Inheritance Tax on lifetime transfers and transfers on death - Exemptions and reliefs: general and lifetime-only exemptions

Learning Outcomes

After reading this article, you will be able to identify and explain the main exemptions and reliefs from Inheritance Tax (IHT) that apply to both lifetime transfers and transfers on death. You will understand the difference between general exemptions (such as the spouse/civil partner exemption and gifts to charity), annual and small gifts exemptions, and reliefs available only in specific circumstances (such as business property and agricultural relief). You will also be able to apply these rules to SQE1-style scenarios.

SQE1 Syllabus

For SQE1, you are required to understand the IHT exemptions and reliefs that apply to both lifetime and death transfers, and how to apply them in practice. In your revision, focus on:

  • the spouse/civil partner exemption and its limits
  • the exemption for gifts to charities and political parties
  • the annual exemption and small gifts exemption for lifetime transfers
  • the exemption for normal expenditure out of income
  • the rules for gifts in consideration of marriage/civil partnership
  • business property relief and agricultural property relief (including qualifying conditions)
  • the distinction between general exemptions and reliefs that apply only to lifetime transfers
  • how to apply these exemptions and reliefs to reduce or eliminate IHT liability in practical scenarios

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. Which of the following is a general exemption from IHT that applies to both lifetime transfers and transfers on death?
    1. annual exemption
    2. spouse/civil partner exemption
    3. small gifts exemption
    4. business property relief

  2. True or false? A gift of £250 to each of five friends in a single tax year is always fully exempt from IHT, regardless of any other gifts made.

  3. What is the maximum value of gifts a parent can make to a child on their marriage that will be exempt from IHT?

  4. Name two key conditions that must be met for business property relief to apply to a transfer of shares in a private trading company.

Introduction

Inheritance Tax (IHT) is charged on transfers of value made during a person’s lifetime or on death. However, a range of exemptions and reliefs can reduce or eliminate IHT liability. For SQE1, you must be able to identify which exemptions and reliefs apply in a given scenario, distinguish between those available for lifetime transfers and those available on death, and apply the correct rules to practical problems.

General Exemptions

Spouse or Civil Partner Exemption

Transfers between spouses or civil partners are fully exempt from IHT, whether made during lifetime or on death, provided both are domiciled in the UK. If the recipient spouse or civil partner is not UK domiciled, the exemption is limited to £325,000 (the current nil-rate band). A non-UK domiciled spouse can elect to be treated as UK domiciled for IHT purposes, but this brings their worldwide assets into the UK tax net.

Key Term: spouse/civil partner exemption A complete exemption from IHT for transfers between spouses or civil partners, provided both are UK domiciled. If the recipient is not UK domiciled, the exemption is capped at the nil-rate band.

Gifts to Charities and Political Parties

Gifts to UK-registered charities are exempt from IHT, whether made during lifetime or on death. The same applies to gifts to qualifying political parties and certain national institutions.

Key Term: charity exemption An exemption from IHT for gifts to UK-registered charities, available for both lifetime and death transfers.

Lifetime-Only Exemptions

Annual Exemption

Each individual can give away up to £3,000 per tax year free of IHT. If the full exemption is not used in one year, it can be carried forward to the next year only (maximum £6,000 in one year if none used previously). The annual exemption applies to the first gifts made in the tax year.

Key Term: annual exemption An exemption allowing an individual to make gifts up to £3,000 per tax year free of IHT. Unused exemption can be carried forward one year.

Small Gifts Exemption

Unlimited gifts of up to £250 per recipient per tax year are exempt from IHT, provided the recipient does not also benefit from the annual exemption in the same year.

Key Term: small gifts exemption An exemption allowing unlimited gifts of up to £250 per recipient per tax year, provided no other exemption is used for that recipient.

Normal Expenditure Out of Income

Regular gifts that form part of the donor’s normal expenditure and are made out of income (not capital) are exempt, provided the donor is left with enough income to maintain their usual standard of living.

Key Term: normal expenditure out of income exemption An exemption for regular gifts made out of income, provided they do not reduce the donor’s standard of living.

Gifts in Consideration of Marriage or Civil Partnership

Certain gifts made on the occasion of marriage or civil partnership are exempt up to specified limits:

  • £5,000 from a parent
  • £2,500 from a grandparent or remoter ancestor
  • £1,000 from anyone else

Key Term: marriage exemption An exemption for gifts made on marriage or civil partnership, up to specified limits depending on the donor’s relationship to the recipient.

Gifts for Family Maintenance

Payments made for the maintenance of a spouse, civil partner, child, or dependent relative are exempt from IHT, provided they are reasonable in amount and purpose.

Key Term: family maintenance exemption An exemption for gifts made for the maintenance, education, or care of a spouse, civil partner, child, or dependent relative.

Reliefs for Business and Agricultural Property

Business Property Relief (BPR)

BPR reduces the value of relevant business property for IHT purposes by 100% or 50%, depending on the type of property. To qualify, the business must be a trading business (not mainly investment), and the property must have been owned for at least two years before the transfer.

  • 100% relief applies to:

    • a business or interest in a business
    • shares in an unlisted trading company

  • 50% relief applies to:

    • shares in a quoted trading company (if the transferor had control)
    • land, buildings, or plant used by a company controlled by the transferor or by a partnership in which the transferor was a partner

Key Term: business property relief (BPR) A relief reducing the value of qualifying business assets for IHT by 100% or 50%, subject to conditions.

Agricultural Property Relief (APR)

APR reduces the value of qualifying agricultural property for IHT purposes by 100% or 50%. The property must have been owned and occupied for agricultural purposes for at least two years (if owner-occupied) or seven years (if let to another).

  • 100% relief applies if the transferor had the right to vacant possession or the property was let on a qualifying tenancy.
  • 50% relief applies in other cases.

Key Term: agricultural property relief (APR) A relief reducing the value of qualifying agricultural property for IHT by 100% or 50%, subject to ownership and occupation conditions.

Application and Interaction of Exemptions and Reliefs

Exemptions and reliefs can be combined to reduce or eliminate IHT liability. For example, a parent could use the annual exemption, small gifts exemption, and marriage exemption in the same year for different gifts. Business and agricultural reliefs can be used to pass on family businesses or farms without a significant IHT charge, provided all conditions are met.

Worked Example 1.1

A UK-domiciled individual leaves £600,000 to their spouse (UK-domiciled), £100,000 to a registered charity, and £200,000 to a friend. What is the IHT position?

Answer: The gifts to the spouse and charity are fully exempt. Only the £200,000 to the friend is potentially chargeable, but the nil-rate band (£325,000) will cover it, so no IHT is due.

Worked Example 1.2

In one tax year, a grandparent gives £2,500 to a grandchild on their marriage, £3,000 to their daughter, and £250 to each of four friends. Which gifts are exempt from IHT?

Answer: The £2,500 marriage gift is exempt under the marriage exemption. The £3,000 gift to the daughter is exempt under the annual exemption. The £250 gifts to each friend are exempt under the small gifts exemption.

Worked Example 1.3

A business owner dies owning 60% of the shares in an unquoted trading company, held for five years. The shares are left to their child. Does business property relief apply?

Answer: Yes. The shares qualify for 100% business property relief, as they are in an unquoted trading company, the business is trading (not mainly investment), and the shares have been owned for at least two years.

Exam Warning

For SQE1, always check the recipient’s domicile for the spouse/civil partner exemption. If the recipient is not UK domiciled, the exemption is capped at the nil-rate band unless an election is made.

Revision Tip

When calculating IHT on lifetime gifts, apply the annual exemption to the earliest gifts in the tax year. Remember that unused annual exemption can only be carried forward one year.

Key Point Checklist

This article has covered the following key knowledge points:

  • The spouse/civil partner exemption applies to both lifetime and death transfers, but is limited if the recipient is not UK domiciled.
  • Gifts to UK-registered charities are exempt from IHT.
  • The annual exemption (£3,000 per year) and small gifts exemption (£250 per recipient) apply only to lifetime gifts.
  • The normal expenditure out of income exemption applies to regular gifts made out of surplus income.
  • Marriage exemption applies to gifts made on marriage or civil partnership, with limits depending on the donor’s relationship to the recipient.
  • Family maintenance payments are exempt if reasonable.
  • Business property relief and agricultural property relief reduce the value of qualifying assets for IHT, subject to strict conditions.
  • Exemptions and reliefs can be combined to reduce or eliminate IHT liability in practical scenarios.

Key Terms and Concepts

  • spouse/civil partner exemption
  • charity exemption
  • annual exemption
  • small gifts exemption
  • normal expenditure out of income exemption
  • marriage exemption
  • family maintenance exemption
  • business property relief (BPR)
  • agricultural property relief (APR)
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