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In the United Kingdom, Inheritance Tax is a transfer tax. It was introduced with effect from 18 March 1986 replacing Capital Transfer Tax.
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From 1796, inheritance taxes, then called legacy, succession and estate duties were collected, in England and Wales on estates over a certain value. The value changed over time and the scope of estate duty was extended. By 1857 estates worth over £20 were taxable but duty was rarely collected on estates valued under £1,500. Death duties were introduced in 1894, and for the next century were effective in breaking up large estates.
In 2007, 94% of all estates escaped Inheritance Tax, mainly because they fell in the nil rate band.[1]
Estate duty was replaced in 1975 by Capital Transfer Tax, which was renamed Inheritance Tax (IHT) in 1986. Partly due to the simple and widely-used methods which are available to avoid it, Inheritance Tax accounts for about 0.8% of government income, raising around £2 billion in 2001[2] and £3.6 billion in 2006.
For the 2010/2011 tax year, the IHT rate is 0% on the first £325,000 (the "nil-rate band), and 40% on the rest of the value, at death, of an individual's tax estate. The nil rate band rises annually; tax is only payable on the value of an estate above the nil rate band.
In the 2007 budget report the Chancellor of the Exchequer announced that the nil rate band was to rise to £350,000 by 2010. This was said to take into account the sharp rise in house prices in the United Kingdom over the previous few years,[3] although in fact it represents an increase below the rate of house price inflation. This increase was cancelled by the Chancellor in December 2009.
The tax estate includes:
There is also a charge on "lifetime chargeable transfers" into certain trusts (and a recalculation of those charges if the giver dies within seven years), and trusts themselves have an inheritance tax regime. See Taxation of trusts (United Kingdom).
There are deductions for:
In order to avoid IHT, many people in the IHT bracket practise some or all of the following avoidance measures:
The Chancellor of the Exchequer's Autumn Statement on 9 October 2007 [5] announced that with immediate effect inheritance tax allowances (often referred to as the nil-rate band) were to be transferrable between married couples and between civil partners. Thus, for the 2007/8 tax year, a married couple will in effect have an allowance of £600,000 against inheritance tax, whilst a single person's allowance remains at £300,000. The mechanism for this enhanced allowance is that on the death of the second spouse to die, the nil rate band for the second spouse is increased by the percentage of the nil-rate band which was not used on the death of the first spouse to die.
For example, if in 2007/08 the first married spouse (or civil partner) to die were to leave £120,000 to their children and the rest of their estate to their spouse, there would be no inheritance tax due at that time and £180,000 or 60% of the nil-rate band would be unused. Later, upon the second death the nil-rate band would be 160% of the allowance for a single person, so that if the surviving spouse also died in 2007/08 the first £480,000 (160% of £300,000) of the surviving spouse's estate would be exempt from inheritance tax. If the surviving spouse died in a later year when the nil-rate band had reached £350,000, the first £560,000 (160% of £350,000) of the estate would be tax exempt.
This measure was also extended to existing widows, widowers and bereaved civil partners on 9 October 2007. If their late spouse or partner had not used all of their inheritance tax allowance at the time of the spouse's death, then the unused percentage of that allowance can now be added to the single person's allowance when the surviving spouse or partner dies. This applies irrespective of the date on which the first spouse died, but special rules apply if the surviving spouse remarries.
In a judgement following an unsuccessful appeal to a 2006 decision by the European Court of Human Rights, it was held that the above does not apply to siblings living together. The crucial factor in such cases was determined to be the existence of a public undertaking, carrying with it a body of rights and obligations of a contractual nature, rather than the length or supportive nature of the relationship.[6]
Prior to this legislative change, the most common means of ensuring that both nil-rate bands were used was called a nil band discretionary trust (now more properly known as NRB Relevant Property Trust*). This is an arrangement in both wills which says that whoever is the first to die leaves their nil band to a discretionary trust for the family, and not to the survivor. The survivor can still benefit from those assets if needed, but they are not part of that survivor's estate.
The Finance Act 2004 introduced a retrospective income tax regime known as pre-owned asset tax (POAT) which aims to reduce the use of common methods of IHT avoidance.[7]