Inheritance Tax (IHT)

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1. Introduction

Inheritance tax (IHT) is the tax paid when one’s property, money or possession is transferred to another person. It was introduced through the Inheritance Act of 1984, and it came into effect in the United Kingdom in 1986. IHT replaced the successor tax to estate duty, that was known as Capital Transfer Tax. However, the inheritance tax is considered less important because of its insignificant contribution to the United Kingdom’s economy, which is, in most cases, less than 1% of the total tax collected. Despite this, it is important for people who are likely to have a significant potential liability to pay inheritance tax, which is paid after the death of the property owner. Thus, it has been popularly renamed “Death Tax”. The tax is also charged on specific gifts that are executed during an individual’s lifetime. Moreover, the tax is charged to a person whose net worth exceeds £325,000. This paper focuses on an overview of how the inheritance tax operates in the UK, and discusses some strategies that can be applied to reduce the potential liability of IHT, as well as the merits and demerits of such strategies.

2.0. Overview of the Inheritance Tax Regime in the United Kingdom

2.1. How Inheritance Tax Operates in the UK

Inheritance tax is that duty charged on the transfer of wealth, especially when a person dies. It is sometimes charged during the lifetime of a person on specific gifts, and this is because people may dispose some of their money, property, or assets during their lifetime and, inevitably, all their worth during death. When the tax is charged following a person’s death, it is imposed at the time of death. However, the executor is given a grace period to enable him to raise the money to remit to the revenue authority (Komarnyckyj, 2012, pg.1).

For an inheritance tax to be charged, there must be a transfer of value from one person to another; that is, there must be a transfer of some ownership rights from one person to another. The value transferred should have monetary value, and must be gratuitous; meaning, the person making the transfer must not have received money or other benefits for the item of transfer. On the other hand, the person receiving the value or gift must not have paid for it (Komarnyckyj, 2012, pg.2).

The inheritance tax is charged on the amount by which the value of the person transferring the estate (transferor) is reduced, and this amount is known as the value of the transfer. When a person transfers an estate at the current market value, there is no transfer of value, hence IHT is not charged. The seller and the purchaser own the same value even after such a transaction; thus, the effect of such a transaction would be the seller exchanging the asset for a monetary value, while the purchaser exchanges money for the value of the asset. However, when one purchases an asset at a price that is more than the market value, there is a transfer of value. The difference between the worth of the assets and the amount paid is the transfer value on which IHT should be charged. On the other hand, when one purchases an asset for a less amount than its worth as a result of a bargain, there is a transfer of value, but it is not likely for one to have an IHT issue (Komarnyckyj, 2012, pg.8). It is also important to note that the following amount to transfer of value and inheritance tax is charged:

➢ When there is a direct gift of money, asset or property from one person to another.

➢ When there is a direct gift of money, asset or property from one person to a trust.

➢ When one person sells property or asset at less than the full market value

➢ When one grant a lease at less than the full market value

➢ When there is a re-arrangement of shares in a private limited company

➢ When a person consents to become a guarantor for another person’s debt

➢ When one party pays premium on a policy of life insurance for the benefit of another person

➢ When a person fails to exercise their rights, thereby reducing the value of their estate (Komarnyckyj, 2012, pg.8).

2.2. Geographical Scope of Inheritance Tax

The domicile of a person is considered when charging Inheritance Tax in the United Kingdom. An individual’s domicile is the place where he or she has or is deemed to have a permanent home. The domicile determines how a person’s money, property, and assets will be taxed concerning Inheritance Tax. (Komarnyckyj, 2012, Pg 10)

The Inheritance Tax is chargeable to all money, assets, and property of an individual who is domiciled in the UK regardless of where the assets and property are located in the world. This would also be the case when a person is deemed by the authority to be domiciled in the UK, even though he or she is not domiciled there. However, when an individual is not domiciled in the United Kingdom, his or her situation is different. The Inheritance Tax will only apply to all his or her money, assets and property that are located in the United Kingdom (Komarnyckyj, 2012, Pg 12)

2.3. Inheritance Tax rate and Thresholds/Nil rate Band

The Inheritance Tax rate is 40%. The Inheritance Tax threshold is £325,000. The threshold implies that when a person dies, £325,000 can be transferred to his or her heirs without charging tax (Which, n.d). The Inheritance Tax rate of 40% applies to any amount above the threshold amount. However, the Inheritance Tax rate may be reduced to 36% if a person transfers 10% or more to charity work (GOV.UK, 2015)

Example 1

If John died in 2010 and left an estate comprising of money, property and assets worth £ 525,000, John’s heirs will get £325,000 tax-free. The remaining £200,000 would be taxed at the rate of 40%. Therefore, the total inheritance tax expense would be £200,000×40% = £ 80,000

However, it is worth noting that Inheritance Tax is not only charged on the assets transferred when the owner dies. It also applies to those assets and property transferred seven years prior to the owner’s death. In some exceptional cases, the Inheritance Tax may even be charged to assets that were transferred fourteen years before the owner died. In such case, ‘cumulation’ is done. ‘Cumulation’ is where the value of a person at death is added to the value of the assets he or she had transferred 7 or 14 years prior to his demise, and IHT is computed on the basis of the total amount (Komarnyckyj, 2012, Pg 13)

Example 2

If John gave away a sum of £ 300,000 to his daughter Jane in the year 2008, then died on 2010 owning £ 425,000 which he gave to his son Joshua in a will, the transfer value that Inheritance Tax will be based on will be £725,000 and not £ 425,000. The calculations would be done as follows.

| |£ |
|Value of John's Estate | 425,000 |
|Add Gift to Jane | 300,000 |
|Total | 725,000 |
|Less NRB | 325,000 |
|Value to be taxed | 400,000 |
|Inheritance Tax @40% | 160,000 |

The (NRN) nil rate band/ threshold is not always £ 325,000. It normally changes per annum depending on the inflation in the UK economy. Therefore, it is advisable to keep on checking the NRB from time to time.

When a person transfers a gift to another in the last seven years of his or her lifetime, it can effectively reduce his or her nil - rate band available at death. For instance, if an individual gives another a gift of £ 325,000 and, unfortunately, dies within the first year, the nil-rate will be zero. The implication is that the entire estate will be taxed at 40%. This will last for seven years since the gift was given away, after which the nil-rate band will not be affected. The nil-rate band is, therefore, available for use once in every seven years and not once at death. (Komarnyckyj, 2012, Pg 15)

2.4. Who pays Inheritance Tax

After the death of an individual, the will executor or the administrator of the deceased estate are responsible for remitting the Inheritance Tax using the funds from the deceased’s estate. In case of an Inheritance Tax on trusts, the trustees are responsible for remitting Inheritance Tax. Also, in a situation where an individual receives a gift before the donor died, he or she may be responsible for paying the inheritance Tax when the donor eventually dies (GOV.UK, 2015)

2.5. The Deadline for paying Inheritance Tax

When the owner of an estate dies, the executor of the will or the administrator of his or her estate has six months to remit the Inheritance Tax. If it is not remitted within six months, the Inheritance attracts interest. The executor should try to avoid the interest. He or she may make early payments before he or she know the value of the deceased estate. This helps because the interest is will not be due to the amount paid in advance. The executor or administrator may also pay the inheritance Tax in installment over 10 years in case the estate takes longer to sell (GOV.UK, 2015) 3. Strategies to mitigate Inheritance Tax The Inheritance Tax was initially meant for the substantially wealthy people. However, more people are progressively being drawn into the bracket due to the rising property prices, so some people who are unlikely to regard themselves as wealthy may find themselves into problems because of the IHT. Thus, it is advisable to be aware of the Inheritance Tax, particularly some strategies that may be applied to mitigate the potential liability to IHT. 1. Using Gifts to mitigate Inheritance Tax The simplest things an individual may do to avoid paying the Inheritance Tax when he or she dies is to spend or give away some of his or her estates during his lifetime. Some gifts during the lifetime of an individual are free of Inheritance Tax. Therefore, they can be an appropriate strategy to mitigate the potential liability to Inheritance Tax. 1. Wedding gifts One can use wedding gifts to relatives and friends during his or her lifetime to mitigate Inheritance Tax. The gift should be given on or shortly before the wedding ceremony. The amounts of the gifts will reduce the IHT liability. However, the amount is limited, and one can only be exempted for a gift of £ 5,000 if given to a child, £2,500 if given to a grandchild or great - grandchild, and £ 1,000 if given to any other person. A gift to married couples is inheritance Tax-free provided they are domiciled in the UK (GOV.UK, 2015). 2. Gift up to £ 250 One may mitigate IHT potential liabilities by being generous. For instance, any amount given away to anyone is tax-free provided it does not exceed £250. When the amount exceeds £250, the whole amount is not exempted. This can be given to as many people as possible during one tax period. This is a good strategy to reduce the IHT liability, but the only demerit is because of the limited amount one can give out (GOV.UK, 2015). 3. Regular gift from the donor’s income It is possible to mitigate the Inheritance Tax liability by giving away regular gifts from the deceased’s income after tax. Some of the gifts that are tax-free include anniversary, birthday, and Christmas presents. Also, paying life insurance policy premium for the beneficiary and regular deposits into their savings account helps to reduce the IHT potential liabilities. 4. Payments to help with living costs Helping people with the living costs is also a strategy that can be applied to mitigate the IHT liabilities. The exemption applies to ex-husband or wife, elderly, ill or physically challenged relative, and a child, whether adopted or step-child provided he or she is under 18 years or in full-time learning. 5. Gift to charities Donation to charitable organizations, community amateur club, museum, and universities are may reduce Inheritance Tax Liability. A philanthropist may use this strategy to mitigate the potential IHT liability by donating part of their estate to these organizations. When the an individual donates 10% or more of their net value to a charitable organization, he or she reduces the IHT liability by 4% (GOV.UK, 2015). 6. The annual exemption

The annual exemption may also be used as a strategy to mitigate IHT liability. When one gives away gifts of up to £ 3,000 annually, the amount is tax exempted. This amount can be carried forward to the next tax period, but the maximum exemption is £ 6,000. Other gifts discussed above do not account towards the annual exemption.Therfore, this gift can be sued to reduce the IHT liability (GOV.UK, 2015)

2. Merits and demerits of using gifts to mitigate IHT liability

Besides reducing the amount of Inheritance Tax one would pay out of his or her estate, gifts are advantageous to the society and the estate owners, family. It enhances the relationship of the estate owners’ family and the surrounding community. However, if it is not used with care, this strategy may deny the estate owner and his or her family a decent lifestyle. Another demerit of this strategy is that some of the gifts would only become fully exempted from Inheritance Tax if the donor lives more than seven years after the gift.

3. Leaving the estate to a spouse or civil partner

When one leaves his her estate to his or her spouse, they enjoy ‘spouse or civil Partner exemption’. This may be a good strategy to mitigate IHT Potential liability since one may leave everything to the spouse, yet not IHT charged. What s more, couples may also transfer their inheritance tax threshold. When the IHT is below the threshold, a wife, husband or a civil partner is permitted to transfer his or her threshold to the spouse. Therefore, the surviving partner’s estate will be relieved £650,000 nil-rate band. (GOV.UK, 2015)

The main merit of this strategy is that substantial amount of Inheritance Tax liability can be reduced or avoided altogether. However, when the surviving partner eventually dies, there might be some IHT issues. Also, if the estate of the first spouse had qualified for relief on heritage assets or on woodland, the threshold cannot be transferred. Furthermore, if the documents showing the unused Inheritance Tax are misplaced, the transfer may not help. Therefore, proper record keeping is required for the transfer is made when the surviving spouse dies. (GOV.UK, 2015)

4. Conclusions The Inheritance Tax should be treated with equal importance as any other Tax in the United Kingdom. The majority has neglected this type of tax just because it affects individuals after their death. This is not right because whatever one does with his estate during his or her lifetime will affect the way the Inheritance Tax would be calculated. As the prices of property increases in many parts of the United Kingdom, many people who would earlier on not be affected by the inheritance tax are now joining the bracket. Therefore, it is advisable to familiarize with the whole Inheritance Tax Act. This will help to understand how the inheritance tax regime operates in the UK. More important, is the understanding the Act would enable people to use some of the strategies available for mitigating the potential liability of Inheritance Tax. This is paramount as it avoids disappointments to the heirs when the estate owner dies.

5. Bibliography
GOV.UK. (2015, July 09). GOV.UK. Retrieved October 07, 2015, from https://www.gov.uk: https://www.gov.uk/inheritance-tax/overview

Komarnyckyj, A. (2012). Inheritance Tax Made Simple: The essential guide to understanding Inheritance Tax. Hampshire, Great Britain : Harriman House Limited.

Which., (n.d). Retrieved October 07, 2015, from http://www.which.co.uk: http://www.which.co.uk/money/tax/guides/inheritance-tax-explained/inheritance-tax-thresholds-rates-and-who-pays/

Comment on the References The first reference is an official government website. It is a website where one can get United Kingdom’s government information and services. The information that can be accessed on this website relates to tax issues in the United Kingdom. Here, one can learn about the tax credit, eligibility for the tax credit and how to appeal for the same. Information concerning parenting, divorce, civil partnership, and lasting power of attorney is available on this website. More important as it relates to the subject matter of the article is the information about the Inheritance Tax. It is useful and relevant since the information is from the government as is regularly updated. The second reference is a book by one Komarnyckyj, who is a director in a legal practice. Before qualifying to be a solicitor, he had had a successful career in sales and marketing. The book is important to a reader who want to understand the operation of the Inheritance Tax in the United Kingdom. This is because the author has simplified the law in a way that everyone would understand the law. The book is useful and relevant to the subject matter because it was authored by an expert in the field of legal services. Furthermore, the book addresses the subject matter of the article. Finally, the third reference is a website, which offer various services in the United Kingdom. It gives expert advice about consumer rights in the UK, expert advice on mortgages, and expert advice on legal issues among other. The information provided on this web site is simplified hence even a layman would understand. The site is useful and relevant source of reference for this article. This is because the information available is provided by a team of expert lawyers who are well versed in the tax matters in the UK. Therefore, the information on the site is credible and relevant to the subject matter of the article.

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