Further to the recent government announcement regarding changes to the system by which inheritance tax is charged, shifting from a domicile-based system to a residence-based one, we have prepared a summary of the tax, its application, and key reliefs.

This will help you better prepare for the future and ensure that your estate planning aligns with the new regulations.

  1. Introduction to Inheritance Tax

Inheritance tax (IHT) applies to estates over a certain value, with various exemptions and reliefs available. It is typically charged at 40% on the portion of an estate that exceeds the available tax-free thresholds (see below).

  1. Territorial Scope and The Charge to Tax (Spring Budget 2024)

The Spring Budget 2024 by the former Conservative Government introduced changes that shift inheritance tax from a domicile-based to a residence-based system after ten year of being resident (it has been confirmed by the current Labour Government that they will follow the same path and that the guidelines will be announced in their first Budget on the 30th October 2024). Currently, non-domiciled individuals are subject to IHT only on their UK-situs assets, with foreign assets exempt. However, under the new rules, tax liability will be determined by residence rather than domicile, broadening the scope of IHT to cover more individuals. IHT is charged on death, certain lifetime gifts, and transfers involving trusts.

  1. On Death

IHT is applied to the estate upon death, which includes all property, possessions, and financial assets. The tax is charged on the portion of the estate that exceeds the nil-rate band, and executors are responsible for paying the tax within six months of death.

  1. Chargeable Lifetime Gifts

Certain gifts made during a person's lifetime are chargeable to IHT if they exceed the available allowances and are made within seven years before death. These gifts may also be subject to additional tax at death if they are classified as chargeable lifetime transfers (CLTs).

  1. On Trust Property

Trusts can be subject to IHT on transfers into or out of the trust and periodically (every 10 years) while the trust holds assets. The type of trust determines how and when IHT is applied. As previously mentioned, the government will end the use of Excluded Property Trusts to keep assets out of the scope of IHT.

  1. The Rate of Tax

The standard rate of IHT is 40%. However, if 10% or more of the estate is left to charity, the estate may qualify for a reduced rate of 36%.

  1. The Nil-Rate Bands

The nil-rate band (NRB) is the threshold below which no IHT is payable, currently set at £325,000. The residence nil-rate band (RNRB) provides an additional £175,000 tax-free allowance when a residence is left to direct descendants (see below).

  1. Transfer of Unused NRB

The unused portion of a deceased spouse or civil partner's NRB can be transferred to the surviving partner, effectively doubling the tax-free allowance available to the survivor.

  1. Residence Nil-Rate Band (RNRB)

The residence nil-rate band applies when a home is passed to direct descendants, offering an additional £175,000 in tax-free relief on top of the basic NRB. The RNRB is reduced for estates valued at over £2 million.

  1. Exemptions and Reliefs

Several exemptions apply to both lifetime gifts and assets passed on death, including:

  • Spousal exemption for transfers to spouses or civil partners via gifts or through a will.
  • Charitable gifts exemption, which also enables a reduction in the IHT rate.
  • Exemptions for gifts to political parties, housing associations, and for national purposes.
  1. Lifetime Gift Exemptions

Some exemptions are available only for gifts made during a person's lifetime:

  • Annual Exemption: £3,000 per year.
  • Small Gifts Exemption: £250 to any one person.
  • Wedding and Civil Partnership Gifts: Tax-free gifts up to £5,000 depending on the relationship to the recipient.
  • Normal Expenditure Out of Income: Regular gifts from surplus income are exempt if they don’t reduce the donor’s standard of living.
  1. Potentially Exempt Transfers (PET)

A potentially exempt transfer (PET) becomes taxable if the donor dies within seven years of making the gift. If the donor survives for more than seven years, the gift is fully exempt from IHT. Gifts given in the 3 years before death are taxed at 40%. Gifts given 3 to 7 years before death are taxed on a sliding scale known as ‘taper relief’. Taper relief only applies if the total value of gifts made in the 7 years before you die is over the £325,000 tax-free threshold.

  1. Relief from Inheritance Tax

There are several reliefs that can reduce IHT liability:

  • Business Property Relief (BPR): Up to 100% relief for qualifying business assets.
  • Agricultural Property Relief (APR): Up to 100% relief for farmland and other agricultural assets.
  • Heritage Property Exemption: Relief for national heritage properties that are preserved for public benefit.
  • Woodlands Relief: IHT on the value of timber can be deferred until the timber is sold.

If you have any further questions or require more detailed advice on how these changes may affect your personal circumstances, please do not hesitate to get in touch.