Inheritance Tax - Budget Update August 2015


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Inheritance Tax – Budget Update August 2015



The Summer Finance Bill, which was published on 12 July, includes legislation to implement the new residence nil rate band announced at Summer Budget 2015. This is an addition to the standard nil rate band of £325,000. This bulletin takes a detailed look at the new rules and explores how they are likely to work in practice through a series of examples based on our understanding of the draft legislation. This bulletin provides an updated analysis of the new legislation.


Prime Minister David Cameron has indicated on more than one occasion that he would like to increase the nil rate band threshold so that only the wealthy pay inheritance tax (IHT). Therefore the Conservatives’ pledge, in their pre-election manifesto, to exempt from IHT family homes of up to the value of £1m came as no great surprise. The proposals – to introduce an additional ‘residence nil rate band’ – were expanded upon in the Conservatives’ Summer Budget and the detail has now been published in the form of legislation included in the Summer Finance Bill 2015.


The rules are analysed in detail below but, in short, the residence nil rate band (RNRB) will take the form of an additional amount that can be offset against the value of property (or possibly assets representing it – see below) that has at some point been occupied as the family home. It is available where that home is transferred on the death of the owner to the direct descendants of the deceased. The amount of the person’s estate over and above any RNRB and standard nil rate band to which they may be entitled is charged to tax at the normal rates that apply for IHT. For married couples and civil partners, the nil rate band entitlement on second death will include any transferable standard nil rate band (TSNRB) or carried forward RNRB that was not used on death of the first of the couple to die.


Legislation to implement the additional RNRB is included in the Summer Finance Bill 2015 and will have effect for deaths occurring on or after 6 April 2017. The Bill amends section 8A(2) Inheritance Tax Act 1984 (IHTA) to ensure that the appropriate amount of the RNRB is taken into account in the calculation to work out whether there is any unused existing nil rate band that can be transferred to a spouse or civil partner; and introduces new sections 8D to 8M into the IHTA.


The new rules in detail


(i) Circumstances in which the additional allowance is available


The additional RNRB is available where all or part of a ‘qualifying residential interest’ is ‘closely inherited’ on or after 6 April 2017. A ‘qualifying residential interest’ is defined in new section 8H IHTA as being an interest in a dwelling-house which has at any time been the deceased’s residence and which forms part of the deceased’s estate. This would therefore exclude a property that has always been a buy-to-let but could include a property which has, in the past, been a residence of the deceased but which was let at the date of death.


Where a person’s estate includes only one residence which meets the criteria, the additional RNRB will clearly be allocated to that residence. However, where a person’s estate includes more than one residence that meets the criteria, the personal representatives of the deceased may nominate which one of those residences (or residential interests) is to be treated as the qualifying residential interest. Note that any unused element cannot be carried across to another property that potentially qualifies.


Example 1


John and Jennifer own two properties, both of which have at some point been occupied by them as a residence. On John’s death after 5 April 2017, he leaves his interest in property A (which is owned by John and Jennifer jointly as tenants in common) to his children. Jennifer continues to occupy property B which is owned as joint tenants and has been the couple’s main residence since they retired. John’s executors are able to nominate John’s interest in property A as his ‘qualifying residential interest’ thereby ensuring that his estate benefits from the additional residence nil rate band (as well as his standard nil rate band) on his death first.


This ability to nominate could be particularly useful where, for example, one property is held in the name of one spouse and one in the name of the other spouse – especially if the combined value of the two properties is below the combined value of two additional RNRBs.


Example 2


Assume that John and Jennifer each own one of the two aforementioned properties in their own sole name and that each property is worth around £200,000. On John’s death, after 5 April 2017, his entire additional RNRB can be offset against a transfer of that property to his children. This will leave Jennifer’s residence nil rate band to be used against the property that she owns when she passes it on to the children on her subsequent death.


Contrast the position if John had left his property to Jennifer. While Jennifer’s executors could claim John’s unused RNRB under the transferable nil rate band rules, they would be able to nominate just one of the two properties as the qualifying residence thereby wasting up to £150,000 of RNRB.


The qualifying residential interest must be ‘closely inherited’ in order for it to obtain the benefit of the additional RNRB. ‘Closely inherited’ is defined in new sections 8J and 8K IHTA as meaning inherited on death (by will, intestacy or some other means) by one or more of the deceased’s children, grandchildren or other lineal descendants. For these purposes, the terms children and grandchildren include children (and children of children) who are step-children, adopted children, fostered children as well as children for whom the deceased had been appointed as guardian.


It is important to note that, for the purposes of the new rules, a person can be treated as having ‘inherited’ even where the property (or an interest in it) has been left to a trust provided the direct descendant is treated as owning the trust assets (ie. a bare trust), or has a qualifying interest in possession (that is, either an immediate post-death interest or a disabled person’s interest) or an interest which meets the conditions for a trust for bereaved minors or an 18-25 trust.


It is proposed that in circumstances where the RNRB or part of it would be lost because the deceased either downsized to a less valuable property or ceased to own a property before their death, relief will still be available provided that the smaller replacement property, and/or assets of equivalent value to the property which has been disposed of, are passed to the deceased’s descendants on death. The detail of how this will work in practice will be the subject of a consultation in the autumn and legislation to implement this aspect of the new relief will be included in next year’s Finance Bill.


(ii) Calculating the amount of the additional allowance


The RNRB will be phased in gradually between 6 April 2017 and 6 April 2020 as follows:


  • £100,000 for the tax year 2017/18;
  • £125,000 for the tax year 2018/19;
  • £150,000 for the tax year 2019/20; and
  • £175,000 for the tax year 2020/21 and subsequent tax years (increased in line with the CP1)


Where the deceased’s estate is below £2,000,000, the residential enhancement for the year of death (increased as appropriate by any transferable amount brought forward from the death of a spouse or civil partner – see below) will constitute the deceased’s ‘default allowance’.


Where the deceased’s estate exceeds £2,000,000 (the taper threshold), the appropriate RNRB amount will be reduced by £1 for every £2 by which the taper threshold is exceeded to provide an ‘adjusted allowance’. Note that the £2m figure is the net estate value after deducting liabilities but before applying any relief or exemptions (including the current nil rate band, business property relief and the spouse exemption). This tapering will mean that for deaths occurring on or after 6 April 2020, no additional allowance will be available for estates with a net value of £2.35m or more (or £2.7m on the death of a surviving spouse where a 100% RNRB is available to be transferred to the survivor). The tapering will not, however, affect entitlement to the standard nil rate band of £325,000.


The taper threshold is due to increase by CPI from the tax year beginning 6 April 2021.


(iii) Transferring the allowance


In the same way that the standard nil rate band is transferable between married couples if unused, the additional RNRB will be similarly transferable. A transferable additional RNRB can be claimed where the second death occurs on or after 6 April 2017 regardless of when the first death occurred.


The amount of transferable RNRB that can be claimed on the second death will depend on how much RNRB was used on the first death. The transferable RNRB is calculated the same way as the existing transferable nil rate band i.e. the percentage unused on first death (taking account of the nil rate amount in force – or deemed to be in force – at that time) is applied to uplift the nil rate band (or RNRB) in force at second death.


Example 3


Bill dies in May 2018 leaving a qualifying residential interest worth £100,000 to his grandchildren, and the balance of his estate to his wife, Sally. As the residential enhancement for the 2018/19 tax year is £125,000, he has used 80% of his RNRB. The unused amount can be carried forward so that on Sally’s death her RNRB can be uplifted by 20% (i.e. £25,000/£125,000).


It should be noted that new section 8E provides that in circumstances where the value of the interest passing to the children exceeds the deceased’s default allowance (or adjusted allowance where the allowance has been reduced) the RNRB will be limited to the value of the interest passing to the children and there will be no amount available to carry forward. The practical effect of this is that wherever a qualifying residential interest is passed to lineal descendants, the RNRB will always be used before the standard nil rate band.


Two further points are worthy of note:


Firstly, there is no requirement for the first of the couple to die to own a qualifying residential interest at the time of their death for unused RNRB to accumulate to the survivor.

Secondly, where the estate on first death is greater exceeds the £2m taper threshold, the amount available for transfer will be reduced by £1 for every £2 the threshold is exceeded in the same way as explained earlier.

Deaths occurring before 6 April 2017


Where the first death occurred before 6 April 2017, the RNRB at the time of first death is deemed to be £100,000 The new legislation further provides that, regardless of the actual circumstances, no part of this RNRB, will be deemed to have been used on first death. This means that where the first death occurred before 6 April 2017, the estate of the surviving spouse will always be entitled to 100% uplift in the transferable RNRB – irrespective of whether the first to die left an interest in a qualifying property direct to descendants.


The exception to this general rule is where the estate of the first to die exceeded the taper threshold of £2 million. In this case, the transferable RNRB will be reduced by £1 for every £2 that the estate exceeds the £2 million taper threshold.


Example 4


Simon died in April 2016 before the new rules come into force, leaving his entire estate (worth less than £2m) to his wife Sue. Sue dies in May 2018 when the standard nil rate band is £325,000 and the additional RNRB is £125,000. She leaves her entire estate (which includes a qualifying residential interest worth £545,000) to her children. Sue’s estate will receive the benefit of a standard nil rate band of £650,000 (100% transferable from Simon) and an additional RNRB of £250,000 (i.e Sue’s £125,000 uplifted by 100%)).


Example 5


Annie owns a residential property with husband Richard as tenants in common. Annie died in January 2016 leaving her share of the residential property to their daughter, Sally. Annie’s share of the property was worth £350,000 at the time of her death. She leaves the balance of her estate to Richard.


On Richard’s death in July 2020, Sally inherits the remainder of her parents’ estate. Richard has his own standard nil rate band of £325,000 plus an additional RNRB of £175,000. Because Annie died before 6 April 2017, Richard’s additional RNRB will benefit from a 100% uplift of £175,000, meaning that, in total, it is £350,000. However there will be no uplift to the standard nil rate band as Annie used her entire nil rate band on her death. Richard’s total nil rate band is therefore £600,000.


Any unused RNRB will need to be claimed by the personal representatives on second death as is the case under the existing TSNRB rules. The claim will need to be made within 2 years of the end of the month in which the death of the surviving spouse occurred.


While the details of the new rules are still emerging, it is already clear that planning opportunities could exist. For example, where couples own two qualifying properties, the combined value of which is below the combined value of two additional RNRBs, there may be merit in structuring the estate so that one of the properties can be passed to children on the first death so as to prevent an additional RNRB from being wasted (although, of course, other considerations may apply). The additional RNRB also provides potential clients with another reason to exercise caution when considering a lifetime gift of an interest in residential property. Not only are there likely to be serious CGT implications in making such a gift, it will also be important to recognise that the additional RNRB will not apply to gifts made during lifetime.


Yet, although the introduction of the RNRB will be openly welcomed by those who intend to leave estates above the current nil rate band to their children or grandchildren, for those not able to benefit from the new allowance (i.e. no children or grandchildren to benefit and/or property value insignificant in relation to other assets) there is a sting in the tail…. The basic nil rate band of £325,000, which has been frozen since April 2009 will now remain the same until April 2021 – representing 12 years of an effectively increasing tax burden and financial planning need.


In the vast majority of cases, a private residence will be owned in joint names and pass on the first death to the surviving spouse. The question therefore will be how much of the RNRB is available for transfer to the survivor.


As ever, changes also provide an opportunity to review existing arrangements. Reviews will be particularly important where wills have been drafted so as to leave the family home or a share of it to a trust on first death or where arrangements involving the family home have been put in place for asset protection purposes. Careful analysis will be required to ensure that such arrangements remain tax efficient in the wake of the new rules.


This detailed view of the evolving position is provided by courtesy of Techlink: Information © Technical Connection Ltd. All Rights Reserved

For further analysis of your current position please contact Charterbridge on 01454 412222 or email