The second article in the series covers those aspects of inheritance tax that you will need to know, such as tax liability on lifetime transfers and death estates, and inheritance tax payments. Read part 1 here
The Paper F6 (UK) syllabus requires a basic understanding of inheritance tax (IHT), and this two-part article covers those aspects that you need to know. It is relevant to those of you taking Paper F6 (UK) in either June or December 2013, and is based on tax legislation as it applies to the tax year 2012–13 (Finance Act 2012).
There will always be a minimum of five marks (but no more than 15 marks) on IHT, with these marks being included in either Questions 3, 4 or 5. The first part of the article covered the scope of IHT, transfers of value, rates of tax and exemptions.
Tax liability on lifetime transfers
When calculating the tax liability on lifetime transfers there are three aspects that are a bit more difficult to understand, and can cause problems for students.
CLT preceded by a PET that becomes chargeable
The situation where a CLT is made before a PET is fairly straightforward, and has been covered in previous examples. However, where the sequence of gifts is reversed the IHT calculations are more complicated because the PET will use some or all of the nil rate band previously given to the CLT.
Example 1
Ali died on 3 March 2013. He had made the following lifetime gifts:
These figures are after deducting available exemptions.
The nil rate band for the tax years 2010–11 and 2011–12 is £325,000.
IHT liabilities are as follows:
Lifetime transfers
1 August 2010 | |
---|---|
Potentially exempt transfer | 360,000 |
_______ | |
21 November 2011 | |
Chargeable transfer | 240,000 |
_______ |
£ | |
---|---|
1 August 2012 | |
Potentially exempt transfer | 360,000 |
_______ | |
21 November 2011 | |
Chargeable transfer | 240,000 |
_______ |
Additional liabilities arising on death
1 August 2010
£ | |
---|---|
Potentially exempt transfer | 360,000 |
_______ | |
IHT liability 325,000 at nil% 35,000 at 40% | 14,000 |
_______ |
21 November 2011
£ | |
---|---|
Chargeable transfer | 240,000 |
_______ | |
IHT liability 240,000 at 40% | 96,000 |
IHT already paid | (Nil) |
_______ | |
Additional liability | 96,000 |
________ |
Grossing up
In all the examples so far concerning a CLT the trust (the donee) has paid any lifetime IHT that has arisen. The loss to the donor’s estate is therefore just the amount of the gift. However, the donor is primarily responsible for any lifetime IHT that arises on a CLT. In this case the loss to the donor’s estate is both the amount of the gift and the related tax liability. To correctly calculate the amount of IHT payable it is therefore necessary to gross up the net gift.
Any available annual exemptions are deducted prior to grossing up, and it is only necessary to gross up the amount in excess of the nil rate band.
Example 2
On 17 June 2009 Annie made a gift of £406,000 to a trust. She paid the IHT arising from the gift.
Annie has not made any other gifts since 6 April 2008.
The nil rate band for the tax year 2009–10 is £325,000.
The lifetime IHT liability is calculated as follows:
£ | £ | |
---|---|---|
Value transferred | 406,000 | |
Annual exemptions 2009–10 2008–09 |
| |
______ | ||
(6,000) | ||
_______ | ||
Net chargeable transfer | 400,000 | |
IHT liability 325,000 at nil% 75,000 x 20/80 | 18,750 |
|
_______ | ||
Gross chargeable transfer | 418,750 | |
_______ |
£ | |
---|---|
IHT liability 325,000 at nil% 93,750 at 20% | 18,750 |
______ |
Once the gross chargeable transfer has been calculated then this figure is used in all subsequent calculations. CLTs are never re-grossed up on death, even if the nil rate band is reallocated as a result of a PET becoming chargeable.
Example 3
Continuing with Example 2, assuming that Annie died on 12 March 2013.
Additional liability arising on death
17 June 2009
£ | |
---|---|
Gross chargeable transfer | 418,750 |
______ | |
IHT liability 325,000 at nil% 93,750 at 40% | 37,500 |
Taper relief – 20% | (7,500) |
______ | |
IHT already paid | 30,000 |
(18,750) | |
______ | |
Additional liability | 11,250 |
______ |
When an IHT question involves a CLT then make sure you know who is paying the IHT. Grossing up is not necessary if the trust (the donee) pays.
Seven-year cumulation period
As far as Paper F6 (UK) is concerned the most difficult aspect to grasp is the seven-year cumulation period.
What the seven-year cumulation period means is that when calculating the IHT on a lifetime transfer (either a PET becoming chargeable or a CLT) it is necessary to take account of any CLT made within the previous seven years despite it being made more than seven years before the date of the donor’s death. Only CLTs have to be taken into account, as PETs made more than seven years before the date of death are completely exempt.
Example 4
Ja died on 18 March 2013 leaving an estate valued at £450,000. She had made the following lifetime gifts:
These figures are after deducting available exemptions. In each case the trust paid any IHT arising from the gift.
The nil rate band for the tax year 2004–05 is £263,000, and for the tax year 2010–11 it is £325,000.
IHT liabilities are as follows:
Lifetime transfers
1 August 2004
£ | |
---|---|
Chargeable transfer | 200,000 |
_______ |
1 November 2010
£ | |
---|---|
Chargeable transfer | 280,000 |
_______ | |
IHT liability 125,000 at nil% 155,000 at 20% | 31,000 |
_______ |
Additional liabilities arising on death
1 August 2004
£ | |
---|---|
Chargeable transfer | 200,000 |
_______ |
1 November 2010
£ | |
---|---|
Chargeable transfer | 280,000 |
_______ | |
IHT liability 125,000 at nil% 155,000 at 40% | 62,000 |
IHT already paid | (31,000) |
_______ | |
Additional liability | 31,000 |
_______ |
Death estate
£ | |
---|---|
Chargeable estate | 450,000 |
_______ | |
IHT liability 45,000 at nil% 405,000 at 40% | 162,000 |
_______ |
Example 5
The same situation as in Example 4, except that on 1 November 2010 Ja made a gift of £280,000 to her daughter rather than to a trust.
IHT liabilities are as follows:
Lifetime transfers
£ | |
---|---|
1 August 2004 | |
Chargeable transfer | 200,000 |
_______ | |
1 November 2010 | |
Potentially exempt transfer | 280,000 |
_______ |
Additional liabilities arising on death
£ | |
---|---|
1 August 2004 | |
Chargeable transfer | 200,000 |
_______ | |
1 November 2010 | |
Potentially exempt transfer | 280,000 |
_______ | |
IHT liability 125,000 at nil% 155,000 at 40% | 62,000 |
_______ | |
Death estate | |
Chargeable estate | 450,000 |
_______ | |
IHT liability 45,000 at nil% 405,000 at 40% | 162,000 |
_______ |
Advantages of lifetime transfers
Lifetime transfers are the easiest way for a person to reduce their potential IHT liability.
Tax liability on death estate
Until now the examples have simply given a figure for the value of a person’s estate. However, it may be necessary to calculate it.
A person’s estate includes the value of everything which they own at the date of death such as property, shares, motor vehicles, cash and other investments. A person’s estate also includes the proceeds from life assurance policies even though these proceeds will not be received until after the date of death. The actual market value of a life assurance policy at the date of death is irrelevant.
The following deductions are permitted:
Example 6
Andy died on 31 December 2012. At the date of his death he owned the following assets:
On 31 December 2012 Andy owed £700 in respect of credit card debts, and he had also verbally promised to pay the £800 legal fee of a friend. The cost of his funeral amounted to £4,300.
£ | £ | |
---|---|---|
Property | 425,000 | |
Mortgage | (180,000) | |
_______ | ||
245,000 | ||
Motor cars | 63,000 | |
Ordinary shares in Herbert plc | 54,000 | |
Building society deposits | 25,000 | |
Other investments (22,000 + 190,000 + 34,000) | 75,000 | |
Proceeds of life assurance policy | 100,000 | |
_______ | ||
562,000 | ||
Credit card debts | 700 | |
Funeral expenses | 4,300 | |
_____ | ||
(5,000) | ||
______ | ||
Chargeable estate | 557,000 | |
IHT liability 325,000 at nil% 232,000 at 40% | 92,800 |
|
______ |
Payment of inheritance tax
Chargeable lifetime transfers
The donor is primarily responsible for any IHT that has to be paid in respect of a CLT. However, a question may state that the donee is to instead pay the IHT. Remember that grossing up is only necessary where the donor pays the tax.
The due date is the later of:
Therefore, if a CLT is made between 6 April and 30 September in a tax year then any IHT will be due on the following 30 April. If a CLT is made between 1 October and 5 April in a tax year then any IHT will be due six months from the end of the month in which the gift is made.
The donee is always responsible for any additional IHT that becomes payable as a result of the death of the donor within seven years of making a CLT. The due date is six months after the end of the month in which the donor died.
Potentially exempt transfers
The donee is always responsible for any additional IHT that becomes payable as a result of the death of the donor within seven years of making a PET. The due date is six months after the end of the month in which the donor died.
Death estate
The personal representatives of the deceased’s estate are responsible for any IHT that is payable. The due date is six months after the end of the month in which death occurred. However, the personal representatives are required to pay the IHT when they deliver their account of the estate assets to HM Revenue and Customs, and this may be earlier than the due date.
Where part of the estate is left to a spouse then this part will be exempt and will not bear any of the IHT liability. Where a specific gift is left to a beneficiary then this gift will not normally bear any IHT. The IHT is therefore usually paid out of the non-exempt residue of the estate.
Example 7
Alfred died on 15 December 2012. He had made the following lifetime gifts:
These figures are after deducting available exemptions.
Alfred’s estate at 15 December 2012 was valued at £850,000. Under the terms of his will he left £250,000 to his wife, a specific legacy of £50,000 to his brother, and the residue of the estate to his children.
The nil rate band for the tax years 2010–11 and 2011–12 is £325,000.
IHT liabilities are as follows:
Lifetime transfers
20 November 2010
£ | |
---|---|
Net chargeable transfer | 420,000 |
IHT liability 325,000 at nil% 95,000 x 20/80 | 23,750 |
_______ | |
Gross chargeable transfer | 443,750 |
_______ |
8 August 2011
£ | |
---|---|
Potentially exempt transfer | 360,000 |
_______ |
Additional liabilities arising on death
20 November 2010
£ | |
---|---|
Gross chargeable transfer | 443,750 |
_______ | |
IHT liability 325,000 at nil% 118,750 at 40% | 47,500 |
IHT already paid | (23,750) |
________ | |
Additional liability | 23,750 |
________ |
8 August 2011
£ | |
---|---|
Potentially exempt transfer | 360,000 |
_______ | |
IHT liability 360,000 at 40% | 144,000 |
_______ |
Death estate
£ | |
---|---|
Value of estate | 850,000 |
Spouse exemption | (250,000) |
_______ | |
Chargeable estate | 600,000 |
_______ | |
IHT liability 600,000 at 40% | 240,000 |
_______ |
Exam standard question
The following is typical of an exam question that could be set on IHT at Paper F6 (UK).
Jing died on 21 January 2013. She had made the following lifetime gifts:
Jing paid any IHT arising from the gifts to the trusts.
Nil rate bands are as follows:
£ | |
---|---|
2004–05 | 263,000 |
2007–08 | 300,000 |
2009–10 | 325,000 |
Required
(a) State the advantages for inheritance tax purposes of making lifetime gifts of assets.
(3 marks)
(b) Calculate the inheritance tax that will be payable as a result of Jing’s death.
(12 marks)
(15 marks)
(a)
(b)
Jing – Inheritance tax computation
Lifetime transfers
3 March 2005
£ | ||
---|---|---|
Value transferred | 126,000 | |
Annual exemptions 2004–05 2003–04 | 3,000 3,000 | |
_____ | ||
(6,000) | ||
________ | ||
Chargeable transfer | 120,000 | |
________ |
12 January 2008
Exempt as a transfer to spouse.
10 May 2009
Exempt as a small gift under £250.
23 June 2009
£ | ||
---|---|---|
Value transferred | 240,000 | |
Annual exemptions 2009–10 2007–08 | 3,000 3,000 | |
______ | ||
(6,000) | ||
_______ | ||
Potentially exempt transfer | 234,000 | |
_______ |
2 September 2009
£ | |
---|---|
Net chargeable transfer | 300,000 |
IHT liability |
|
_______ | |
Gross chargeable transfer | 323,750 |
_______ | |
Notes:
Additional liabilities arising on death
3 March 2005
£ | |
---|---|
Chargeable transfer | 120,000 |
_______ |
23 June 2009
£ | |
---|---|
Potentially exempt transfer | 234,000 |
_______ | |
IHT liability | 11,600 |
Taper relief reduction – 20% | (2,320) |
______ | |
9,280 | |
______ |
2 September 2009
£ | |
---|---|
Gross chargeable transfer | 323,750 |
_______ | |
IHT liability 323,750 at 40% | 129,500 |
Taper relief reduction – 20% | (25,900) |
_______ | |
IHT already paid | 103,600 |
(23,750) | |
_______ | |
Additional liability | 79,850 |
_______ |
Notes:
Written by a member of the Paper F6 examining team
The following example brings together most of the points covered in the IHT article. It is much longer than a typical exam question.
Jing died on 21 January 2013. She had made the following lifetime gifts:
Jing paid any IHT arising from the gifts to the trusts.
At the date of her death Jing owned the following assets:
On 21 January 2013 Jing owed £3,600 in respect of a personal loan from a bank, and had gambling debts of £600. The cost of her funeral amounted to £3,200.
Under the terms of her will Jing left £100,000 to her husband, a specific legacy of £40,000 to her brother, and the residue of the estate to her children.
Nil rate bands are as follows:
£ | |
---|---|
2004–05 | 263,000 |
2007–08 | 300,000 |
2009–10 | 325,000 |
IHT liabilities are as follows:
Lifetime transfers
3 March 2005
£ | £ | |
---|---|---|
Value transferred | 126,000 | |
Annual exemptions 2004–05 2003–04 | 3,000 3,000 | |
_____ | ||
(6,000) | ||
_______ | ||
Chargeable transfer | 120,000 | |
_______ |
8 August 2007
£ | £ | |
---|---|---|
Value transferred | 206,000 | |
Annual exemptions 2007–08 2006–07 | 3,000 3,000 | |
_____ | ||
(6,000) | ||
_______ | ||
Potentially exempt transfer | 200,000 | |
_______ | ||
12 January 2008
Exempt as a transfer to spouse.
10 May 2009
Exempt as a small gift under £250.
23 June 2009
£ | £ | |
---|---|---|
Value transferred | 40,000 | |
Marriage exemption | 5,000 | |
Annual exemptions 2009–10 2008–09 | 3,000 3,000 | |
_____ | ||
(11,000) | ||
_______ | ||
Potentially exempt transfer | 29,000 | |
_______ |
2 September 2009
£ | |
---|---|
Net chargeable transfer | 300,000 |
IHT liability 205,000 at nil% 95,000 x 20/80 | 23,750 |
_______ | |
Gross chargeable transfer | 323,750 |
_______ |
Additional liabilities arising on death
3 March 2005
£ | |
---|---|
Chargeable transfer | 120,000 |
_______ |
8 August 2007
£ | |
---|---|
Potentially exempt transfer | 200,000 |
_______ |
23 June 2009
£ | |
---|---|
Potentially exempt transfer | 29,000 |
______ | |
IHT liability 5,000 at nil% 24,000 at 40% | 9,600 |
Taper relief reduction – 20% | (1,920) |
______ | |
7,680 | |
______ |
2 September 2009
£ | |
---|---|
Gross chargeable transfer | 323,750 |
_______ | |
IHT liability 323,750 at 40% | 129,500 |
Taper relief reduction – 20% | (25,900) |
_______ | |
103,600 | |
IHT already paid | (23,750) |
_______ | |
Additional liability | 79,850 |
_______ |
Death estate
£ | £ | |
---|---|---|
Property | 220,000 | |
Units in Global Trust | 12,000 | |
Individual savings accounts | 16,800 | |
Motor car | 8,000 | |
Proceeds of life assurance policy | 50,000 | |
______ | ||
306,800 | ||
Bank loan | 3,600 | |
Funeral expenses | 3,200 | |
_____ | ||
(6,800) | ||
______ | ||
Value of estate | 300,000 | |
Spouse exemption | (100,000) | |
________ | ||
Chargeable estate | 200,000 | |
IHT liability 200,000 at 40% | 80,000 | |
________ |