest of his estate to Melanie. He had not made any lifetime gifts. Melanie remarried in April 2013.

• In her will she left her house in the UK to her second husband and the remainder of the estate to her children.

• • Required:• Explain the inheritance implications of the lifetime gifts made by Melanie.• Compute Melanie’s estate at death and the IHT due on it. State who is

liable to pay the tax due and the due date for payment.

Inheritance Tax

Seminar Answer 1 (1)• Lifetime transfers:• 8 July 2003 • PET - Gift of house to her daughter - became exempt on 8 July 2010

(after 7 years). • 13 June 2009 • PET - Unquoted shares gifted to her son. Melanie dies before 7 years

passes. The value of the shares on the diminution basis is:• Valued before the gift 9,000 shares valued at £160,000 • Value after the gift 3,000 shares were valued at £22,500. • Fall in value £137,500 – AE £3,000 – AE £3,000 = £131,500

• On Melanie’s death £131,500 is covered by nil rate band of £325,000+

Inheritance Tax

Seminar Answer 1 (2)• Assets £• Shares in Tesco plc 320,000• Life assurance policy 250,000• House in UK (less mortgage £10,000) 165,000• Villa in France 80,000• Household furniture and jewelry 20,000• Car 5,000• Cash in bank 14,750• 854,750• Debts: - £7,000+£2,500+£250 (9,750)• 845,000• Less: Funeral expenses (reasonable) (2,500)• Carried Forward 842,500

Inheritance Tax

Seminar Answer 1 (3)• Bought Forward 842,500

• Less: Exempt transfer (to wife) – house (165,000)• 677,500• Nil rate IHT band (includes unused % of first husband)• £325,000 + (£325,000 x £305,000/£325,000) • = £630,000 less used by lifetime transfer (see earlier)• - £131,500 = £498,500 (498,500)• Taxable estate 179,000• £179,000 x 40% = £71,600• Payable by Personal Representatives on or before 30 April 2015• Who suffers tax? • Melanie’s children – as it comes out of their inheritance.

Inheritance Tax