# Taxation in the United Kingdom/Inheritance tax
## Introduction

In the United Kingdom, Death Duty was first introduced as a tax on estates in England and Wales over a certain value from 1796, then called legacy, succession and estate duties. The value changed over time and the scope of estate duty was extended. By 1857 estates worth over £20 were taxable but duty was rarely collected on estates valued under £1500. Death duties were introduced in 1894, and for the next century were effective in breaking up large estates.

## Inheritance Tax

Estate duty was replaced in 1975 by Capital Transfer Tax, which was replaced by Inheritance Tax (IHT) in 1986. Partly due to the simple and widely-used methods which are available to avoid it, Inheritance Tax is a small, but by no means insignificant, revenue generator for the UK government, raising around £2,000,000,000 in 2001.
For the 6 April 2008 to 5 April 2009 tax year, the IHT rate is 40% on the value, at death, of an individual's tax estate over £312,000. This figure is known as the nil rate band, and rises annually.

### Tax estate

The tax estate includes:
* all of the deceased's assets, whether real estate or personal estate, and includes even small-value items such as the contents of his or her home;
* any gifts made in the seven years before death;
* some assets which were not owned by the deceased but which are affected by the death (the most common example is a life interest in a trust, technically known as an interest-in-possession);
* gifts with reservation of benefit. These are gifts where the legal ownership passes to the recipient. However, the donor continues to enjoy the benefit of the asset either rent free or at reduced cost. The seven year period outlined above does not begin counting down whilst a gift is considered to be under a reservation of benefit.
There is also a charge on "lifetime chargeable transfers" into certain trusts (and a recalculation of those charges if the giver dies within seven years), and trusts themselves have an inheritance tax regime. See Taxation of trusts (United Kingdom).

### Deductions

There are deductions for:
* all assets left to a spouse or civil partner. However the exemption is limited to £55,000 where the deceased is domiciled in some part of UK and the surviving spouse/civil partner is domiciled outside of the UK;
* all assets left to a charity registered in the UK;
* some political donations;
* gifts totalling up to £3000 in a given year, to one person or split between several people;
* unlimited gifts of up to £250 per recipient per year. This relief cannot apply to gifts to people in respect of whom the £3000 relief is also claimed ;
* some business assets (under Business Property Relief or "BPR");
* some farmland (under Agricultural Property Relief or "APR").
* gifts made out of income that do not impact upon the standard of living of an individual.
* gifts made in contemplation of a marriage or civil partnership. The level of this deduction varies according to the relationship of the donor to person marrying or entering into a civil partnership.

### Minimising IHT

In order to avoid IHT, many people in the IHT bracket practise some or all of the following avoidance measures:
* Outright gifts to another individual made during a person's lifetime are known as "potentially exempt transfers" or PETs. They are taxable if the person dies within seven years, but have the potential to become exempt from tax once seven years have gone by with the giver still alive. If the giver survives three years, the value of the PETs that is taxable reduces by 20%, and then by a further 20% of the original value on each of the subsequent anniversaries, reaching 0% after seven years. This is a form of taper relief. Since the original PET value takes precedence over any other asset in making up the nil rate band, the relief is only effective with gifts in excess of this amount. For example, a PET of £575,000 when the nil rate band is £275,000 would see a reduction in taxable value of £60,000 (20% of £300,000) every anniversary between the third and sixth. The whole gift becomes entirely exempt from tax seven years after it was made
* Gifting assets to a trust fund before death. (Some gifts of this kind, however, are disadvantageous as they amount to lifetime chargeable transfers on which IHT is paid straight away. This applies to many more trusts than previously under legislation announced in the 2006 budget. See Taxation of trusts (United Kingdom).)
* Charitable giving, which is IHT exempt.
* Lifetime gifts within certain limits are completely exempt. These include any number of "small gifts" (up to £250), an annual amount of £3,000, all regular gifts from surplus income, and some wedding gifts.
* Upon death, passing non-taxable assets to the next generation (or to a discretionary trust for the benefit of the whole family) and therefore NOT to the spouse. To many people this seems counter-intuitive because they are aware that gifts to a spouse are IHT exempt and should therefore be maximised. However, if something is non-taxable on the first death it should not go to the spouse as it will merely increase his or her tax estate upon his or her later death. (The nil-band discretionary trust, discussed below, is an example of this principle in action.)

#### Nil rate bands

A person who has a tax estate less than the nil rate band may consider himself or herself outside the IHT bracket. Since October 2007, unused nil rate bands have been transferable between spouses and civil partners. That is, if on the first death, the nil rate band is not fully used, then the remainder can be used on the second death.
For unmarried couples and those not in a civil partnership, the most common means of ensuring that both nil rate bands are used is called a nil band discretionary trust. This is an arrangement in both wills which says that whoever is the first to die leaves their nil band to a discretionary trust for the family, and not to the survivor. The survivor can still benefit from those assets if needed, but they are not part of that survivor's tax estate.
A gift is not valid for IHT purposes if the giver retains any benefit from it. There are quite complex and rigid rules which establish whether the giver has retained a benefit, and where there is a retention of benefit all IHT advantages from the gift are effectively lost.
More detail on discretionary trusts can be found in this module: Discretionary Trusts.

#### Pre-owned assets

The Finance Act 2004 introduced an income tax regime known as pre-owned asset tax which aims to reduce the use of common methods of IHT avoidance.

## References

* ↑ s18 Inheritance Tax Act 1984
* ↑ REV BN 40: Tax Treatment Of Pre-Owned Assets