THE NIL-RATE BAND

Every tax year the government decides upon a sum below which value no inheritance tax is payable in respect of taxable transfers of value. This sum is known as the tax threshold. The rate of tax payable in respect of taxable transfers of value in the band between zero and the tax threshold is nil and accordingly the band is known as the nil-rate band. Transfers of value within the nil-rate band are not exempt transfers; they are taxable but the rate of tax charged is nil. When once the total of all taxable transfers which have been made exceeds the tax threshold, tax is charged upon the excess at the rate applicable to lifetime chargeable transfers or to chargeable transfers on death, as appropriate. The present tax threshold is £300,000 and it will be £312,000 in 2008/9 and £325,000 in 2009/10. The rate applicable to lifetime chargeable transfers in excess of the nil-rate band is 20% and the rate applicable to chargeable transfers on death in excess of the nil-rate band is 40%.

VALUING GIFTS AND TRANSFERS OF VALUE

Gifts and transfers of value are valued for inheritance tax purposes at the amount by which the estate of the person making the transfer is diminished as a result of the transfer and not by the amount by which the recipient or any other person benefits from the transfer.

HOW TO CALCULATE INHERITANCE TAX PAYABLE ON GIFTS MADE IN LIFE

To calculate the amount of inheritance tax payable on a gift made during life:

• 1.total all the chargeable transfers of value made by the giver within the previous seven tax years taking care to exclude any exempt gifts and gifts of excluded property
• 2.deduct any debts and financial liabilities which are transferred with the asset to which the debt or financial liability relates, e.g. any mortgage upon the property given if the recipient is to be responsible for discharging the mortgage debt
• 3.deduct the balance of the tax threshold which remains unused by previous non-exempt gifts made in the previous seven years
• 4.apply the full lifetime rate of tax to the resultant figure
• 5.if the transfer was made more than three years before death, apply taper relief to the amount of tax so ascertained (not to the value of the transfer) (taper relief is explained in Chapter 5).

HOW TO CALCULATE INHERITANCE TAX PAYABLE ON DEATH

To calculate the inheritance tax payable on a death estate, add the total of the net death estate to the total of the chargeable lifetime gifts made in the previous seven years and deduct any balance of the tax threshold which has not been used in respect of the lifetime gifts. Apply the full death tax rate to the resultant figure and then deduct the full tax payable on the lifetime gifts (calculated as above before the application of taper relief).

PERMISSIBLE DEDUCTIONS WHEN CALCULATING THE NET ESTATE ON A DEATH

The deductions that it is permissible to make from the total of the values which have been transferred by a death are:

• any legacies which are exempt gifts, e.g. legacies to a spouse or to a registered charity for its charitable purposes
• reasonable funeral and mourning expenses including the cost of a memorial
• any debts and liabilities existing at the date of death for which the taxpayer had received value or that were imposed by the law, e.g. outstanding income tax, but not the inheritance tax payable as the result of the death
• the cost of realising or administering any property which is situated outside the United Kingdom up to 50% of its value
• excluded property.

CALCULATING THE NIL-RATE BAND WHICH REMAINS AVAILABLE ON DEATH

Any non-exempt gift (other than a gift of excluded property) made in the seven years before a death is deducted from, and will reduce, the tax exemption threshold available to be set against the net estate at death by the value transferred by the gift, but exempt gifts (listed on pages 12–15), do not do so.

CALCULATING THE NIL-RATE BAND WHICH IS AVAILABLE WHEN MAKING AN IMMEDIATELY CHARGEABLE LIFETIME GIFT

When dealing with immediately chargeable lifetime gifts (gifts made during one’s life to trusts, other than trusts for the benefit of disabled beneficiaries, or to companies), to calculate the value of the inheritance tax exemption threshold which is available to be set against the gift, it is necessary to deduct from the then current inheritance tax threshold figure the total value of all immediately chargeable gifts made by the giver in the previous seven years. If the total value of the immediately chargeable gifts made in the previous seven years and the current gift exceeds the current inheritance tax threshold, tax is payable on the excess. Gifts other than immediately chargeable gifts are ignored and are not deducted from the threshold figure when calculating how much of the nil-rate band remains and is available to be set off against an immediately chargeable gift, because being PETs, they are still potentially exempt and not chargeable.

Gifts are deducted from the inheritance tax threshold in the chronological order in which they are made. For example, assuming that no other non-exempt gifts have been made, if a gift of £250,000 is made to X and 13 months later a similar amount is given to Y, the donor dying one month after the second gift, the gift to X will be exempt from tax (being below the tax exemption threshold) but the gift to Y will probably suffer some tax, the amount of tax depending upon the amount of the threshold at the date of the death.

If the total value of immediately chargeable non-exempt gifts made in the previous seven years and the value of the immediately chargeable gift currently being made exceeds the then tax threshold, inheritance tax (at one-half of the rate then payable in respect of gifts made on death) is immediately payable on the excess. Credit is given on death for tax that has been paid on immediately chargeable gifts made in the previous seven years, but if the tax paid exceeds the tax payable on them at death the excess is not repayable.

As has been previously explained and with the exception of cumulation which is explained in the following section, transfers made more than seven years before death are exempt transfers. Transfers made in the seven years immediately preceding death are potentially exempt until death occurs, unless they are immediately chargeable gifts. Transfers other than immediately chargeable transfers are not taken into account when calculating the tax payable on immediately chargeable transfers until death occurs when a revision of the tax might or might not become necessary, depending on how long has elapsed between the transfer and death. Referring back to the example given above, if Mr A had died on 9 May 2005 leaving a net estate of £300,000, the tax on the 1998 transfer to the trust would have to be revised because it was made within seven years of the death and tax would be payable at the death rate of 40% instead of at the lifetime rate of 20%. The amount of the nil-rate band used up by the 1997 gift to the trust would remain the same in this calculation but allowance would be made for the tax already paid. The tax payable in respect of the 1998 gift would therefore be £6,800 (40% of £17,000) and after allowing for the tax paid at the time of the 1998 gift a further £3,400 would have to be paid.

The tax payable on the death estate would be calculated as follows:

For the sake of comparative simplicity any available reliefs and exemptions have been ignored in the above calculations.

Cumulation

Chargeable transfers made within the seven-year period prior to a chargeable transfer are taken into account when calculating the tax on the presently made chargeable transfer, whether those chargeable transfers are immediately chargeable lifetime transfers or potentially exempt transfers which have become chargeable as a result of the transferor’s death occurring within the following seven years.