SQE 1 - Wills and Administration (Inheritance Tax)

What are the three different times IHT is charged?

1. At the time that a transfer made during a person's lifetime (a 'lifetime transfer'), is made (by the transferor)

2. on the same lifetime transfer if the transferor dies within seven years of making the transfer;

3. On the transferor's estate after the transferor has died.

What are the two types of lifetime transfers?

1. the lifetime chargeable transfer (LCT) and

2. the potentially exempt transfer (PET) s 3 IHTA 1984.

What is a lifetime chargeable transfer (LCT)?

• made while the transferor is still alive

• made to any natural person or legal entity which is not an individual or a trust in favour of a disabled person (so, for example, to a company, a discretionary trust or an unincorporated association)

• a transfer for value (see below)

• charged to tax at 0% if it falls within the nil rate band (see The nil rate band (NRB) and the cumulative total below)

• charged to tax at the lifetime rate (currently 20%) when made, if it falls outside the nil rate band

• if the transferor dies within seven years of the transfer, possibly charged to tax a second time at 40% (the 'death rate')

• subject to taper relief (see Taper relief below) if the transferor dies between three and seven years after making the transfer

What is a potentially exempt transfer (PET)?

This transfer is:

• made while the transferor is still alive

• made only to an individual, or to trustees of either a bare trust in favour of an individual or a trust in favour of a disabled person ('disabled trust')
  a transfer for value

• is not charged to tax at all if the transferor survives for seven years after the transfer is made

• is charged to tax at the death rate (currently 40%) if the transferor fails to survive for seven years

• subject to taper relief if the transferor dies between three and seven years after making the transfer.

What are the common similarities between PETs and LCTs?

They are always transfers for value, and they are always made during the lifetime of the transferor.

What is the major difference between PETs and LCTs?

One major defining difference: PETs can only be made to individual persons, bare trusts in favour of individual persons or trustees of a disabled trust. Everything else must be an LCT (s 2 of the IHTA 1984).

Remember that every time we talk about a transfer to a trust, we are in fact referring to a transfer to the trustees of that trust: only the trustees can receive any gifts that the transferor makes (see also Chapter 11 for more on will trusts).

What is a transfer of value?

In order for the rules to apply, the transfer must be a transfer for value. If the transferor is making a gift of money, that is quite easy to determine: for example, if the transferor gives £10,000, then the value of the transfer is £10,000. If the transferor gives away an item of property, however, the rule is that the value transferred is the amount by which the transferor's estate is reduced by the disposition. So if, for example, the transferor gives away a diamond ring worth £5,000, the value of the transfer is the market value of that ring.

Where a person is making a straight gift of money or property to another person, there is no problem. However, sometimes a person will try to get around the rules by not making a straightforward gift, but pretending that they are selling to another person. The pretence is that the sale is at market value when in fact it is at a bargain price

Clarice wants to make a gift of an expensive item of jewellery to her cousin Patrice. The jewellery is worth £35,000 but Clarice can save a substantial amount of IHT by selling it to Patrice for the sum of £5,000. Patrice pays the sum of £5,000 to Clarice and is given the jewellery.

Will the tax to Clarice's estate be impacted by this transaction?

This is called a 'sale at an undervalue' and, as you can see, what Clarice has in fact done is make a gift of £30,000 to Patrice. However, the amount by which Clarice's estate has been reduced is also £30,000. This 'sale', therefore, is considered as a transfer for value of £30,000 and will be taxed on that basis.

What are the exceptions to the transfer of value rules?

There are a couple of important exceptions to the transfer for value rules, both connected with the rule that the transferor must be intending to make a 'gratuitous disposition' - a gift, in other words. If the transfer is not intended to be a gift, then it does not attract IHT.

So if the transfer is being made to fulfil an obligation to maintain a spouse, a civil partner, a child or a dependant relative, that is not a transfer for value. The other exception is where the transferor has sold on an open market at an undervalue without knowing that they were doing so. An accidental 'bad bargain' is not a transfer for value

GENERATE QUESTION

1. Annual exemption

2. Presents, including wedding and engagement presents and small gifts

3. Small gifts s20

What are exempt transfers?

Some transfers for value, even though they fall within the class of LCTs, are exempt from IHT.

What is the difference between exemptions and reliefs?

the difference between 'exemptions' and 'reliefs'; we are going to consider 'reliefs' shortly. If a transfer is exempt or part exempt, then we do not consider the exempt part for IHT purposes at all; we ignore it. We do not ignore transfers which attract reliefs.

What is annual exemptions?

Every taxpayer can make lifetime transfers up to a limited amount in each tax year without paying IHT: currently, that limit is £3,000 per year in total (which can be split across as many people as you choose). This is called the 'annual exemption'. It is possible to carry forward the unused amount of an annual exemption from one tax year to another, but only for one tax year. If, for example, a taxpayer does not use their annual exemption in tax year 1 or tax year 2, they can only carry forward their exemption from tax year 2 into tax year 3. The tax year 1 exemption has been lost. Annual exemptions do not apply to the death estate.

What are Presents, including wedding and engagement presents and small gifts?

There are also some limited exemptions for wedding or engagement presents.

• The parent of a bride or groom can give them up to £5,000 free of IHT

• a grandparent can give £2,500

• a person not related to the bride or groom can give £1,000; s 22 IHTA 1984.

This of course includes not just gifts of money but also gifts of other property up to those values. Any amount given in excess of these values will be charged to tax at the appropriate rate.

What are small gift exemptions?

Exemption at s 20 IHTA relates to small gifts: any gift to an individual not exceeding £250 will be disregarded. These small gifts cannot be added together either, and therefore will not count towards a person's cumulative total.

What types of transfers do annual exemptions for wedding, engagement and other small gifts apply to?

Annual exemptions and the exemptions for wedding, engagement and other small presents apply to lifetime gifts only.

Ghyslain would like to make some gifts to friends, family and associates. He decides to do the following:

• give £5,000 to his 20-year-old niece Sancha

• give his collection of antique silver yachting trophies (valued at £35,000) to the local sailing club of which he is a member (the sailing club is a profit-making institution)

• give £25,000 to the trustees of a trust set up to help his friend Bogdan, who was severely injured in a motorbike accident

• give £15,000 to the Pantheist Party, a political party which supports green and ecological
  causes

• add a codicil to his will giving the sum of £7,500 to his uncle Yannick.

Are these gifts an LCT, a PET or neither? In each case, if you decide it is a transfer for value, what is the value of the transfer?

The gift to Sancha is made during Ghyslain's lifetime and is to an individual. It has a value of £5,000 and it is therefore a PET of £5,000:

• the gift to the sailing club is made during his lifetime, but is not to an individual or to a bare/disabled trust (it is in fact to an unincorporated association) and is therefore an LCT; because the club makes a profit, the transfer is not exempt; the value of the transfer will be £35,000

• the £25,000 is a gift during his lifetime to a trust, which would normally be an LCT, but as this is a disabled trust, it is a PET; the value is £25,000

• the £15,000 is a gift to a political party and is therefore automatically exempt from IHT

• the gift made in a codicil is not a lifetime gift; it takes effect only when the will takes effect. It therefore does not qualify as either an LCT or a PET.

What is taxation of PETs?

Using Ghyslain's gift of £5,000 to Sancha in Practice example 10.2, let's see how this might be taxed in Practice example 10.3. We already know that this is a PET. It is sometimes helpful to think of a PET as a 'wait and see' transfer - we literally 'wait and see' whether the transferor survives for seven years after the transfer or not. If the transferor survives seven years, then no IHT is ever payable. However, if the transferor dies, then tax will be payable at the appropriate full IHT rate, unless taper relief applies.

Ghyslain makes the £5,000 PET to Sancha in December 2016 when he is 35 years old. If he survives until December 2023, then no IHT will be payable. In fact, Ghyslain contracts Covid-19 in March 2021 and dies.

How much IHT is now payable?

If the gift falls outside the NRB, IHT is now payable at 40% on the entire gift. However, this is a case in which taper relief will apply. If a transferor dies between four and five years after making a gift, the tax payable will be 60% of the total IHT liability on that gift. The total tax payable without taper relief would be £2,000; with taper relief of 60%, the total tax payable is £1,200.

We will come across taper relief again when we look at LCTs. For the moment, concentrate on how taper relief works and how the calculation of the tax is arrived at. The main point here is that no tax is payable on a PET at all unless the transferor dies within seven years of the transfer.

What is taxation of LCTs?

The position is a little more complicated here. Using Ghyslain's gift of the trophy collection to the sailing club in Practice example 10.2, let's see how this might be taxed in Practice example 10.4. The collection was valued at £35,000, so this is an LCT of £35,000. Again, to keep things simple, let's assume for the moment that no exemptions or reliefs could be applied to this gift.

This time, there is no 'wait and see'. An LCT attracts IHT as soon as it is made. If the gift falls within the NRB, IHT is charged at 0%. If it falls above the NRB, it is payable at the 'lifetime rate' of 20% as opposed to the 'death rate' of 40%.

Ghyslain's gift to the sailing club is made in January 2017. The value of the gift is £35,000. Ghyslain dies in March 2021 having used up all of his NRB.

How much IHT is payable on this LCT?

As the gift falls above the NRB, the tax is charged at the lifetime rate: 20% of £35,000 is £7,000, and this is the amount that must be paid in IHT straight away.

If Ghyslain had survived for seven years, there would be no further tax to pay. However, as he died in March 2021, he survived for only four years and two months after making the gift. Therefore, following Ghyslain's death, the gift will be reviewed and IHT will then be charged at the death rate: 40% of £35,000 is £14,000, and this further amount will be payable subject to deductions. This means that the same gift can be taxed twice: once when it is made, and again if the transferor fails to survive for seven years.

Strictly speaking, it is the transferor (the giver of the gift) who is responsible for paying the IHT, but it usually the transferee (the recipient) who actually hands the money over to HMRC. This can cause issues with the value of the transfer, so transferors often prefer to pay the gift to the recipient and pay any tax due to HMRC. To calculate what the correct transfer value should be, the 'grossing up' rules are used. These are outside the scope of this book but you should ensure that you revise and know them.

HOW TO CALCULATE INHERITANCE TAX: THE ORDER IN WHICH TO CALCULATE

For every transfer, lifetime and on the death estate, you need to perform a calculation as follows:

1. What is the value of the transfer?

2. Deduct any available exemptions from that value.

3. Deduct any available reliefs from that value.

4. Calculate the cumulative total of all of the transfers to date.

5. Calculate whether there is anything remaining in the NRB.

6. Apply IHT to the new transfer value at the applicable rate.

7. Where you can, apply taper relief.

What are exemptions?

Step 2

Annual exemptions are the most relevant here. The maximum amount of annual exemption that can ever be claimed is the maximum exemption for the tax year in which the gift is made, plus (if it has not been used) the exemption for the previous tax year. As the current maximum per tax year is £3,000, this means that currently, total annual exemptions can never exceed £6,000-but they will often be much less than that. Remember that annual exemptions are not included in a death estate calculation.

What are Reliefs?

Step 3

There are two main types of tax reliefs on IHT:

• business property relief

• and agricultural property relief (APR).

Where a chargeable transfer has been made within four years of the transferor's death, taper relief may also reduce the amount of tax payable.

What is BPR?

BPR will be available at 100% (that is, all of the transfer will be free of IHT) if:

• the transferor is selling a business or an interest in a business (including a partnership),

• and the transferor has owned the business as sole proprietor for at least two years/has been a partner for the same length of time;

• or if the transfer is of shares in an unquoted company (that is, a company whose shares are not traded on any public stock market, i.e. private companies).

BPR is available at 50% (that is, half of the applicable IHT rate will be charged) if:

• the transferor has control of a public company (that is, a plc) and is transferring shares of that company,

• or if the transferor is transferring specified assets (including land, buildings, plant or machinery) of a company (private or public) that is controlled by the transferor, or a partnership in which the transferor was a partner.

What is APR?

APR is available at 100% if the transferor occupied the transferred property for agricultural purposes for at least two years prior to the transfer, or it was owned by the transferor for at least seven years prior to the transfer but was occupied during that time by someone else who was using the property for agricultural purposes. So a transfer by a farmer of a working farm that she has owned for over two years will attract 100% relief from IHT, and so will a transfer by a landlord who has rented the property out to a tenant farmer, provided the landlord has owned the land for at least seven years and the tenant has worked it as a farm during that time. APR is also available at 50% in other specified circumstances.

What is taper relief?

• If the transferor has died within six to seven years of the transfer, then only 20% of that charge is payable.

• If the death is within five to six years of the transfer, then 40% of the charge is payable;

• if within four to five years, 60%; and

• if within three to four years, 80%.

• If the death is within three years of the transfer, there is no taper relief.

What is taper relief available on?

Taper relief is also only chargeable on lifetime transfers: it never applies to calculations on the death estate.

Mikaela died in October 2021. She had made a lifetime transfer of £200,000 in May 2017 which, after calculation of her cumulative total and NRB, was all chargeable to IHT at the death rate of 40%. The basic amount of IHT payable was therefore £80,000. However, Mikaela died within four to five years of making the transfer.

How much IHT is payable?

Taper relief meant that only 60% of the £80,000 was payable: the total amount of IHT was therefore £48,000.

The nil rate band (NRB) and the cumulative total As well as the annual exemptions of f 3,000, which can be made in each tax year free of any tax at all, each taxpayer can transfer up to £325,000 over a total period of seven years at a tax rate of 0%: this is the so-called 'standard' NRB. Note that this is tax charged at 0% and is not an exemption.

What are the additional nill rate bands relevant only on death?

1. Transferable NRB (s 8A IHTA 1984)

2. Residence NRB

What is transferable NRB?

Spouses (including civil partners) have the benefit of what is called the 'transferable' NRB. If a married person dies with part of their NRB unused, that unused portion can be transferred to their widow(er).

What is Residence NRB?

The 'residence' NRB of £175,000 is available where after 6 April 2017 a residential property in the deceased's estate is being transferred to a direct descendant either of the deceased (including grandchildren or great-grandchildren) or direct descendants of the deceased's spouse.

Again, this can be a very significant advantage, particularly where, as with most estates in the UK, the single biggest asset is the deceased's former home. The NRB limit on death is in effect lifted by a further £175,000. However, if an estate is worth over £2 million, the residence NRB is reduced by £1 for every £2 over the £2 million limit.

What is standard NRB and it’s effect on lifetime transfers?

Taxation on the gift at the point of transfer: the cumulative total In order to work out how much is in the NRB, we look back seven years from the date of a lifetime transfer and work out how much the transferor has gifted over that seven-year period. If the transferor is still alive, PETs are ignored. The resulting figure is the cumulative total. If the amount exceeds £325,000, then the transferor has used up all of their NRB and tax on lifetime transfers above the £325,000 limit is now payable at 20%. This is the 'lifetime rate'.

Park makes a gift of £10,000 to a discretionary trust, the Haviland Trust, in January 2019. This is an LCT. To calculate if he must pay tax on that transfer, we first need to establish whether he has exhausted his NRB or still has part of it remaining. We must therefore look back at all the transfers he has made in the seven-year period between January 2012 and January 2019. We do not include any PETs made while Park is still alive (which he currently is) because we 'wait and see' whether these will become chargeable transfers. It turns out that Park made the following transfers in that period:

• February 2014 £125,000 to his business

• October 2017 £75,000 to another discretionary trust

• December 2017 £150,000 to his partner Suki

• June 2018 £85,000 to a family trust with a life interest for his father

• November 2018 £30,000 to the alumni fund of his old university (not a charity)

• January 2019 £10,000 to the Haviland Trust

To simplify the point, we have shown the net values of all of these transfers - that is, that all available exemptions and reliefs have been deducted. Remember that in practice, you will first have to apply these to the gross value of each transfer, and calculate the correct net figure. Including the transfer of January 2019 in your calculation, has Park used up all of his NRB or not?

The answer is that he has not - but only just. Over the past seven years, he has used up all £325,000 of his NRB; in other words, his cumulative total over those seven years is £325,000. If you thought that he had used it up because he has transferred a total of £475,000, you have made the mistake of counting the transfer to Suki. That transfer is to an individual, so it is a PET and it is not counted: we 'wait and see', remember. This means that the gift to the Haviland Trust would just fall within the NRB. (There may be further exemptions or reliefs which could be deducted: see below.) Remember that any transfer that falls within the NRB is not exempt from tax: it is taxed at 0%. The result is that Park has no IHT to pay.

Please note that we have only considered the question of the cumulative total in this example -we would also have to go on to consider exemptions and reliefs before calculating IHT. We will do this in the examples which follow.

company in May 2021. This is an LCT. We must look back over the previous seven years: that is, from May 2014 to May 2021. Here is the picture now:

October 2017 £75,000 to a discretionary trust December 2017 £150,000 to his partner Suki June 2018 £85,000 to a family trust with a life interest for his father November 2018 £30,000 to the alumni fund of his old university January 2019 £10,000 to the Haviland Trust May 2021 £250,000 to the IT company

Note that the seven-year period has changed: you always count back seven years from the date of the most recent transfer. This means that the gift made in February 2014 is no longer included for cumulative total or NRB purposes. What is the cumulative total including this new gift and is any IHT payable?

Remember, again, that to simplify matters, all of the figures given from October 2017 to January 2019 are shown net of any applicable reliefs and exemptions. However, in practice you would first have to apply these to the gross value of the transfer to give the correct net value.

First of all, let's consider the transfer of £250,000 itself. When it was made, you will note that two annual exemptions of £3,000 were available: one for the tax year ending 5 April 2021, and another for the tax year ending 5 April 2022. This sum of £6,000 can be deducted from the total amount of the transfer: the total taxable transfer in May 2021 was therefore £244,000.

Now let's look at the new cumulative total. It is £450,000. Before the May 2021 gift is made, the cumulative total is £200,000 (that is, there is £125,000 of the NRB left). That means that f125,000 of the taxable May 2021 transfer of £244,000 is taxed at 0% but the remaining £119,000 that falls outside the NRB is taxable at the lifetime rate of 20%. The tax payable will be 20% of £119,000 = £23,800. This is payable immediately.

What is tax chargeable on LCT if the transferor dies within seven years?

If the transferor dies within seven years of making an LCT, the inheritance tax must be recalculated at the death rate.

When a transferor dies, we must re-calculate the inheritance tax due, looking at each individual transaction which took place in the 7 year period prior to death. In this next example, Fela died in May 2022, so the relevant 7 year period is May 2015-May 2022. He made no transfers before November 2015. After that, he made the following transfers (in all cases, we are again using the net values, after deductions of any applicable exemptions and reliefs):

November 2015 £80,000 to his sister's limited company

January 2016 £75,000 to a discretionary trust for his nieces and nephews

March 2018 £225,000 to the Baxis Foundation, a profit-making association

May 2022 Fela dies

Fela paid all chargeable inheritance tax on these gifts at the time they were made. What further inheritance tax is payable after his death?

We must now take each individual chargeable transfer, from the earliest to the latest, and work out the post-death inheritance tax for each one. In each case, we look back seven years from the transfer in question to see how much of the relevant NRB has been used. In the seven-year period prior to November 2015, Fela had the full NRB of £325,000 available. His transfer of £80,000 was therefore within that NRB and is now charged to tax at 0%. In January 2016, when he transferred the net sum of £75,000, he had used up £80,000 of his NRB within the past 7 years, and therefore still had £245,000 of it available. His transfer of £75,000 was well within that band, and is again charged to tax at 0%. However, by March 2018, when he transferred the £225,000 to the Baxis Foundation, he had only £170,000 of his NRB available. The first £170,000 of the March 2018 £225,000 transfer is therefore charged to inheritance tax at 0%, but the balance of £5 5,000 is now charged at the death rate of 40%, a total of £22,000. As the March 2018 transfer was made between four and five years of Fela's death, taper relief is available at 60%, so the chargeable total is £13,200. HMRC will take account of any tax paid on this transfer during Fela's lifetime (that is, at the lifetime rate).

What is the effect of death on PETs?

Causes a big impact as the PET is no longer exempt from tax at all.

In September 2019, Maisie makes a gift of £75,000 to her sister Purdie. It is the first transfer for value she has ever made. At the time it is made, it is a potentially exempt transfer and would attract annual exemptions of £3,000 for the tax years ending April 2019 and April 2020, meaning that the total taxable value of the gift is £69,000.

We then 'wait and see' whether Maisie will survive seven years. We know therefore that at the time it is made, the transfer is not liable for any inheritance tax. If Maisie survives until September 2026, then no IHT is ever payable on that gift. However, Maisie dies in June 2023. Assuming she made no other transfers before she died, how much IHT is now payable on that gift?

Although no tax was payable in September 2019, IHT will now be payable. Just as we did in the previous examples relating to Fela, we have to look back at the seven-year period between June 2016 and June 2023 to calculate the cumulative total. In this case, that is simple: the cumulative total is £69,000 (because Maisie had made no other transfers) and therefore the NRB has not been used up. The gift is therefore taxed at 0% and no tax is payable on the lifetime transfer.

In September 2019, Maisie makes a gift of £75,000 to her sister Purdie. It is the first transfer for value she has ever made. At the time it is made, it is a potentially exempt transfer and would attract annual exemptions of £3,000 for the tax years ending April 2019 and April 2020, meaning that the total taxable value of the gift is £69,000.

What would the position be, though, if Maisie had made an LCT of £300,000 (after deductions of exemptions and reliefs) in July 2016, and then the gift to Purdie, and then died in June 2023?

In this case, the cumulative total from June 2016 to June 2023 would be £369,000, and C44,000 of the gift to Purdie would exceed the NRB. This would now be chargeable to tax at the death rate of 40% and therefore £17,600 would be payable in tax. As Maisie died within three to four years of the September 2019 gift, taper relief is available at 40%, which makes the total amount of tax payable £7,040.

What is inheritance tax on the death estate?

In fact, the law looks on what then happens as a further transfer: all of the deceased's property passes from their hands into the hands of their PRs (s 4 of the IHTA 1984). When that happens, there is another taxable transfer. In a very real sense, the passing of the estate to the PRs is the deceased's last ever gift.

When calculating the amount of 1HT payable on death, you move through the applicable rules in the same strict order that you move through them in relation to lifetime transfers.

Madox dies, leaving an estate worth £425,000. Within seven years of his death, he had made an LCT of £100,000 after deduction of all applicable reliefs and exemptions. He made no other transfers during his lifetime.

How much IHT is payable on the estate?

When Madox died, he had £225,000 of the NRB remaining and this passed to his estate. This means that IHT is due on £200,000 of his estate at the death rate of 40%. No taper relief is available on the death estate; taper relief applies to lifetime transfers only. The tax due is £80,000.

Which items are not included in the death estate for inheritance tax purposes?

• Joint tenancies

• Donatio mortis causa gifts and interests in settled property

• Property that passes outside of the estate

What is joint tenancies?

The principle of survivorship applies to joint tenancies and that the deceased's interest in the property, whatever it is, will immediately pass to the other co-owners on death and does not form part of the inheritable estate.

However, the deceased's interest in the joint tenancy is in fact included in the death estate for tax purposes only. For example, if the deceased owned a property worth £2 50,000 jointly with a business partner, the property would pass entirely to the business partner on the deceased's death, but the estate would be liable for tax on the deceased's 'share' of 125,000.

The rule does not change if the deceased shared the joint tenancy with a spouse or civil partner, but the effects of the rule in that case are generally very different because, as we have seen, transfers to spouses or civil partners are always exempt from IHT.

What is Donatio mortis causa?

Donatio mortis causa gifts and interest in settled property Donatio mortis causa gifts (see Chapter 6) are also included in the death estate for IHT purposes, because the deceased owned them at the moment of death - they only pass to the donee in the seconds after death.

There are complex rules about inclusion in the death estate if the deceased had a life or a limited interest in settled property. If the interest was created before 2006, it may be valued as if the deceased owned all of the capital in the trust fund. The subject is too complex to be dealt with in the scope of this book.

Gifts with a reservation are also included in the death estate for tax purposes (see Anti-avoidance: gifts subject to a reservation below).

What is property ignored (property passing outside estate)?

Property ignored IHT can only apply to property owned by the deceased at the time of death. This means that many of the assets that we looked at in Chapter 6 as property passing outside of the estate will not be liable to IHT, including life insurance policies written into trust and pension scheme nominations. If the benefits are discretionary (see Chapter 6, Proceeds of life insurance policies), even if they might be payable to the deceased, the deceased had no right to them at the time of death. You should now be able to see why, for example, well-advised testators will want to write their life insurance policies into trust: otherwise, 40% of the payout could be spent on IHT when it might be desperately needed by the family they leave behind.

All of the assets in the estate have to be valued in order for a correct calculation to be made. If there are particularly valuable assets, including land and antiques, specialist valuers will be called on to give a market valuation.

What is anti-avoidance: gifts subject to a reservation?

The most commonly used stratagem to attempt to defeat the effects of IHT is the gift subject to a reservation (s 102 Finance Act 1986).

Mitzi owns a London flat worth £575,000. She has decided to retire to her cottage in Dorset. In order to minimise her IHT liabilities, she decides to make a lifetime gift of the flat to her nephew, Rowan. However, Mitzi tells Rowan that although she is transferring the flat to him, she wants to be able to live there rent-free for at least two months in the summer and one month in the winter.

Can Mitzi claim that this gift is a PET?

What Mitzi has done is to reserve some of the benefit of the property to herself: she has given Rowan a gift with strings, the string specifically being that Mitzi wants to carry on getting use and benefit from the property while appearing to give it away. This means that Mitzi cannot claim that this is a PET. If she tried to do so, and she was still using the flat at the time that she died, then the entire transfer would be ignored and the flat would be treated as part of her death estate. Note that if Mitzi died within seven years of this attempted PET, not only would the value of the flat be added to her estate but IHT may also be charged on the failed exempt transfer: in other words, the transfer would be taxed as if it had succeeded and also as if it had failed. This means that the same property would be taxed twice. The consequences of such an outcome are, as you will understand, potentially disastrous for the estate and therefore for all of the beneficiaries, and very strong efforts have to be made to avoid such an outcome.

Mitzi owns a London flat worth £575,000. She has decided to retire to her cottage in Dorset. In order to minimise her IHT liabilities, she decides to make a lifetime gift of the flat to her nephew, Rowan. However, Mitzi tells Rowan that although she is transferring the flat to him, she wants to be able to live there rent-free for at least two months in the summer and one month in the winter.

What could change to not make Mitzi's gift subject to a reservation?

the gift would not be subject to a reservation if Mitzi decided to pay the market rent for staying in the flat, or if she decided that she would not stay in the flat at all. The gift would then not be subject to the reservation after the date of her decision; it would become a PET. However, as you will have seen, any potential gifts with reservations are best avoided because the sanction of double taxation is particularly severe.

What other taxes are present during administration of the estate?

1. CGT

2. Income Tax

What is the principles of CGT on PRs?

If the deceased died owing CGT on a taxable gain, then the PRS must obviously pay that as part of their duty to administer the estate. One thing to note, however, is that although for IHT purposes death is a 'transfer' (see above), for capital gains purposes death is not a 'disposal'. This means that there is no CGT chargeable as the death estate passes into the hands of the PRS. Instead, the PRs take on the assets with the (market) value they have at the date of death. They will in due course have to distribute those assets to the beneficiaries and no CGT arises when they do so (even if values have risen in the meantime). This includes transfers to non-natural persons such as trusts.

However, PRS may have to, or choose to, sell assets of the deceased's estate once it is in their hands. If they do, and the proceeds of sale exceed the market value on death, there is a chargeable gain on which they must pay CGT.

What is the principles of CGT on beneficiaries?

We have already seen that for CGT purposes assets come into the estate and are passed out to beneficiaries at their market value on the date of death: therefore, no CGT is payable. However, there is an area in which beneficiaries can be caught out. This is where they sell the inherited asset on at a higher value. For example, if a beneficiary receives an asset worth £15,000 but then decides to sell it the following year for £25,000, they will be liable for CGT on that gain (although they may be able to use their personal CGT allowance to reduce or extinguish their liability).

CGT is never payable…

when you make a loss.

What is income tax on PRs?

While the estate is being wound up, investments (building society accounts, investment accounts and so on) may be earning some income in the way of interest.

• If the income earned is less than £100 and is only from interest on savings accounts, the PRS do not need to pay income tax on it.

• However, if it is larger than £100 and comes from other sources, then income tax will arise and it is the PRS who are responsible for paying it.

• While most estates only earn a small amount of interest and almost wholly from savings accounts, watch out for the anomalies, which will include income tax on rent paid to the estate for a property which is currently being rented out. A residuary fund, which is being invested in a number of places in order to provide income for life tenants, is another example.

• PRS will pay income tax on the income of that fund, but that is not the end of the matter: beneficiaries may also have to pay some income tax, as we will see below. Income tax is payable at the basic rate on all income, but there is no income tax personal allowance.

What is income tax on beneficiaries?

Beneficiaries must pay income tax on any residuary fund during the administration of the estate, but will then pay out of the income to any beneficiaries of the residuary estate entitled to income. Those Bs will also have personal liability to pay income tax on that income. As a result, Bs can generally claim a tax credit for income tax already paid by the PRs.