Inheritance tax in the United Kingdom is a levy on someone who inherits from a deceased estate. The UK government deducts it from the estate itself before the proceeds can be distributed. If this is not practical, it may be willing to negotiate.
A Brief History of Inheritance Tax in the United Kingdom
The Finance Act 1894 provided the first consolidated framework for inheritance tax in the United Kingdom. It was however cumbersome. A new Finance Act replaced it in 1914 to simplify matters.
In 1949, Parliament approved the Estate Duty Act aiming to make the system fairer and simpler to administer. However, gifts made more than seven years before death still avoided inheritance tax. A Capital Transfer Tax plugged that gap in 1975, although there were still loopholes in the law.
The Finance Act 1986 swept the above aside and started anew with a clean slate. It introduced the cleaner concept of a unitary inheritance tax based on the value of the estate. This is the topic we unpick and explore today.
Definition of an Estate for Inheritance Tax Purposes
- For purposes of calculating inheritance tax in the United Kingdom a deceased estate includes all possessions. Except certain excluded assets where the testator was living outside the UK for tax purposes. Entitlements under a trust are also exempt from the tax.
- However, the executor must first offset all liabilities before establishing the true value of the estate to which the tax applies.
This does not include an obligation to pay any duty attached to transferring assets to beneficiaries. Obligations without monetary value are exempt because there is no way to calculate the estate tax.
Excluded Property and Other Tax Relief
Property owned outside the United Kingdom may be exempt from tax on the deceased’s assets. However, this is provided these assets are in a country where they had their permanent home as opposed to being on holiday abroad.
Awards for gallant conduct and valour, and other decorations are also exempt provided they have not been monetised by being sold, transferred, or leased.
Relief may also be available for businesses, and agricultural properties and woodlands in terms of a scheme aimed at keeping these assets intact and functional. This may also apply to certain transfers made within three years of death for example to family trusts.
Transfers before Death that May Incur Tax
Nil rate bands for calculating inheritance tax in the United Kingdom are £325,000 for the primary amount. HM Customs and Excise allows an additional £175,000 for the residence.
- Tax on transfers with values exceeding limits applying at the time are off-set against those nil band credits. The same applies to gifts whereby property exchanged hands at value below market rates. This would be the case, for example where a parent sold their home to a child at a bargain price.
- The same situation arises where (a) property leases are below market rates, (b) there was a taxable reallocation of shares in a private company, (c) changes were made to rights applying to those shares, or (d) there was a guarantee in place over another’s debt.
- Other transactions that may reduce the residual nil band credit include transfers of value to a life interest trust at a loss, and paying insurance premiums on another’s behalf
However, the estate is still tax liable for any excess once these nil band rates are exhausted.
Rate of Inheritance Tax in the United Kingdom
Estates are liable for 40% tax on their assessed value after allowing for the nil rate bands. However the rate value itself depends on the time of year of the death.
- If the death occurred between 6 August and 5 April, then the current band applies
- If the death occurred after 5 April but before 6 August, then the previous year’s band applies
An exception to the 40% across-the-board rate has been in force since 5 April 2012. All deceased estates from that date forward, pay only 36% if at least 10% of a baseline amount went to charity.
Such donations may include (a) an item, (b) a fixed amount, or (c) the residual value of the estate. The state separates the estate into three sections each of which must normally pass the 10% test:
- The joint and common property that passes to any surviving spouse or to a nominee in the will
- The settled property such as land, money or buildings the deceased placed in a legal trust
- All other remaining value with the exception of gifts of reservation whereby the deceased withheld some value
The actual calculations are too complicated to delve into in a general article about inheritance tax in the United Kingdom. In certain case, meeting the 10% threshold for only one of the three above divisions may suffice. In the event of a deadlock, the successors can break it by jointly agreeing to a deed of variation that achieves the desired result.
The Steadily Increasing Nil Rate Band for Main Residences
In the summer of 2015 the UK government resolved to find ways to reduce the onus of inheritance tax on families. It wanted their homes to pass intact down the generations, and not have to be sold to pay the tax.
Parliament approved the Finance (No. 2) Act 2015 during the summer budget. This scheduled a new, second nil rate band for main residences as follows:
- £100,000 for the 2017-18 tax year
- £125,000 for the 2018-19 tax year
- £150,000 for the 2019-20 tax year
- £175,000 for the 2020-21 tax year
From 2021-22 future amounts will link to the September to September consumer price index variation.
The Finance Act 2016 Provided Further Relief
The Finance Act 2016 brought more relief to families with their own homes in the event the persons owning them died. It addressed two situations where all or part of the benefits of the secondary nil rate band could be lost. Briefly, these were:
- Where the deceased had downsized to a less valuable home after 8 July 2015 before they died
- Where the deceased had ceased to own a home after 8 July 2015 before they passed on
This relief is however conditional on them having bequeathed the lesser residence, or assets of equivalent value to their direct descendants. In this way, the law hoped to retain the value in the family even though the home itself was in other hands.
Direct descendants are blood relatives in the direct line of descent, spouses or civil partners of such descendants, or former ones who have not formed new relationships.
One More Tweak to Inheritance Tax in the United Kingdom
The Finance Act 2004 introduced a new previously-owned asset tax. This is where the deceased person passed the asset to another, but continued to benefit from its use.
The work-around for this aspect of inheritance tax in the United Kingdom is to convert those transactions to gifts with reservations.
In Concluding ….
We named our article ‘Inheritance Tax in the United Kingdom – A Snapshot’ because UK law is by no means cast in stone. The rules pertaining to what many still call ‘a tax on the dead’ will continue to change each time major parties swap musical chairs.