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TaxationWeb by Jennifer Adams

An article detailing the valuable IHT exemptions available for everyone and when they can be usedInheritance tax is well-known as being the tax that hits those who are not what could be called "well off". Those who are of millionaire status can afford to enlist the best tax advisers to enter into sophisticated tax planning to mitigate their tax bill and those whose estates are less than the exempt amount of £263,000 (the so-called "nil rate" band - as announced in Budget 2004) are exempt in any event. As we are increasingly becoming aware what this actually means is someone who leaves an Estate amounting to little more than the cost of an average semi-detached house in a London suburb may be caught.



Although the tax is called "Inheritance Tax" mitigation need not be left until someone dies. There are actually valuable exemptions available for the living which may not be common knowledge. The annual allowance of £3000 is well known but it is interesting to note that the amount of £3000 has remained static since 1981/82; taking inflation into account this amount should have at least doubled by now. If the previous years allowance has not been used then a total of £6,000 can be given in one year; if individual gifts are made on the same day then the allowance is apportioned on a pro rata basis. Also, it must be remembered that the £3000 does not have to be in the form of cash - it could be used to cover gifts of chattels or premiums into a life policy written in trust for the donee if this is not already covered under the "normal expenditure" exemption (see below). By just using the annual exemption allowance over a period of say, 10 years a husband and wife could save IHT of £24,000. If other allowances are also used further IHT can be mitigated with not much paperwork involved at all.



One such allowance is the often overlooked "Small Gifts exemption" where transfers of value in any one year to any one person can be exempt from IHT so long as the total value does not exceed £250. There is no limit to the number of persons to whom the £250 can be given; neither does the donee have to be a relative. The only proviso is that the gift must be an outright gift and as such could be used to forego interest on a fixed period beneficial loan. The foregoing of the actual loan would not be a transfer of value but the act of foregoing the interest would be. Further, it might be possible for someone who is ill and knows that he is dying to arrange for a number of these gifts to be made using this exemption whilst he is alive and this will then reduce the amount of IHT subsequently chargeable on his estate.



The amount given does not actually have to be exactly £250; exemption is still available on smaller amounts paid so long as the total made during the year ended 5th April is less than the £250 limit. The only proviso is that whereas the annual exemption can be used in conjunction with other reliefs, the "Small gifts Exemption" must stand-alone and as such cannot be used with any other exemption. Even so it is an exemption that should not be wasted if at all possible.



Another valuable exemption that should also be used at the time because the event does not take place every year is the marriage exemption.

Just as a reminder the exempt amounts are: -

Gift by the Parents of a couple £5,000

Gift by the Grandparents £2,500

Gifts by Others £1,000



As ever in the matter of Tax Planning, the timing of this gift is important. Not only must the marriage actually go ahead but the gift should preferably be made before the wedding with the strict proviso that the marriage will actually take place. If anything happens so that the wedding is cancelled altogether then the gift must be returned otherwise the donor will find himself with an IHT bill should the value exceed the annual exempt amount of £3,000 (assuming, of course, that no other gifts have been made that year by the donor that utilise his annual exemption.).



After a valid marriage has taken place, any transfers from one spouse to another are covered by the "Spouse exemption". This is true whether the transfers are made during lifetime or on death providing the receiving spouse is domiciled in the UK. Unlike as for the CGT exemption, there is no requirement for the spouses to be either living together or for the receiving spouse to actually live in the UK. For IHT the key word is "domicile" which, in fact has an extended meaning under IHT in comparison to ordinary Income Tax rules.



"Domicile" is established in the normal way but differs in that a person's domicile under IHT rules remains in place for three years after it has ceased to apply. So a couple who want to preserve their assets should arrange for one spouse to leave the country first and then over the next 3 years the assets be transferred to that non-resident spouse free of IHT. This is possible because that non-resident spouse is still deemed to be domiciled in the UK and the transfer of the assets would be covered by the above "Spouse exemption." If the assets are transferred after the 3 years then the receiving spouse will be deemed to be of foreign domicile and the rules change so that they are only allowed to take £55,000 out of the UK in total (not per year but in total).



The £55,000 limit and the 3 year domicile rule are supposed to be in place to deter tax avoidance but if looked at carefully it does expose this tax planning opportunity. As such property can be transferred out of the country without attracting either UK IHT, nor in fact CGT, if gifted, transferred out of the country and then subsequently sold as CGT is a purely a residency based tax.



A further planning point concerning the marriage exemption is that it is continues until the marriage is terminated either by death or until the date of the decree absolute of a divorce (note NOT just separation). If monies are given after divorce then these amounts can be covered with no limit by the exemption titled "Capital transfers for family maintenance" but only if comprised in a formal agreement.



A minor exemption that is often misunderstood concerns gifts that satisfy the "Normal expenditure" rules. This exemption can be very useful in the appropriate circumstances given the proper planning. Taking one year with another, any payments made (however large) are allowable and do not have to be declared to the taxman so long as a "normal" standard of living is maintained. "Normal standard of living" is taken to mean that the donor is left with enough money to live on without resorting to drawing to his capital to see him through the month.



If this exemption is to be used then it is preferable to start giving as soon as possible so that a pattern is in place; one idea is for the payments to be made by standing order so that they show up on the bank statement alongside such payments as for the mortgage and rates. Up to 1995 and the "Bennett" case the Revenue liked to see payments over a period of 3 years but this case, where lump sums of differing amounts were made over a period of only one year, showed that this is actually not necessary. In fact there is an instance where there is no need for a series of payments to be made at all so long as a clear commitment is in place to actually make the payment. This concerns the situation where a premium has been paid for a Life Assurance policy or under a Deed of Covenant but the payee dies before the second payment can be made -here it can be seen that there is a clear intention to make a series of payments. Where there is no such written commitment then the Revenue will look for a series of payments already made.



These "small exemptions" from IHT have not changed over the years and should be considered by everyone whose final Estate is going to come to the attention of the Revenue in the end but obviously they will not be of much help if the only asset you have is your main residence.



Jennifer Adams is TaxationWeb's Capital Taxes Editor. Click here for more information on Jennifer and her contact details.