Replies to queries - 4 - Simple gifts

Our client was given £35,000 by his mother on 20 August 1994 and a further sum of £200,000 on 3 March 1995. Our client's mother died on 25 April 2001 leaving net estate of £261,359.

We would have expected the gift of £235,000 in 1994-95 to be subject to the annual exemption to the extent of £6,000 (1993-94 and 1994-95) and then the whole to be liable to tax but with an 80 per cent taper as the gift was made between six and seven years before death.

We are advised by the Inland Revenue that this is not so, but it has given no reasoning and is to tax the whole at 40 per cent.

What is the correct position?

(Query T15,955) - Mike.

First the, admittedly small, good news: on the facts stated, I see no reason why the annual exemption of £3,000 for 1994-95 (together with £3,000 brought forward from 1993-94 if unused) should not be set against the potentially exempt transfers becoming chargeable on death.

The effect of section 19(3A), Inheritance Tax Act 1984 is not totally clear and the Revenue's view has changed slightly over the years since inheritance tax was introduced. Tolley's Inheritance Tax at paragraph 38.3 records the developments.

However, I think that we can safely take it that the annual exemptions are available against the failed potentially exempt transfers. The next step is to ascertain the tax due:

This amount falls entirely within the nil rate band for 2001-02 (the year in which death occurred) so the tax due is nil. 'Mike' is correct to say that 80 per cent taper may be applied, since the gifts were made between six and seven years before death. But 80 per cent of nil is still nil.

Next, we must look at the estate on death:

'Mike' seems to have fallen into an all too common misconception. The tapering of inter vivos gifts is on the tax chargeable - see section 7(4), Inheritance Tax Act 1984 - not the chargeable transfer. In this instance, there is no tax payable on the potentially exempt transfers, so no taper relief is due. The full amount of the failed potentially exempt transfers is cumulated in ascertaining the tax due on the estate at death.

It should be noted that there is absolutely no advantage at all of making potentially exempt transfers within the nil rate band, unless the donor survives a full seven years when the gifts fall out of account altogether.

Subject to a possible misunderstanding regarding the annual exemptions, the Inland Revenue is correct. - The Snark.

On the facts as stated, neither 'Mike' nor the Capital Taxes Office appears to have applied the cumulation principle in section 7, Inheritance Tax Act 1984 correctly. To determine the rate of inheritance tax applicable to any particular transfer, one must consider the cumulative total of chargeable transfers made in the seven years before the transfer in question, taking each transfer in turn. Assuming there were no earlier transfers in either 1993-94 or 1994-95, annual exemptions totalling £6,000 for those two tax years should be applied to the 20 August 1994 gift of £35,000, reducing the value of that potentially exempt transfer to £29,000. The donor died on 25 April 2001, within seven years of the potentially exempt transfer, and the current rates of inheritance tax (nil rate band of £242,000, excess at 40 per cent) should be applied to the potentially exempt transfer. Thus £29,000 is charged at nil per cent, leaving £213,000 of the nil rate band outstanding.

The second potentially exempt transfer (no annual exemptions available) made on 3 March 1995 absorbs a further £200,000 of the nil rate band, so that only £13,000 remains to be carried forward and set against the transfer on death. Assuming that the entire £261,359 is chargeable, and that no exemptions or reliefs are applicable, this leaves £248,359 subject to inheritance tax at 40 per cent resulting in an inheritance tax liability on the personal representatives for the death estate of £99,343.60. Since there is no tax payable on the life gifts, there is nothing for the 80 per cent taper (potentially relevant to gifts made between six and seven years before death) to bite on.

The approach of the Capital Taxes Office may be explicable in either of the following circumstances. If the mother had made chargeable transfers amounting to £242,000 (e.g. into discretionary trusts) in the seven years prior to 20 August 1994, they would, for the purposes of cumulation, mean that the potentially exempt transfers entered the inheritance tax table at a point above the nil rate band. In that case, particularly if there were no annual exemption(s), the whole amount of the potentially exempt transfers would suffer 40 per cent but would then be eligible for the 80 per cent taper. However, any gift to an individual (a potentially exempt transfer) made before 26 April 1994 would be fully exempt and would not affect the computation.

The other possibility is that the gifts were not outright cash gifts enjoyed to the entire exclusion of the donor but were gifts under which the mother retained an interest or reserved a benefit under the Finance Act 1986 provisions. If so, the earlier transfers are, in effect, ignored and they would be taxed as if they were part of the death estate. In that case the nil rate band is apportioned to each part of the transfer. - Percy Lion.

Extract from a reply by 'Hodgy':

At the time that the gifts were made, they exceeded the nil rate band - which was only £150,000. Therefore the lack of any inheritance tax taper relief is largely due to subsequent hikes in the nil rate band. There has been press speculation about a substantial increase in the nil rate band being in the Budget speech on 17 April 2002. If this is correct, this query demonstrates that this could create the need for tax practitioners to review previous inheritance tax planning exercises, where an element of inheritance tax taper relief is expected in the event of death before seven years has expired.

Issue: 3844 / Categories: