ATXP6 UK
Syllabus A3. Inheritance Tax A3a. IHT arising on lifetime transfers and on death

A3a. Tax implications of lifetime transfers

Syllabus A3a)

D2 The liabilities arising on the chargeable lifetime transfers and on the death of an individual

What tax liability arises 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 therefore cause problems.

Chargeable lifetime transfer preceded by a potentially exempt transfer that becomes chargeable

The situation where a chargeable lifetime transfer (CLT) is made before a potentially exempt transfer (PET) is fairly straightforward, and was covered previously. 

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.

Illustration:

Ali died on 3 March 2019. He had made the following lifetime gifts:

  • 1 August 2016 – A gift of £360,000 to his son

  • 21 November 2017 – A gift of £240,000 to a trust

These figures are after deducting available exemptions.

The nil rate band for all the tax years is £325,000.

IHT liabilities are as follows:

Lifetime transfers £
1 August 2016
Potentially exempt transfer 360,000
21 November 2017
Chargeable transfer 240,000

No lifetime IHT is payable because the CLT is less than the nil rate band for 2017/18.

Additional liabilities arising on death

£
1 August 2016
Potentially exempt transfer 360,000
IHT liability 325,000 at nil% 0
35,000 at 40% 14,000
14,000
£
21 November 2017
Chargeable transfer 240,000
IHT liability 240,000 at 40% 96,000
IHT already paid (Nil)
Additional liability 96,000

The nil rate band for 2018/19 of £325,000 has been fully utilised by the PET made on 1 August 2016.

Grossing up

So far, in all of the examples concerning a CLT, the trust (the donee) has paid any lifetime IHT at the rate of 20%.

However, when the donor of the gift is paying IHT on the gift into the trust the rate of 20/80 (25%) is used as the gift is deemed to be the net amount of money that is leaving the donors estate. The estate value falls by the gift plus the tax in this case.
 

For the death tax calculations, the amount of the gift will need to be grossed up by the amount of the tax.  Any available annual exemptions are deducted prior to grossing up.

The annual exemptions are explained in Topic: Exemptions. - there is an annual exemption of £3,000 each year that is allowed, and if the annual exemption of £3,000 of the previous year has not been used, this can be brought forward and used in the current year, after allocating the current year annual exemption.

For example  if a cash gift was made into a trust in February 2019 of £100,000 and no other gifts had been made previously, then the annual exemptions of £3,000 (18/19) and £3,000 (17/18) would be deducted first.

£100,000 - £3,000-£3,000 = £94,000 would be the value of the transfer and IHT would be calculated on the 94,000.

Illustration:

On 17 June 2015, 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 2015.

The nil rate band for the tax year 2015/16 is £325,000.

The lifetime IHT liability is calculated as follows:

£ £
Value transferred 406,000
Annual exemptions
2015–16 3,000
2014–15 3,000
(6,000)
Net chargeable transfer 400,000
IHT liability
325,000 at nil% 0
75,000 x 20/80 18,750
Gross chargeable transfer 418,750

The amount of lifetime IHT payable by Annie is £18,750. This figure can be checked by calculating the IHT on the gross chargeable transfer of £418,750:

£
IHT liability
325,000 at nil% 0
93,750 at 20% 18,750
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.

Illustration:

Continuing with example 2, Annie died on 12 March 2019.

Additional liability arising on death

12 March 2019 £
Gross chargeable transfer 418,750
IHT liability
325,000 at nil% 0
93,750 at 40% 37,500
Taper relief reduction – 20% (7,500)
30,000
IHT already paid (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

Jayne died on 18 March 2019 leaving an estate valued at £450,000. She had made the following lifetime gifts:

  • 1 August 2010 – A gift of £200,000 to a trust

  • 1 November 2016 – A gift of £280,000 to a trust

These figures are after deducting available exemptions. In each case, the trust paid any IHT arising from the gift. Note: if the question in the exam does not say who pays the tax then you will always assume that the donor pays the tax and use 20/80 (25%).

The nil rate band for the tax year 2010/11 is £325,000, and for the tax year 2016/17 it is £325,000.

IHT liabilities are as follows:

Lifetime transfers - 1 August 2010 £
Chargeable transfer 200,000

No lifetime IHT is payable because the CLT is less than the nil rate band for 2010/11.

Lifetime transfers - 1 November 2016 £
Chargeable transfer 280,000
IHT liability
(325,000 - 200,000) = 125,000 at nil% 0
155,000 at 20% 31,000
31,000

The CLT made on 1 August 2010 is within seven years of 1 November 2016, so it utilises £200,000 of the nil rate band for 2016/17.

Additional liabilities arising on death

1 August 2010 £
Chargeable transfer 200,000

There is no additional liability because this CLT was made more than seven years before the date of Jayne’s death on 18 March 2019.

1 November 2016 £
Chargeable transfer 280,000
IHT liability
125,000 at nil% 0
155,000 at 40% 62,000
IHT already paid (31,000)
Additional liability 31,000

The CLT made on 1 August 2010 utilises £200,000 of the nil rate band for 2018/19 of £325,000 because it was made 7 years before this CLT.

Death estate

£
Chargeable transfer 450,000
IHT liability
45,000 at nil% 0
405,000 at 40% 162,000
162,000

The CLT made on 1 August 2010 is not relevant when calculating the IHT on the death estate because it was made more than seven years before the date of Jayne’s death on 18 March 2019.

Therefore, only the CLT made on 1 November 2016 is taken into account, and this utilises £280,000 of the nil rate band of £325,000.

Total IHT: life tax £31,000 + death tax £31,000 + 162,000 = £224,000

Illustration:

The same situation as in example 4, except that on 1 November 2016 Jayne made a gift of £280,000 to her daughter rather than to a trust.

IHT liabilities are as follows:

Lifetime transfers £
1 August 2010
Chargeable transfer 200,000
1 November 2016
Potentially exempt transfer 280,000

Additional liabilities arising on death

£
1 August 2010
Chargeable transfer 200,000
1 November 2016
Potentially exempt transfer 280,000
IHT liability
The CLT is entirely covered by the NRB, therefore there is no lifetime tax payable, and it was made 7 years before death, therefore there will be no additional death tax payable. Notice that the PET does not pay lifetime tax, and on death it used NRB first, therefore paying no death tax either.

Death estate

Chargeable estate 450,000
IHT liability
45,000 at nil% 0
405,000 at 40% 162,000
162,000

Total IHT: Life tax £0, death tax £162,000.