WAE and BLP - IHT: Exemptions and Reliefs

What is a PET?

gift to a person; not chargeable unless they fail (donor dies within 7 years).

What is an LCT?

gift into a trust; chargeable when made and are re-taxed again at a higher rate if the donor dies within 7 years.

How is an exemption/relief different from NRB?

- gifts that are exempt are made free of IHT and have no effect on NRB

- gifts that benefit from relief benefit from a reduced amount of IHT to be paid

At what point are exemptions applied?

- before the amount goes from the 'wine glass' to the 'beaker'

- eg before you start using up the NRB

Which exemptions only apply to lifetime transfers? (cannot be used on death)

- annual exemption

- small gifts

- normal expenditure out of income

- marriage exemption

- family maintenance exemption

What are the relevant reliefs from IHT?

Business property relief (s 104)

Agricultural property relief (s 116)

Taper Relief (s 7)

if an exemption/relief can only be made during T's lifetime, when will it apply?

- for failed PET (donor died within 7 years of making a gift)

- for LCT (taxed when made)

- for LCT (if re-taxed following the donor's death within 7 years)

but not when calculating IHT for estate after death

Which exemptions and reliefs are available for both lifetime transfers and death estate?

Spouse exemption

Charity exemption

Business property relief

Agricultural property relief

Political party exemption

Exemptions for gifts for national purposes or to heritage

maintenance funds

Exemption for gifts to Employee Benefit Trusts

Exemption for gifts to housing associations

What is the spouse exemption?

- All transfers between spouses/civil partners during life or after death are fully exempt

- both parties must be long-term UK resident taxpayers

- gift may be conditional provided the condition is satisfied within 12 months of death (e.g., must survive 28 days after me)

Does the spouse exemption apply to a life interest trust where spouse is life tenant?

- will also apply to assets in a life interest trust if spouse is life tenant (not if they are remainderman and someone else is life tenant)

- when the interest vests in the remainderman, they will have to pay IHT

What will be charged if spouse is not a long-term UK resident?

up to £325,000 of transfers tax free

after this, taxed at 40%

What is the charity exemption?

- All transfers to registered charities in the UK during life and following death are exempt irrespective of the amount given

- provided the gift is used exclusively for the purposes of the charity

- gift can be conditional as long as condition is satisfied within 12 months of death

What is the reduced rate for leaving assets to charity?

- reduced rate of IHT applies overall where a deceased leaves at least 10% of their estate to charity.

- 36% instead of 40%

What is required for gifts to political parties to be exempt?

- party must have had at least 2 MPs elected at the last election

- OR party had at least one MP elected and at least 150,000 votes given to candidates representing that party.

What are gifts for national purposes?

- e.g., given to National Gallery or British Museum

- there is a list of bodies in the Inheritance Tax Act

What is business property relief?

- reduces the IHT payable on transfers of qualifying business property

What is qualifying business property for the sake of Business Property Relief?

- unlisted shares

- listed shares (if T owns more than 50% of the company)

- a business or interest in a business, if T is sole trader or a partner

- assets owned by T but used for business (e.g., land, machinery)

What are the different rates of relief for different qualifiying business property under BPR?

unlisted shares - 100%

business or interest in a business - 100%

listed shares where T has controlling share - 50%

assets owned by T and used for business - 50%

Why would shares in a company, a business, or an interest in a business not be considered qualifying business property?

business/interest in business shares will not qualify if the business concerned consists wholly or mainly of:

- dealing in securities/stocks/shares/land/buildings

- making or holding investment (inc rental property)

- furnished holiday letting(s)

could cause problems for property management firms, and assets in a business not used for trade

How long must transferor have held the business assets for them to qualify for BPR?

- transferor must have owned the business assets continuously for at least 2 years immediately before the relevant transfer

- can have changed to a different type of business during that time

What are the exceptions to the rule re holding assets for 2 years for BPR?

- if assets are sold and replaced, period of ownership usually considered continuous

- if X inherits business assets after a death, they are deemed to inherit on the date of death, not the date they actually received them

- if X inherits from their spouse, deemed to have owned the assets from the time it was acquired by spouse - can validly split between 1 year of ownership by each party e.g.

What is agricultural property relief?

- Reduces the IHT payable on the agricultural value of qualifying assets, owned for the qualifying period of time

- AV is different to market value

e.g., if land has vaue of £2.3m and agricultural value of £2m, will get APR on the £2m - remaining £300,000 will be taxed at usual 40% rate

What is included as agricultural property?

- land

- buildings

- farmhouses and cottages - if they are of a 'character appropriate' to the associated agricultural land and have been occupied for the purposes of agriculture

What is the qualifying period of ownership for to get agricultural property relief?

- occupied for agricultural purposes by transferror for the 2 years immediately before transfer

- OR owned by T and occupied by them or another for agricultural purposes for 7 years immediately before transfer

What are the exceptions to qualifying period of ownership for to get agricultural property relief? (same as for BPR)

- ownership treated as continuous when assets are sold and replaced

- if someone inherits the property, they are deemed to inherit on date of death, not date of transfer

- if someone inherits after the death of spouse, they are deemed to have owned the property from when it was acquired by the spouse, regardless of length of marriage

What are the rate of relief for Agricultural Property Relief?

100% - if T was the owner occupier for agri. purposes for at least 2 years

100% - if T let it to another person for agri. purposes on or after 1st September 1995 for at least 7 years

50% - for tenancies created before Sept 1995

What takes priority: APR or BPR?

APR is given priority over BPR where both apply - cannot claim BPR on an asset that already qualifies for APR

example:

- barns may apply for both, so will apply APR

- livestock will not apply for APR, so can apply BPR

What is woodlands relief?

- Gifts of woodland following death may qualify for woodlands relief.

- Must have been owned for at least 5 years before death

- unless deceased themselves inherited the woodland from someone else - in that case, there is no qualifying period of ownership

How does woodlands relief act as a deferral?

- defers IHT that would otherwise be payable on the transfer

- PRs should make an election to exclude the value of the woodland from the death estate

- value of the woodland = value of the trees, not value of the land

- tax will only be payable when the timber (not land) is sold or given away later

What is quick succession relief?

- intended to help inheritor when the same assets would be subject to more than 1 IHT charge in quick succession

- Applies where D dies and their death estate includes assets received by way of gift or inheritance from the 5 years before their death

- and those assets were subject to IHT charge when transferred to D.

Example: A dies, leaves estate to B, who pays IHT. B dies, leaving estate to C. QSR reduces IHT payable by C, tax already paid acts as a credit aaginst IHT now payable.

What are the rules around quick succession relief?

- IHT must have been payable on original transfer and the following transfer - e.g., if original transfer was not subject to IHT, cannot carry any relief over

- if death of B occurs within a year of A, relief is 100% off the amount of IHT paid previously

- this amount reduces every year

What is the annual exemption?

- can give away assets or cash up to a total of £3,000 in a tax year without it being added to the cumulative total for Inheritance Tax purposes.

e.g., gift to son of £10,000 two years before death

= is a PET that became chargeable since not enough time has passed before death

= can claim annual exemption for year of the gift and the previous tax year too, if exemption is unused

= exemption will reduce chargeable value of the gift to £4,000 (= 10,000-3,000-3,000)

When (chronologically) should the annual exemption be used?

- should be used after any other available exemption or relief is applied to ensure the AE is available for later transfers

- once the AE for that tax year is used, can use what is left from the previous tax year - but no further than that!!!

- therefore absolute maximum of £6,000 can apply

- if used, applies chronologically based on transfers were made (e.g., £3,000 transfer on January 1st will eat the whole AE before it can be applied to £2,000 on January 3rd)

- however, if more than one transfer is made in one day, the exemption will not be applied chronologically, but will be split proportionally between the transfers

What is the family maintenance exemption for lifetime transfers?

Maintenance payments are not treated as transfers for IHT purposes, if made to:

- spouse/former spouse in a divorce settlement

- minor child of either party to a marriage for maintenance, education or training

- adult child in full-time education or training

- a dependent relative to make reasonable provision for their care

When will maintenance exemption not apply to spouses?

will only apply if both parties are long-term UK resident taxpayers

What is the small gifts allowance?

- Small gifts (of up to £250 per recipient per tax year) can also be made free from tax

- £100 + £150 to B in the same tax year = SGE applies

- £200 + £100 to B in the same tax year = SGE does not apply to any of the transfers

- A transferor can make multiple gifts of up to £250 to as many different people as they like

Can small gifts allowance be used with other exemptions for the same gift?

- cannot use this along with another exemption for the same person in the same tax year

- e.g., cannot use along with AE for a gift of £3,250

- but could validly use AE and SGE to give £3,000 to one person and £250 to another, and claim both reliefs

- if donor wants to make a gift of more than £250 tax-free, should use AE instead

Will small gifts allowance apply partially for gifts of more than £250?

No - the gift must be £250 or less for the exemption to apply at all

- will not apply to the first £250 of a £500 gift eg

What is the marriage exemption?

a wedding gift given in consideration of a marriage, to one of the people getting married, will be exempt, up to...

- £5,000 if made by a parent of one of the parties

- £2,500 if made by one party of the marriage to the other or by their remoter ancestor e.g. grandparent or great-grandparent

- £1,000 in any other case.

When does the marriage exemption apply?

- applies to gifts given to an illegitimate child, an adopted child and a step-child.

- must be in relation to a specific marriage - either before the marriage, contemporaneously, or after, if satisfying previous legal obligation

- relief applies per donor, not per recipient

- can also apply AE to the same gift

What is the exemption for normal expenditure out of income?

A transfer of value is exempt if made:

- from the donor's income (not capital)

- as part of a normal/regular pattern of giving, and

- does not affect the donor's standard of living (is surplus)

HMRC are more likely to accept this when transfers are made out of legal obligation or if there is a clear history of regular payments

Is there a limit for normal expenditure out of income?

no limit

What is taper relief?

A reduction of the amount of IHT which would otherwise be payable:

- for lifetime transfers made 3-7 years before the death of T

- where IHT is payable in respect of the lifetime transfer, separately from that due on the death estate

- when there is tax actually payable e.g., amount is above the NRB

How does taper relief work?

- does not reduce the value of a lifetime transfer or alter the percentage rate of IHT

- it reduces the final tax bill due on that specific transfer by a percentage, depending on on number of years between date of transfer and death

- not related to tax payable on the death estate - this is tax payable on a lifetime transfer, and so will be added to total tax due on death estate at the end

At what point do you apply taper relief for PETs and for LCTs?

- for PETs: simple version, just reduce the tax by the amount

- for LCTs: apply taper relief and THEN give tax credit for having already paid 20% rate at the time of the transfer

How do LCTs and failed PETs affect the NRB upon death?

How do lifetime exemptions affect this?

- even if the value of a PET or LCT is not high enough to trigger a charge, if death occurs within the 7 years that follow, the chargeable value of these transfers "uses up" the NRB available for the death estate.

- therefore, exemptions that reduce the chargeable value of a PET or LCT, in whole or part, leaves the taxpayer with a larger NRB than would otherwise have been the case.