Inheritance tax - Interaction with other taxes

Learning Outcomes

This article explains how inheritance tax (IHT) interacts with capital gains tax (CGT), income tax, and stamp duty land tax (SDLT) in England and Wales, including:

• Tax consequences of lifetime gifts and death, and the role of business property relief
• Circumstances where multiple taxes may apply to the same transaction
• Core CGT concepts: no gain/no loss transfers between spouses/civil partners, hold-over relief on business assets and gifts to trusts, and CGT re-basing on death
• Separate income tax treatment of estate income and anti-avoidance regimes, including the pre-owned asset tax and GAAR
• SDLT triggers on assumption of debt and consideration in deeds of variation and lifetime gifts
• Use and limits of deeds of variation for IHT/CGT treatment and potential SDLT consequences
• Interplay of IHT reliefs (BPR/APR) with CGT hold-over relief and base cost implications
• Spouse/civil partner exemptions for IHT alongside the CGT no gain/no loss rule
• Application to SQE1 exam scenarios involving estate planning and tax liabilities

SQE1 Syllabus

For SQE1, you are required to understand how inheritance tax interacts with capital gains tax, income tax and stamp duty land tax across lifetime gifts, death, trusts and related reliefs (including BPR/APR), with a focus on the following syllabus points:

• The relationship between inheritance tax and capital gains tax on lifetime gifts and death
• The impact of inheritance tax on income tax during estate administration
• The effect of business property relief on inheritance tax and its practical requirements
• The circumstances where stamp duty land tax may arise in connection with inheritance or related transactions
• Interactions of IHT reliefs (BPR/APR) with CGT hold-over relief and the implications for base cost
• Spouse/civil partner exemptions for IHT and the CGT no gain/no loss rule
• The use and limits of deeds of variation, including their treatment for IHT/CGT and potential SDLT consequences
• Anti-avoidance: GAAR scope and pre-owned asset tax where benefits are retained after gifts
• SDLT where a transferee assumes mortgage debt on a gift or inheritance

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the capital gains tax consequence of a lifetime gift of an asset to an individual?
2. How does the value of an asset for CGT purposes change when it passes on death?
3. When might SDLT be payable in connection with an inheritance?
4. What are the main conditions for business property relief to apply for inheritance tax?

Introduction

Inheritance tax (IHT) is a tax on the transfer of wealth, typically arising on death or certain lifetime gifts. However, IHT does not operate in isolation. Its interaction with other taxes—especially capital gains tax (CGT), income tax, and stamp duty land tax (SDLT)—can have significant consequences for individuals, beneficiaries, and personal representatives. Understanding these interactions is essential for effective estate planning and for answering SQE1 questions on tax liabilities arising from gifts, death, and business succession.

Key Term: Potentially Exempt Transfer (PET)
A gift to an individual that is exempt from IHT if the donor survives seven years from the date of the gift.

Key Term: Chargeable Lifetime Transfer (CLT)
A transfer of value (such as a gift to most trusts) that may be immediately chargeable to IHT.

Key Term: General Anti-Abuse Rule (GAAR)
A statutory rule allowing HMRC to counteract “abusive” tax arrangements across major taxes (including IHT, CGT and SDLT) by making a just and reasonable tax adjustment.

The IHT regime includes a nil-rate band and various reliefs (notably business property relief (BPR) and agricultural property relief (APR)). These reliefs reduce the IHT value of qualifying assets but do not, in themselves, alter the CGT or SDLT rules. The GAAR and targeted anti-avoidance measures can apply to arrangements designed to sidestep tax on transfers or retained benefits.

Inheritance Tax and Capital Gains Tax

Lifetime Gifts

When an individual makes a lifetime gift of an asset (such as property or shares) to another individual, two taxes may be relevant: IHT and CGT.

Key Term: Disposal at Market Value
For CGT, a gift is treated as if the donor sold the asset at its current open market value, potentially triggering a CGT liability.

For IHT, a gift to an individual is a PET. If the donor survives seven years, no IHT is due. If the donor dies within seven years, the value of the gift may be included in the donor's estate for IHT (with taper relief potentially reducing IHT on gifts made more than three years before death). The PET concept is purely an IHT concept; the CGT position at the time of the gift is often immediate.

For CGT, a lifetime gift is treated as a disposal at market value. The donor may have to pay CGT on any chargeable gain, even though no money is received. The donee’s base cost for future CGT is the market value at the date of the gift (unless hold-over relief applies).

There are key exceptions and reliefs in CGT that directly affect the interaction with IHT:

• No gain/no loss for spouses/civil partners: Transfers between spouses/civil partners who are living together occur on a no gain/no loss basis, so there is no immediate CGT and the donee acquires the donor’s base cost. For IHT, such transfers are generally exempt.
• Hold-over relief (business assets): If the asset is a qualifying business asset (e.g., interests in a trading business, unquoted trading company shares), the donor and donee can elect to “hold over” the gain so it is deferred and effectively transfers to the donee. This mitigates CGT at the time of the gift but increases the donee’s future CGT exposure. BPR may also be available for IHT, but BPR does not itself defer CGT.
• Hold-over relief (gifts to trusts): Gifts to most trusts are CLTs for IHT. CGT hold-over relief can generally be claimed for gifts to trustees, regardless of asset type, because the transfer is a CLT (subject to conditions and exclusions). The gain is deferred into the trustees’/beneficiary’s base cost.
• Gifts to charities: Gifts to charities are generally exempt for IHT. For CGT, gifts to charities are treated on a no gain/no loss basis (so the donor’s gain is not chargeable on the gift).

Key Term: Hold-over Relief
A CGT relief that defers the donor’s chargeable gain on certain gifts (notably business assets and gifts to trusts), transferring the gain to the recipient’s base cost.

Key Term: No Gain/No Loss (Spouses/Civil Partners)
A CGT rule treating transfers between spouses/civil partners as occurring at no gain/no loss, so the recipient acquires the transferor’s base cost.

Death

On death, IHT is charged on the value of the deceased's estate. For CGT, death is not a disposal. Instead, assets pass to personal representatives or beneficiaries at their market value at the date of death. This "rebases" the asset for CGT, so any gain during the deceased's lifetime is wiped out.

Key Term: CGT Re-basing on Death
On death, assets are treated as acquired by the estate at their market value at the date of death for CGT purposes.

When the asset is later sold by the estate or beneficiary, CGT is only charged on any increase in value from the date of death to the date of sale. The personal representatives typically have access to the estate’s CGT annual exempt amount for the year of death and the following two tax years; beyond that, exemption availability is limited. Beneficiaries selling inherited assets compute gains by reference to the probate value.

Deeds of variation can affect CGT and IHT. If executed within two years of death and made effective for IHT (and, where appropriate, CGT), the variation can be treated as if the original disposition had been made by the deceased to the new beneficiary. This preserves re-basing for CGT and can secure IHT reliefs (e.g., redirecting to a charity). SDLT treatment follows its own rules: consideration given under a variation can create an SDLT charge.

Key Term: Deed of Variation
A post-death instrument (within two years) that can re-direct inheritances; if the appropriate statements are included, it is treated for IHT/CGT as made by the deceased.

Key Term: Gift with Reservation of Benefit (GWR)
For IHT, a lifetime gift where the donor retains a benefit (e.g., continued occupation of a gifted house) causes the asset to be treated as part of the donor’s estate on death.

Worked Example 1.1

A client gifts a second home to her daughter. She bought the property for £100,000; it is now worth £300,000. What are the tax consequences?

Answer:
For IHT, the gift is a PET. If the client survives seven years, no IHT is due. For CGT, the client is treated as disposing of the property at £300,000, so a gain of £200,000 may be subject to CGT.

Worked Example 1.2

A client dies owning shares purchased for £10,000, now worth £50,000. The shares are inherited by his son, who sells them a year later for £60,000. What taxes apply?

Answer:
For IHT, the shares are valued at £50,000 in the estate. For CGT, the son is treated as acquiring the shares at £50,000. If he sells for £60,000, CGT is due only on the £10,000 gain since death.

Additional interactions and pitfalls

• Gifts of the main residence: A gift of the donor’s main residence to an individual is a CGT disposal at market value; principal private residence relief can shelter the donor’s gain if conditions are met. If the donor continues living there rent-free after the gift, a GWR will bring the property back into the donor’s estate for IHT and may trigger the pre-owned asset tax for income tax unless market rent is paid.

• Double relief coherence: IHT reliefs (BPR/APR) reduce IHT value but do not change CGT. An asset qualifying for 100% BPR can be gifted with CGT hold-over relief (if business asset conditions are met), deferring CGT until the recipient disposes.

• Timing differences: PETs do not cause immediate IHT, but CGT can arise immediately on gifts. CLTs (e.g., gifts to trusts) may cause immediate IHT at lifetime rates if the value exceeds the available nil-rate band and can also engage CGT hold-over relief.

Key Term: Pre-Owned Asset Tax (POAT)
An income tax charge that can apply where an individual benefits from property they previously owned or provided funds for, after arrangements intended to avoid IHT; can be avoided if a genuine market rent is paid.

Worked Example 1.3

A married client transfers her let flat (worth £400,000, base cost £250,000) to her spouse, who also takes over the existing £150,000 mortgage. What taxes apply?

Answer:
For IHT, the transfer to a spouse is exempt. For CGT, transfers between spouses are no gain/no loss, so there is no immediate CGT; the spouse takes the £250,000 base cost. For SDLT, the spouse’s assumption of the £150,000 mortgage is chargeable consideration. SDLT may be payable by the spouse on £150,000 at the prevailing rates and surcharges, subject to residential property rules.

Worked Example 1.4

A client gifts unquoted shares in a trading company worth £600,000 to a discretionary trust. The company is a trading company; the donor held the shares for more than two years. What taxes apply?

Answer:
For IHT, the gift to the trust is a CLT. BPR at 100% may reduce the IHT value to nil if conditions are met. For CGT, the gift is a disposal at market value, but CGT hold-over relief on gifts to trustees can defer the gain (the trustees take a reduced base cost). No SDLT arises as shares are not chargeable interests in land.

Worked Example 1.5

A parent gifts her home to her son but continues to live there rent-free. She had bought it for £200,000; it is now worth £500,000. What are the tax implications?

Answer:
For CGT, the gift is a disposal at £500,000; principal private residence relief may cover the donor’s gain if conditions are met. For IHT, this is a gift with reservation (GWR): the property is treated as part of her estate on death. Unless full market rent is paid, POAT may apply as an annual income tax charge. On death, the property is re-based for CGT in the estate, but IHT will be charged on the value (subject to any applicable allowances/reliefs).

Worked Example 1.6

Within two years of death, the residuary beneficiary executes a deed of variation redirecting £100,000 of the estate to a charity. What are the tax consequences?

Answer:
If the deed of variation contains the appropriate statements, for IHT and CGT it is treated as though the deceased made the gift to the charity. The £100,000 qualifies for the IHT charity exemption, and the recipient charity receives assets without CGT consequences at that point. SDLT is not normally payable as this is a variation of the devolution on death without consideration; however, if consideration is given under the variation, SDLT may be triggered.

Inheritance Tax and Income Tax

Estate Administration

During the administration of an estate, the personal representatives may receive income (such as rent or dividends) from estate assets. This income is subject to income tax, separate from any IHT due on the estate's value at death. The personal representatives account for income tax on estate income before distribution. Beneficiaries who receive income distributions may be treated as having tax deducted at source and may have further income tax liabilities depending on their circumstances.

Key Term: Estate Income
Income arising from estate assets after death and before distribution to beneficiaries, taxable under income tax rules.

The CGT treatment of estate assets is separate from estate income. Sales by personal representatives may give rise to CGT on gains since death, with allowances and rates specific to personal representatives. Beneficiaries receiving capital (not income) do not incur income tax but may face CGT on later disposals.

Specific Asset Types

• Pension Funds: Lump sums from defined contribution pensions may be outside IHT in many cases, but withdrawals by beneficiaries can be subject to income tax depending on the deceased’s age at death and the scheme rules. IHT classification depends on whether the death benefits are paid at trustees’ discretion.

• ISAs: Individual Savings Accounts lose their tax-free wrapper on death. The capital value is included in the estate for IHT, and any income generated during administration is taxable. There may be an “additional permitted subscription” for a surviving spouse/civil partner to continue tax-efficient saving, which is separate from IHT treatment.

• Life Insurance: If written in trust, life policy proceeds may be outside the estate for IHT. Income arising from investing the proceeds is taxable. If a policy is not in trust, its proceeds are part of the estate for IHT.

• Rental Property: Rental income received by personal representatives is taxable. If a beneficiary receives the property and then lets it, the beneficiary is liable to income tax on rents thereafter. The transfer on death does not itself trigger income tax.

• GWR and POAT: Where a donor retains benefits after gifting assets during lifetime, POAT can impose an income tax charge annually to counteract IHT avoidance. Paying full market rent to the recipient can prevent POAT, but doing so may have other tax consequences.

Key Term: Pre-Owned Asset Tax (POAT)
An annual income tax charge where an individual enjoys benefits from property they previously owned or provided funds for, under arrangements intended to avoid IHT.

Worked Example 1.7

During estate administration, a rental property generates £5,000 in rent. What taxes apply?

Answer:
The rental income is subject to income tax, payable by the personal representatives. The property itself is included in the estate for IHT at its value at death. Any later sale by the PRs could trigger CGT on post-death gains.

Inheritance Tax and Business Property Relief

Business property relief (BPR) can reduce or eliminate IHT on certain business assets, but does not affect CGT or income tax directly.

Key Term: Business Property Relief (BPR)
A relief reducing the value of qualifying business assets for IHT, potentially to nil.

BPR is available at 100% for a business or interest in a business, and for unquoted shares in a trading company. It is available at 50% for certain other assets, such as land or buildings used by a business. Broadly, the conditions are:

• Qualifying business activity: The business must be a trading business, not one mainly holding or making investments.
• Ownership period: The asset must have been owned for at least two years before transfer (lifetime or death).
• No binding contract for sale: A binding contract for sale at death or at the time of gift typically prevents BPR.

BPR interacts with CGT in two notable ways:

• Hold-over relief: Gifts of BPR-qualifying assets (e.g., shares in a trading company) may qualify for CGT hold-over relief if the conditions for business asset hold-over are met. BPR reduces or removes IHT; hold-over defers CGT. They operate independently.
• CGT base cost after death: Where BPR eliminates IHT at death, the asset still re-bases for CGT to market value at death. A later sale by beneficiaries can trigger CGT on post-death appreciation.

Agricultural property relief (APR), which applies to agricultural land and certain farmhouses, similarly reduces IHT value but does not alter CGT rules at gift or sale. Gifts to trusts of agricultural land may secure APR and hold-over relief (depending on asset/business conditions), but subsequent disposals by trustees or beneficiaries are subject to CGT on gains from the relevant base cost.

Key Term: Agricultural Property Relief (APR)
An IHT relief for agricultural property (e.g., farmland and certain farmhouses), reducing its value for IHT; it does not affect CGT computations.

Worked Example 1.8

A client owns 100% of an unquoted trading company worth £1 million and leaves it to her son. What is the IHT consequence?

Answer:
The shares qualify for 100% BPR, so their value is reduced to nil for IHT. No IHT is payable on the transfer. For CGT, the son acquires the shares at the market value at the date of death and pays CGT only on any gains after death when he later disposes of them.

Stamp Duty Land Tax and Inheritance Tax

SDLT is not charged on assets passing by inheritance on death. However, SDLT may arise in certain situations involving property transfers connected to inheritance or gifts.

Key Term: Stamp Duty Land Tax (SDLT)
A tax on the purchase or transfer of land and property in England and Northern Ireland.

If a beneficiary inherits property and assumes responsibility for a mortgage, SDLT may be payable on the amount of debt taken on. If a deed of variation is made after death and consideration is given (e.g., cash paid between beneficiaries to reallocate property), SDLT may also arise. Lifetime gifts of property can trigger SDLT if the recipient assumes debt or gives consideration.

Practical points:

• Assumption of debt amounts to chargeable consideration for SDLT. In a lifetime gift, if the donee takes subject to an existing mortgage, the mortgage balance assumed counts as consideration for SDLT.
• Post-death variations without consideration typically do not give rise to SDLT. Where there is consideration, SDLT may be due on the consideration amount, applying residential/non-residential rates and any surcharges according to the transferee’s position.
• Transfers to or from trusts can engage SDLT where trustees or beneficiaries give consideration or assume debt (including a mortgage).
• Transfers of shares in companies or units in funds do not involve SDLT (but other stamp taxes may apply).

Worked Example 1.9

A beneficiary inherits a house worth £400,000 with a £100,000 mortgage and takes over the mortgage. Is SDLT payable?

Answer:
SDLT may be due on the £100,000 debt assumed by the beneficiary, even though the property was inherited.

Worked Example 1.10

Two siblings vary their late mother’s will within two years so that the sister takes the house and pays the brother £200,000 to compensate him. What taxes apply?

Answer:
If the deed of variation is effective for IHT/CGT, the re-direction is treated as though made by the deceased for those taxes: no CGT on the variation and IHT based on the new devolution. SDLT may be payable by the sister because she gives £200,000 consideration for the property acquired under the variation; SDLT rates/surcharges depend on the property type and her circumstances.

Key Point Checklist

This article has covered the following key knowledge points:

• Inheritance tax interacts with capital gains tax, income tax, and stamp duty land tax in various scenarios.
• Lifetime gifts may trigger immediate CGT for the donor, even if exempt from IHT as a PET; no gain/no loss applies between spouses/civil partners.
• CGT hold-over relief can defer gains on gifts of business assets and gifts to trusts; the deferred gain increases the recipient’s future CGT exposure.
• On death, assets are re-based for CGT, wiping out gains accrued during the deceased's lifetime; IHT reliefs (BPR/APR) do not alter CGT rules.
• Estate income (rents, dividends, interest) is taxed under income tax separately from IHT on the estate’s value; personal representatives account for this tax before distributions.
• Gifts with reservation of benefit bring the asset back into the donor’s estate for IHT; the pre-owned asset tax can impose an income tax charge on retained benefits unless market rent is paid.
• Deeds of variation (within two years) can be effective for IHT and CGT, preserving re-basing and securing IHT reliefs; SDLT may arise where consideration is given.
• SDLT is not charged on inheritance, but may arise if a beneficiary or donee assumes a mortgage or consideration is given in a deed of variation or a lifetime gift.
• Business property relief reduces IHT on qualifying business assets; conditions include trading status, ownership period, and no binding contract for sale.
• The GAAR can apply across IHT, CGT and SDLT to counteract abusive arrangements; plan within the rules and be alert to anti-avoidance regimes.

Key Terms and Concepts

• Potentially Exempt Transfer (PET)
• Chargeable Lifetime Transfer (CLT)
• Disposal at Market Value
• CGT Re-basing on Death
• Estate Income
• Business Property Relief (BPR)
• Stamp Duty Land Tax (SDLT)
• Hold-over Relief
• No Gain/No Loss (Spouses/Civil Partners)
• Deed of Variation
• Gift with Reservation of Benefit (GWR)
• Pre-Owned Asset Tax (POAT)
• General Anti-Abuse Rule (GAAR)
• Agricultural Property Relief (APR)