On 22 March 2006, proposals to change the inherittance tax treatment of UK trusts were announced. When the legislation has received Royal Assent, usually towards the end of July, we will post revised briefings, but in the meantime, please contact Bart Peerless, Stephen Pallister or Catriona Syed if you need any information.

INHERITANCE TAX

A brief introduction to inheritance tax ("IHT") & outline of some useful IHT exemptions

United Kingdom IHT may be payable following your death, depending on the value of your estate as calculated for tax purposes. At the present time, the first £263,000 ("the nil-rate band") is free of tax wherever it goes: the balance of your chargeable estate is subject to tax at the rate of 40%.

No IHT liability arises on an outright gift to an individual at the time when the gift is made: further, such a gift will escape tax altogether if you survive the date of the gift by seven years. Gifts within seven years form part of your aggregate chargeable transfers, and affect the tax payable on your death. The value of a gift is measured by your loss, as donor, at the date it is completed.

• If the total of all chargeable lifetime gifts is within the nil-rate band, there is no tax payable by the donee, but the gifts made by your will receive proportionately less benefit from that nil-rate band.

• If such total is larger than the nil-rate band, and death occurs more than three (but less than seven) years from a gift, then the tax on the gift reduces on a sliding scale. Note: there is no reduction save insofar as a gift turns out to be taxable.

Gifts into trust are treated in much the same way as gifts to individuals, with the exception of gifts into discretionary trusts: these can give rise to an immediate tax liability, but any tax is payable at 20%, not 40%. (If you die within three years of such gifts, an extra 20% tax is payable on death.)

Gifts must be outright to be effective for IHT purposes: property given with strings attached is treated as still belonging to the donor at death, and valued as at that time.

All property situated in the UK is potentially subject to IHT. Your foreign property is also liable - unless you are domiciled abroad (and not deemed domiciled here) at your death.

IHT exemptions
• Parliament has laid down certain specific exemptions, e.g. for heritage, agricultural and business property, for woodlands and pension schemes, and gifts to charity: detailed advice can be provided on these if required.

• In addition, there is normally an unlimited exemption for transfers between husband and wife, even if living separately. The effect of this, when a husband or wife dies leaving a surviving spouse, is as follows:

• only if more than £263,000 is left to people other than the surviving spouse is there IHT payable; and

• if the combined assets of the couple amount to more than £263,000 at the time of the first death, then it is possible to save IHT by both spouses ensuring that their wills are drawn up in the right way.

(Careful advice should be sought if one of you or your spouse is domiciled in this country, but the other domiciled abroad.)

• Gifts out of income: if you are giving away money out of your current income (as opposed to your capital) you can do so free of IHT up to any amount, so long as you still have enough income to live off. (In other words you cannot obtain this exemption if you give away all your income, and then live off capital.)

It is best to make a calculation of what you can give each tax year (6th April to 5th April in the following calendar year), and to set up a quarterly or monthly standing order (or standing orders), to show your intentions clearly. You cannot use this exemption to cover gifts other than of money; but donees could of course use the money to buy anything they liked.

• When you have exhausted the scope of the gifts out of income exemption, there are others to bear in mind:

• The £3,000 a year exemption: this can be carried forward for one (tax) year, but one year only.

• You can also give £250 a year (again, "year" means tax year) to any number of different people, provided they are not amongst those to whom you have given all or part of the £3,000. The intention is that this should cover Christmas and birthday presents etc.

• If a child or grandchild is getting married, there is an opportunity to make them pre-marriage gifts (£5,000 for parents, £2,500 for grandparents) which are free of IHT.

N.B. Even though no IHT is payable on exempt gifts, it is still advisable to keep a careful record of the amounts given, to whom and the dates. (The date a gift by cheque is completed is when the cheque has been cleared through your bank account.)

On death, details may need to be submitted to the tax authorities. If they cannot be produced, then the Inland Revenue may require production of bank statements etc.: they can assess tax on an alleged basis, which may in fact be too high.

This note states the current IHT law only: it does not take any account of capital gains tax, upon which we can provide separate advice if required.

Click here for information on personal tax planning.

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