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UK inheritance tax – Frequently asked questions

By: Bill Blevins

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Q: What is UK inheritance tax (IHT)?

A: IHT is a combination of death duty and, in certain circumstances, a gifts tax. The tax is payable on the value of all the worldwide assets you own on the date of your death, plus those you gave away in the previous seven years over a set threshold. It’s also payable on certain lifetime gifts.

Q: What is the tax rate?

A: The tax rate is 40 per cent. There are no published plans to lower or increase it, though not so long ago the government was advised to raise it to 50 per cent!

Q: What is the threshold?

A: For the 2006/07 tax year the nil rate band is 285,000 pounds sterling. It will rise as follows: 2007/08: 300,000 pounds sterling, 2008/09: 312,000 pounds sterling, 2009/10: 325,000 pounds sterling. This threshold increases in line with inflation rather than house price increases. This means that thousands more families are falling into the IHT net each year.

Q: What assets are included in calculating IHT?

A: Pretty much all your worldwide assets, minus any liabilities. To see how much IHT you are liable for, add together the current values of all the following:

• Your house value (including any second homes and business properties).

• The value of all your household contents and personal effects.

• Bank and building society accounts.

• All your stocks, shares, savings and investments (including any held offshore, ISAs, endowments and so on).

• Life assurances.

• Other assets (cars, boats and so on).

Once you have the total, subtract any debts (mortgages, loans and so on). From this subtotal, subtract the nil rate band to establish your approximate net estate size. Work out 40 per cent to find the amount that will go to the taxman rather than your heirs.

Q: What happens if my heirs cannot afford to pay this tax?

A: The tax is paid by your estate, before it’s distributed to your heirs, rather than by the beneficiaries themselves. If most of your net worth is tied up in property and there isn’t enough cash to pay the bill, the property may have to be sold to generate funds. You may be able to take out life assurance to prevent this happening. Any policy established for this purpose must be assigned or written under a simple policy trust to ensure the proceeds do not form part of your taxable estate at death.

Q: I am an expatriate, am I still liable to IHT?

A: IHT depends on domicile, not residence, so you may well be liable. If you are a UK domicile (your ‘domicile of origin’ is usually that of your father at the time of your birth, or of your husband if you married before 1974), then you are liable to IHT. It’s possible to acquire a ‘domicile of choice’ elsewhere, but as the UK Revenue’s leaflet explains: “You need to provide strong evidence that you intend to live there permanently or indefinitely. Living in another country for a long time, although an important factor, is not enough on its own to prove you have acquired a new domicile.” You need to take expert advice to be able to prove a UK non-domicile status in the future. Remember the burden of proof will be on your estate and not the Revenue – i.e. the Revenue will consider you a UK domicile until your heirs can prove otherwise. Any assets located in the UK are liable to IHT, regardless of whether you are a UK domicile or not.

Q: What happens if I return to the UK in the future?

A: If you return to the UK to live, then you become a UK domicile and your estate is liable for IHT, even if you have lived overseas for a long time unless, that is, you have taken steps to avoid this, by setting up an offshore discretionary trust while non-domicile.

Q: Will my wife have to pay IHT when I die?

A: No, provided you are both UK domiciles, transfers between spouses are exempt – there will be no tax to pay. However, your children will then have to pay IHT on the death of the second spouse and they will only benefit from one nil-rate band. You can take steps to utilise the two nil-rate bands (one for each spouse) to save your estate 114,000 pounds sterling. If you are a UK domicile and your spouse is not, if you die first your spouse is not eligible for the inter-spousal exemption, he/she will only have a one-off allowance of 55,000 pounds sterling (in addition to the nil-rate band).

Q: Can I give assets away as gifts?

A: Yes, but you must live for seven years after the date of the gift and you must not be able to benefit from the gift in any way. You can also give away up to 3,000 pounds sterling tax free each year.

Q: Are there other ways to avoid IHT?

A: IHT is often called a “voluntary tax” because it is possible to avoid it – by not taking steps to do so you are as good as offering to give the UK government 40 per cent of your wealth. For expatriates, the best option is to take out an offshore discretionary trust while living abroad.  This will protect your wealth from IHT and it also offers various other advantages – estate planning, no need for probate, avoiding succession laws and so on. Take expert advice.

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