INHERITANCE TAX

1
INHERITANCE TAX
Theory and Practice of Taxation C Year
2006-07 Lec 4

• PRINCIPLES OF VALUATION AND COMPUTATION ON DEATH

2
Principles of valuation and computation on
death

• Transfers of value
• Exempt beneficiaries / non-exempt beneficiaries
• Gifts with reservation
• Estate at death
• Post mortem reliefs
• Grossing up gifts
• Specific dispositions and residue
• IHT planning

3
Transfers of value

• A transfer of value is the diminution in value of
  the transferors estate as a result of the
  transfer.
• Principles of valuation
• IHTA 1984 s. 160 - valuation at market value at
  the date of the transfer.
• Specific rules - quoted shares and securities
• Market value is the lower of
• one quarter up from the lower to the higher limit
  of the quotation or...
• halfway between the lowest and highest bargains
  recorded for the day, ignoring any special prices.

4
Exempt beneficiaries / non-exempt beneficiaries

• Transfers between husband and wife (lifetime and
  death)
• are exempt from inheritance tax
• (includes inheritance of half share of jointly
  owned matrimonial home on death.)

5
Principles of valuation and computation on death-
continued

• GIFTS WITH RESERVATION
• 1. Where the property given is not enjoyed
  virtually to the entire exclusion of the donor
  or
• 2. Possession and enjoyment of the property
  transferred is not bona fide assumed by the
  donee.
• Eg where parents gift their house to their
  children but continue to live in it rent free.

6
Principles of valuation and computation on death-
continued- gifts with reservation 2

• During life treated as any any other gift at the
  time it is made (PET or CLT)
• BUT - at death of donor
• if reservation still exists - the asset is
  included in the donors estate - at its value at
  that date
• if reservation ceases within 7 years before
  death, the gift is treated as a PET made at time
  the reservation ceased. The charge is based on
  its value at at that time. Annual exemption
  cannot be used against such a PET.

7
Principles of valuation and computation on death-
continued- gifts with reservation 3

• EXCEPTIONS
• A gift will NOT be treated as being with
  reservation if
• 1. Full consideration is given for any right of
  occupation or enjoyment retained by the donor -
  and the property is land or chattels (parents
  paid market rent for continuing to occupy their
  old house)
• 2. The circumstances of the donor change in a way
  unforeseen at the time of the gift and the
  benefit provided by the donee to the donor only
  represents reasonable provision for the care and
  maintenance of the donor, being an elderly or
  infirm relative (land only)

8
Estate at death

• An individuals estate at death comprises all
  property to which he was beneficially entitled
  immediately prior to his death - excepting
  excluded property - including anything acquired
  as a result of death (eg insurance policy
  proceeds) and may include
• Free estate
• Property given subject to a reservation
• Settled property in which the deceased had an
  interest in possession

9
Estate at death contd

• The three classes of property must be kept
  separate because the primary responsibility for
  the payment of tax depends on the type of
  property
• Tax on free estate is paid by the personal
  representatives
• Tax on property given under reservation is
  payable by the person in possession of the
  property
• Tax on settled property is payable by the
  trustees When IHT is calculated on
  the total chargeable estate, the tax is shared
  proportionately among the different classes

10
Estate at death contd

• The computation of the chargeable estate at death
  should be set out thus
• Free estate
  
  Personalty (moveable - details)
  xxxx Less
  debts due by deceased/funeral expenses
  xxx Realty (Heritable property) - less charges
  xxxx Net free estate
  xxxxx
  Settled property
  xx Gifts with
  reservation
  x Chargeable estate
  xxxxx
  

11
Estate at death contd

• Y died on 18 June2006. His estate comprised
• 10,000 shares in A plc quoted at 84p-89p with
  bargains marked at 85p, 87p and 90p
• Various moveable estate valued at 9,920
• His house valued at 150,000 - subject to a
  mortgage of 45,050
• Liabilities and funeral expenses amounted to
  2,450
• Y had an interest in possession in the Q trust
  (set up before March 2006) whose assets were
  valued at 85,200 at the date of death
• Y had made a chargeable lifetime transfer of
  290,000 in July 2001
• Compute the IHT liability on the estate at death

12
Estate at death contd -solution

• Free Estate
• Personalty
• A plc shares - 10,000 at lower of 85.25p or
  87.5p 10,000 x 85.25
  8,525
  Various
  9,920
• 
  18,445
  Less debts and
  funeral expenses 2,450
• 
  15,995
• Realty
  House
  
  150,000 Less mortgage
  45,040 104,960 Net free
  estate
  120,955 Settled property - Q trust
  assets 85,200
  Total chargeable estate
  206,155
  

13
Estate at death contd -solution

• IHT payable
• On chargeable lifetime transfer -
  290,000
• Uses nil rate band 285,000
• Payable on estate 206,155 _at_ 40
  82,462
• Payable by Ys executors 120,955 x 82,462
  48,382
• 
  206,155
• Payable by C trustees 85,200 x
  82,462 34,080
• 
  206,155

14
Post Mortem Reliefs

• 1. Quoted investments sold within 12 months of
  death If sold for less than Probate value -
  and a claim is made -all shares sold from the
  holding must be re-valued and total loss deducted
  from value of estate and IHT recalculated
  accordingly.
• 2. Land buildings sold within 3-4 years of
  death - a similar relief is available where such
  property is sold at less than Probate value.
• 3. Fall in the value of lifetime gifts again
  relief is available where such gifts became
  chargeable on death/taxable at death rate.

15
Post Mortem Reliefs 2

• WILLS AND DEEDS OF FAMILY ARRANGEMENT
• It is important that individuals make wills so
  that their estates may be distributed in a
  tax-efficient way. These should be regularly
  reviewed.
• Wills may be varied
• 1. By application to the courts
• 2. By means of voluntary variation (deeds of
  family arrangement)
• Within 2 years of death the wills terms may be
  changed by a written instrument with the change
  being effective for IHT purposes

16
GROSSING UP GIFTS ON DEATH

• The value of a specific gift of UK property on
  death must be grossed up when the residue of the
  estate is exempt
• Since specific gifts of UK property do not bear
  their own tax
• Thus the tax must be borne by the residue of the
  estate
• Specific gifts of foreign property bear their own
  tax
• Do not gross up specific gifts if the whole
  estate is chargeable

17
SPECIFIC GIFTS AND EXEMPT RESIDUE - EXAMPLE

• John dies on 29 May 2001 leaving an estate valued
  at 408,000. Included is UK property valued at
  308,000, which he leaves to his daughter
  (specific gift). The residue is left to his widow
  (exempt residue).
• Calculate the IHT liability arising, assuming
  that John has made no lifetime transfers.
• SOLUTION
• The specific gift to the daughter does not bear
  its own tax - it is a net gift which must be
  grossed up (nil rate band in 2001-02 242,000)
• 242,000 gross 242,000 net
• The balance (308,000 - 242,000) 66,000 (net)
  is taxable at 40

18
SPECIFIC GIFTS AND EXEMPT RESIDUE - EXAMPLE 2

• Gross equivalent is 66,000 x 100/60 110,000.
• Gross legacy is 242,000110,000 352,000
• IHT payable (352,000-242,000) x 40 44,000
• Residue available to widow is 408,000-352,000
  56,000
• This calculation would not have applied if
• 1. The residue of the estate had been chargeable,
  rather than exempt, when IHT would have been
  calculated on the gross estate.
• 2. The will had left 100,000 to the widow and
  the residue to the daughter. Then she would have
  received 308,000 less IHT of (308,000-242,000)
  _at_40 26,400 281,600 and the widow 100,000

19
IHT PLANNING 1

• DEVOLUTION OF ASSETS
• Each spouse should aim to own assets to be left
  to non-exempt heirs e.g. children, at least equal
  to the nil rate band
• If assets are left to the surviving spouse but
  the survivor has sufficient wealth of their own -
  use a deed of variation to direct assets to
  non-exempt heirs.

20
IHT PLANNING 2

• LIFETIME GIFTS
• If an individual can afford to give away assets
  during lifetime, PETs should be made -
• Taper relief will be available if the donor
  survives 3 years
• If the donor survives 7 years the gifts become
  exempt.
• BUT
• If the disposals would give rise to substantial
  CGT liabilities - consider retaining the assets
  until death (not a chargeable event
  for CGT and donee gets a CGT free uplift to
  market value)
• Converse is true if assets are standing at a loss
  BUT remember the rule re transfers to connected
  persons

21
IHT PLANNING 3

• LIFETIME GIFTS continued
• If the recipients are too young to be entrusted
  with outright gifts
• consider transfers to interest in possession, or
  accumulation and maintenance trusts

22
IHT PLANNING 4

• THE CHOICE OF ASSETS
• An individuals choice of assets should take
  account of their IHT treatment -
• Investments in businesses/farms may make BPR and
  APR available BUT consider the commercial merits
  of the investments.
• ACTION AFTER DEATH
• If an estate includes land or quoted stocks which
  fall in value after death, executors should
  consider selling them in time to ensure that the
  value of the estate is reduced.