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This is the Finance Act 2017 version of this article. It is relevant for candidates sitting the Taxation – United Kingdom (TX-UK) (F6) exam in the period 1 June 2018 to 31 March 2019. Candidates sitting TX-UK (F6) after 31 March 2019 should refer to the Finance Act 2018 version of this article (to be published on the ACCA website in 2019).

From the September 2018 session, a new naming convention is being introduced for all of the exams in the ACCA Qualification, so from that session, the name of the exam will be Taxation – United Kingdom (TX-UK). June 2018 is the first session of a new exam year for tax, when the exam name continues to be F6 Taxation (UK). Since this name change takes place during the validity of this article, TX-UK (F6) has been used throughout.

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 which are a bit more difficult to understand and can therefore cause problems for students.

Chargeable lifetime transfer preceded by a potentially exempt transfer which becomes chargeable
The situation where a chargeable lifetime transfer (CLT) is made before a potentially exempt transfer (PET) is fairly straightforward, and was covered in the first part of the article. 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 18
Ali died on 3 March 2018. He had made the following lifetime gifts:

  • 1 August 2015 – A gift of £360,000 to his son.
  • 21 November 2016 – A gift of £240,000 to a trust.


These figures are after deducting available exemptions.

The nil rate band for the tax years 2015–16 and 2016–17 is £325,000.

IHT liabilities are:
 

Lifetime transfers

 £ 
1 August 2015  
Potentially exempt transfer360,000 
21 November 2016  
Chargeable transfer240,000 


 

No lifetime IHT is payable because the CLT is less than the nil rate band for 2016–17.


Additional liabilities arising on death

 £ 
1 August 2015  
Potentially exempt transfer360,000 
   
IHT liability
  325,000 at nil%
  35,000 at 40%

0
14,000
 
 14,000 


 £
 
21 November 2016  
Chargeable transfer240,000 
   
IHT liability 240,000 at 40%
IHT already paid
96,000
0
 
Additional liability96,000 



The nil rate band for 2017–18 of £325,000 has been fully utilised by the PET made on 1 August 2015.

Grossing up
So far, in all of the examples concerning a CLT, the trust (the donee) has paid any lifetime IHT which 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 which 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 19
On 17 June 2014, 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 2013.

The nil rate band for the tax year 2014–15 is £325,000.

The lifetime IHT liability is calculated as:

 ££ 
Value transferred 406,000 
Annual exemptions
  2014–15
  2013–14


3,000
3,000

  
  (6,000) 
Net chargeable transfer 400,000 
IHT liability
  325,000 at nil%
  75,000 x 20/80
 
0
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%
  93,750 at 20%

0
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.

EXAMPLE 20
Continuing with example 19, Annie died on 12 March 2018.


Additional liability arising on death
17 June 2014

 £ 
Gross chargeable transfer418,750 
   
IHT liability
  325,000 at nil%
  93,750 at 40%

0
37,500
 
Taper relief reduction – 20%(7,500) 
 30,000 
IHT already paid(18,750) 
Additional liability11,250 



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 TX-UK (F6) is concerned, the most difficult aspect to grasp is the seven year cumulation period.

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 this CLT being made more than seven years before the date of the donor’s death. Only CLTs have to be taken into account in this way, because PETs made more than seven years before the date of death are completely exempt.

EXAMPLE 21
Ja died on 18 March 2018 leaving an estate valued at £450,000 (the residence nil rate band is not available). She had made the following lifetime gifts:

  • 1 August 2009 – A gift of £200,000 to a trust.
  • 1 November 2015 – 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.

The nil rate band for the tax year 2009–10 is £325,000, and for the tax year 2015–16 it is £325,000.

IHT liabilities are:
 

Lifetime transfers
1 August 2009

 £ 
Chargeable transfer200,000 


No lifetime IHT is payable because the CLT is less than the nil rate band for 2009–10.
 

1 November 2015

 £ 
Chargeable transfer280,000 
   
IHT liability
  125,000 at nil%
  155,000 at 20%

0
31,000
 
 31,000 


The CLT made on 1 August 2009 is within seven years of 1 November 2015, so it utilises £200,000 of the nil rate band for 2015–16.


Additional liabilities arising on death
1 August 2009

 £ 
Chargeable transfer200,000 


There is no additional liability because this CLT was made more than seven years before the date of Ja’s death on 18 March 2018.


1 November 2015

 £ 
Chargeable transfer280,000 
   
IHT liability
  125,000 at nil%
  155,000 at 40%

0
62,000
 
IHT already paid(31,000)  
Additional liability31,000  


The CLT made on 1 August 2009 utilises £200,000 of the nil rate band for 2017–18 of £325,000.


Death estate

 £ 
Chargeable estate450,000 
   
IHT liability
  45,000 at nil%
  405,000 at 40%

0
162,000
 
 162,000 


  • The CLT made on 1 August 2009 is not relevant when calculating the IHT on the death estate because it was made more than seven years before the date of Ja’s death on 18 March 2018.
  • Therefore, only the CLT made on 1 November 2015 is taken into account, and this utilises £280,000 of the nil rate band of £325,000.


EXAMPLE 22
The same situation as in example 21, except that on 1 November 2015 Ja made a gift of £280,000 to her daughter rather than to a trust.

IHT liabilities are:

 £ 
1 August 2009  
Chargeable transfer200,000 
   
1 November 2015  
Potentially exempt transfer280,000 


 

Additional liabilities arising on death

 £ 
1 August 2009  
Chargeable transfer200,000 
   
1 November 2015  
Potentially exempt transfer280,000 
   
IHT liability
  125,000 at nil%
  155,000 at 40%

0
62,000
 
 62,000 
   
Death estate  
Chargeable estate450,000 
   
IHT liability
  45,000 at nil%
  405,000 at 40%

0
162,000
 
 162,000 


Advantages of lifetime transfers

Lifetime transfers are the easiest way for a person to reduce their potential IHT liability.

  • A PET is completely exempt after seven years.
  • A CLT will not incur any additional IHT liability after seven years.
  • Even if the donor does not survive for seven years, taper relief will reduce the amount of IHT payable after three years.
  • The value of PETs and CLTs is fixed at the time they are made, so it can be beneficial to make gifts of assets which are expected to increase in value such as property or shares.

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 the value.

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 the 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:

  • Funeral expenses
  • Debts due by the deceased provided they can be legally enforced. Therefore, gambling debts cannot be deducted, nor can debts which are unenforceable because there is no written evidence.
  • Mortgages on property. This does not include endowment mortgages because these are repaid upon death by the life assurance element of the mortgage. Repayment mortgages and interest-only mortgages are deductible.


EXAMPLE 23
Andy died on 31 December 2017. At the date of his death he owned the following assets:

  • A main residence valued at £425,000. This had an outstanding interest-only mortgage of £180,000.
  • Motor cars valued at £63,000.
  • Ordinary shares in Herbert plc valued at £54,000.
  • Building society deposits of £25,000.
  • Investments in individual savings accounts valued at £22,000, savings certificates from NS&I (National Savings and Investments) valued at £19,000 and government securities (gilts) valued at £34,000.
  • A life assurance policy on his own life. On 31 December 2017, the policy had an open market value of £85,000 and proceeds of £100,000 were received following Andy’s death.


On 31 December 2017, 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.

The residence nil rate band is not available.

The IHT liability is:

 £ 
Property425,000 
Mortgage(180,000)
 
 245,000 
Motor cars63,000 
Ordinary shares in Herbert plc
54,000
 
Building society deposits
25,000
 
Other investments (22,000 + 19,000 + 34,000)

75,000
 
Proceeds of life assurance policy100,000 
 562,000 
Credit card debts(700) 
Funeral expenses(4,300) 
Chargeable estate557,000 
IHT liability
  325,000 at nil%
  232,000 at 40%

0
92,800
 
 92,800 


 

  • The promise to pay the friend’s legal fee is not deductible because it is not legally enforceable.
  • Unlike capital gains tax, there is no exemption for motor cars, individual savings accounts, saving certificates from NS&I or for government securities.
  • The IHT liability on the life assurance policy could have easily been avoided if the policy had been written into trust for the beneficiaries of Andy’s estate. The proceeds would have then been paid direct to the beneficiaries, and not formed part of Andy’s estate. However, this aspect is not examinable at TX-UK (F6).

Residence nil rate band

For residence nil rate band purposes, the value of the main residence is after deducting any repayment mortgage or interest-only mortgage secured on that property.

If a main residence is valued at less than the available residence nil rate band, then the residence nil rate band is reduced to the value of the residence.

EXAMPLE 24
Una died on 10 July 2017 leaving an estate valued at £600,000. Under the terms of her will, Una’s estate was left to her children. The estate included a main residence valued at £200,000 on which there was an outstanding interest-only mortgage of £130,000.

The IHT liability is:
 

Death estate

 £ 
Chargeable estate600,000 
   
IHT liability
  395,000 (325,000 + 70,000)
  at nil%
  205,000 at 40% 


0
82,000
 
 82,000 


The value of Una’s main residence is £70,000 (200,000 – 130,000), so the residence nil rate band is restricted to this amount.

Payment of inheritance tax

Chargeable lifetime transfers
The donor is primarily responsible for any IHT which 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:

  • 30 April following the end of the tax year in which the gift is made.
  • Six months from the end of the month in which the gift is made.


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 which 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 which 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 which 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 25
Alfred died on 15 December 2017. He had made the following lifetime gifts:

  • 20 November 2015 – A gift of £420,000 to a trust. Alfred paid the IHT arising from this gift.
  • 8 August 2016 – A gift of £360,000 to his son.


These figures are after deducting available exemptions.

Alfred’s estate at 15 December 2017 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 residence nil rate band is not available).

The nil rate band for the tax years 2015–16 and 2016–17 is £325,000.

IHT liabilities are:
 

Lifetime transfers
20 November 2015

 £ 
Net chargeable transfer420,000 
IHT liability
  325,000 at nil%
  95,000 x 20/80

0
23,750
 
Gross chargeable transfer443,750 



The due date for the IHT liability of £23,750 payable by Alfred was 31 May 2016.


8 August 2016

 £ 
Potentially exempt transfer360,000 


The PET is initially ignored.


Additional liabilities arising on death
20 November 2015

 £ 
Gross chargeable transfer443,750 
   
IHT liability
  325,000 at nil%
  118,750 at 40%

0
47,500
 
IHT already paid(23,750) 
Additional liability23,750 



The due date for the additional IHT liability of £23,750 payable by the trust is 30 June 2018.


8 August 2016

 £ 
Potentially exempt transfer360,000 
IHT liability 360,000 at 40%144,000 


  • The CLT made on 20 November 2015 has fully utilised the nil rate band.
  • The due date for the IHT liability of £144,000 payable by Alfred’s son is 30 June 2018.


Death estate

 £ 
Value of estate850,000 
Spouse exemption(250,000) 
Chargeable estate600,000 
IHT liability 600,000 at 40%240,000 


  • The due date for the IHT liability of £240,000 payable by the personal representatives of Alfred’s estate is 30 June 2018.
  • Alfred’s wife will inherit £250,000, his brother will inherit £50,000 and the children will inherit the residue of the estate of £310,000 (850,000 – 250,000 – 50,000 – 240,000).

Basic inheritance tax planning

Make gifts early in life
Gifts should be made as early in life as possible so that there is a greater chance of the donor surviving for seven years.

Gifts made just before death will be of little or no IHT benefit, and may result in a capital gains tax liability (whereas transfers on death are exempt disposals).

Make use of the nil rate band
Gifts can be made to trusts up to the amount of the nil rate band every seven years without incurring any immediate charge to IHT.

Gifts to trusts within seven years of each other will be subject to the seven year cumulation period, whilst an immediate charge to IHT will arise if a gift exceeds the nil rate band.

However, as far as TX-UK (F6) is concerned, there is no advantage to making gifts to a trust on death. This will not save any IHT.

Skip a generation
When making gifts either during lifetime or on death, it can be beneficial to skip a generation so that gifts are made to grandchildren rather than children. This avoids a further charge to IHT when the children die. Gifts will then only be taxed once before being inherited by the grandchildren, rather than twice.

Of course such planning depends on the children already having sufficient assets for their financial needs.

Residence nil rate band
Given that the residence nil rate band is only available where inheritance is by direct descendants, rearranging the terms of a will can save IHT.

EXAMPLE 26
Victor has an estate valued at £1,200,000, including a main residence valued at £400,000. He has not made any lifetime gifts. Victor’s wife died on 17 May 2007 and all of her estate was left to Victor. Under the terms of his will, Victor has left his main residence to his brother, with the residue of the estate left to his children.

Currently, Victor’s estate will benefit from a nil rate band of £650,000 (325,000 + 325,000). The residence nil rate band is not available because the main residence will not be inherited by a direct descendant.

Victor could amend the terms of his will so that his brother inherited £400,000 of other assets, with the main residence being included within the residue. A residence nil rate band of £200,000 (100,000 + 100,000) would then be available, saving IHT of £80,000 (200,000 at 40%).

There is no reason why Victor’s brother could not purchase the main residence from the children following Victor’s death.

Capital gains tax (CGT)

Although the interaction of IHT and CGT is not examinable at TX-UK (F6), the two taxes could be examined within the same question and the information given could be relevant to both taxes.

For a lifetime gift of unquoted shares, the IHT transfer of value will be based on the diminution in value of the donor’s estate. In contrast, for CGT purposes the valuation will be based on the market value of the shares gifted.

As far as tax planning is concerned, a lifetime gift can avoid or reduce the IHT that would arise if assets were retained until death. However, the potential IHT saving must be weighed against any immediate CGT cost. There are no CGT implications if assets are retained until death, because transfers on death are exempt disposals. CGT is not an issue if a cash gift is made.

EXAMPLE 27
On 20 October 2017, Craig made a gift to his grandson of a residential property valued at £250,000. The gift of the property resulted in a chargeable gain of £145,000.

The value of the property is expected to increase to £300,000 by 31 December 2021, and to £340,000 by 31 December 2026.

Craig is an additional rate taxpayer. He will not make any other disposals during the tax year 2017–18, and he has not made any previous lifetime gifts. Craig has an estate valued in excess of £2,000,000 for IHT purposes.

CGT liability
Craig’s CGT liability for 2017–18 is:

 £ 
Chargeable gain145,000 
Annual exempt amount(11,300) 
 133,700 
   
Capital gains tax:
133,700 at 28%

37,436
 


Craig dies on 31 December 2026
The gift of the property is a PET. If Craig lives until 31 December 2026, then the PET will be exempt because he will have survived for seven years. The IHT saving will be £136,000 (£340,000 at 40%), so a lifetime gift would appear to be beneficial despite the immediate CGT cost of £37,436.

Craig dies on 31 December 2021
If Craig were to die on 31 December 2021, the IHT saving (ignoring annual exemptions) would be:

 £ 
Value of house on
31 December 2021
300,000 
Value of house on
20 October 2017
(250,000) 
   
Increase in value50,000 
   
IHT saved: 50,000 at 40%20,000 


Note that although there will be no IHT liability in respect of the PET, the PET will reduce the amount of nil rate band available against Craig’s death estate.

The lifetime gift no longer appears to be beneficial because the immediate CGT cost of £37,436 outweighs the IHT saving of £20,000.

Written by a member of the TX-UK (F6) examining team

Last updated: 22 Feb 2018