Benjamin Franklin said in 1789 “nothing can be said to be certain, except death and taxes.” Inheritance tax is the meeting point of these two certainties of life! Government will take 40% of the value of estate and property that your loved ones inherit upon your death (with some exceptions & reliefs).
Although it is generally true that inheritance tax arises at the point of death, there are some situations where it arises during lifetime of a person (explained later).
Good news is that you can avoid all of inheritance tax by good tax planning well ahead of your death. The government encourages you to do proper tax planning.
Who is Liable For Inheritance Tax?
Individuals domiciled in the UK are liable to inheritance tax on transfers of property, shares and all assets anywhere in the world. On the other hand, individuals not domiciled in the UK, are liable to inheritance tax on transfers of their UK assets only.
1. Domicile of Origin
At birth, an individual acquires domicile of his/her father when they are born. For example, a child of UK parents will be UK domiciled.
2. Domicile Of Dependency
Until the age of 16, your domicile status depends on your parents or guardians. If your parents’ domicile status changes, the domicile status of the child automatically changes with the parent.
3. Domicile Of Choice (Emigration)
Although the name implies, you don’t have any choice under this method! However, you can change your personal circumstances proving your intention to reside permanently in your new home country. However, you have to work really hard to be able to prove HMRC that you have acquired a domicile status somewhere else outside the UK.
4. Deemed Domicile
From April 2017, if you have been tax resident in the UK for at least 15 tax years out of 20, you will be deemed to be UK domiciled. Before April 2017, it was 17 tax years out of 20.
What is Rate of Inheritance Tax?
On death, inheritance tax is collected at single rate of 40%. So, if you have taxable value of £2.5 million, inheritance tax of £1 million is payable.
On lifetime transfers (explained later), the rate of immediate inheritance tax is 20%. Extra tax is payable if taxpayer dies with 7 years of transfer.
0% Nil Rate Band – £325,000
20% Chargeable Lifetime Transfer
40% Transfer at Death
The nil rate band is currently £325,000. Also, for the main residence, there is an additional residence nil rate band of £175,000 for each spouse or civil partner. For a typical couple, the total nil rate band for the main residence would be £1 million, assuming that both of the spouses have full un-used nil rate band.
A property must have been the deceased’s private residence at some point during their ownership to qualify for the additional nil rate band.
How to Reduce Inheritance Tax?
Though full avoidance may not be possible, you can reduce Inheritance Tax (IHT) bill by utilising reliefs and exemptions as below:
Small Gifts (Exempt Transfers)
Exemption from inheritance tax is available for certain transfers like:
- Gifts to spouse/civil partner
- Gifts to UK/EEA Charity
- Small gifts up to £250 to any done
- Gifts on marriage (between £1,000 to £5,000 depending upon relationship)
Property Transfer to Your Descendants (Potentially Exempt Transfer)
Gifting property to your descendants will not give rise to inheritance tax during your lifetime. But IHT may be payable after the death.
Good news is, if the donor lives for more than 3 years after the transfer, s/he gets deduction in IHT rate. This is called ‘Taper Relief’. Longer the donor lives, more is the relief (full relief if the donor lives for more than 7 years):
|
No. of years after transfer, before death |
% of Taper Relief |
Effective rate of IHT |
|---|---|---|
|
Not more than 3 years |
Nil |
40% |
|
3 years to 4 years |
20% |
32% |
|
4 years to 5 years |
40% |
24% |
|
5 years to 6 years |
60% |
16% |
|
6 years to 7 years |
80% |
8% |
|
More than 7 years |
100% |
0% |
Only the gifts to individuals are potentially exempt transfer. This means any gifts to trusts (except bare trusts & disabled trusts) are not potentially exempt (see below).
Property Transfer to Trusts and Companies (Chargeable Lifetime Transfer)
Any transfers that are neither exempt nor potentially exempt are chargeable to inheritance tax and so are chargeable lifetime transfers. The most common type of chargeable transfer is transfer to discretionary trusts and interest in possession trusts. In the UK, IHT of 20% is charged while transferring to the trusts, with additional 20% if the donor dies within 7 years. It may be possible to defer initial 20% IHT using Annual payment scheme.
The gift to company is also chargeable lifetime transfer. However, in most of the cases, the donor receives share or loan capital in return of the transfer and so there is no loss to the donor.
As a result, in majority of the cases, there will not be any charge on transfer to the company. However, if donor gifts assets to the company and receives nothing in return, this will be chargeable.
Transferring Property to Business (Business Property Relief)
Inheritance tax relief is available on certain businesses (or business shares) in the UK. The relief, called “Business Property Relief (BPR)” is 50% or 100% depending upon the situation as shown below:
- Transfer of businesses or shares in unquoted trading companies – 100%
- Transfer of assets where those assets are used by his partnership or by a company he controls – 50%
- Transfer of shares in quoted trading company with controlling interest – 50%
In any case, to qualify for business property relief, business needs to be qualifying business which is quite restrictive for property investors. Usually, this relief is not available to property investors as described below:
- Property investment or letting businesses do not qualify for BPR
- Furnished holiday lettings, generally do not qualify for BPR unless substantial services are provided to holidaymakers
- Dealing in land and buildings do not qualify
- Property development business will qualify – only one good news for property businesses!
- For other businesses with use of property such as caravan parks, residential care homes, hostels, guest-houses, the availability of relief is quite complicated. The general principle is that if the majority of the income of the business comes from the provision of services instead of mere rental income, the businesses are likely to qualify. As explained, expert tax advice needs to be sought for these types of businesses.
Further details on BPR can be found on “HMRC Guide on Business Relief for Inheritance Tax“.
Transfer of Agricultural Property (APR)
Similar as BPR, agricultural property relief is also given at the rate 50% or 100% depending upon the situation. 100% APR is available to a farmer who owns the land and buildings and uses these assets in his own business. In case of tenanted land, either 50% or 100% APR is available depending upon the case. For further details on this, Click HMRC guide on Agriculture Relief.
Contribution to Pension Schemes
You can use pension in various ways to save IHT. Contribution to the pension scheme of your family members will not give rise to IHT. Similarly, mostly, lumpsum payment to your family member after your death is also free of IHT. Gifting pension right before two years of death may be IHT free if you were at the good health while making gift.
Transfer of Nil Rate Band
A married couple/civil partners can save Inheritance tax by transferring property to the spouse/partner IHT free. Also, an individual is entitled to a Nil Rate Band of £325,000. Unused NRB can be transferred to the spouse/civil partner. So, after the death of a spouse, the surviving spouse will get £650,000 NRB in total.
Visit our article Top 10 Tips for Avoiding Inheritance Tax in UK for further IHT saving tips.
UK Inheritance Tax for Non-UK Residents
Mostly, non-UK residents are charged IHT on their UK properties only.
But how inheritance tax works for UK domiciled non-UK resident is different. A UK domiciled non-UK resident is the one who has strong family or business connection to the UK, or who had been the UK resident for 15 out of last 20 tax years. They might be liable to IHT on worldwide properties. However, they can save IHT by investing in Qualifying Non-UK pension scheme (QNUPS).
Frequently Asked Questions
Who Has To Pay Inheritance Tax?
The one who inherits the property under the will/probate or as per the law (generally, the sons/daughters of the deceased) pays inheritance tax.
What Should I Do If I Think I Might Have To Pay Inheritance Tax?
As you can see, Inheritance tax is quite complicated tax, and substantial tax saving can be achieved with property tax planning well in advance of the death. As property tax specialists, we will provide you holistic tax advice considering the implication on inheritance tax together with other taxes such as capital gains & income tax.
What are The Latest Changes To Inheritance Tax Rules?
The current inheritance tax rules might change in future. However, there has not been significant changes in IHT recently.
What Is The Residence Nil Rate Band?
Residence nil rate band is the threshold (£325,000 per person) below which IHT is not payable. IHT is charged only if the value of estate exceeds £325,000. The Nil Rate Band is frozen until 5 Aril 2028.
What Are The Penalties For Not Paying Inheritance Tax/Death Tax?
Failing to file IHT return leads to initial penalty of £100 and daily penalty of £60 (but total penalty will not be more than total IHT liability).
Non-payment or underpayment of IHT leads to penalty from 15% to 100% of the underpaid or unpaid IHT.
How can UK Property Accountants Help You in Inheritance Tax Planning?
As you can see, Inheritance tax is quite complicated tax, and substantial tax saving can be achieved with property tax planning well in advance of the death. As property tax specialists, we will provide you holistic tax advice considering the implication on inheritance tax together with other taxes such as capital gains & income tax.
We are dedicated to solve your queries.
Contact us for assistance at any stage of your journey.
