Inheritance Tax on lifetime transfers and transfers on death...

Learning Outcomes

This article outlines IHT exemptions and reliefs for lifetime transfers and transfers on death, including:

• Identification and explanation of the main IHT exemptions and reliefs, distinguishing between general exemptions and lifetime-only exemptions
• Application of the spouse/civil partner exemption (non-domiciled spouse cap and election), the charity and political party exemptions, and the annual and small gifts exemptions
• Assessment of gifts qualifying as normal expenditure out of income and gifts in consideration of marriage or civil partnership
• Qualifying conditions and scope of Business Property Relief (BPR) and Agricultural Property Relief (APR), including ownership periods, trading/agricultural use, control thresholds, and excepted assets
• Combination of exemptions and reliefs to reduce or eliminate IHT in realistic scenarios, including the order of application and the interaction with PETs and LCTs

SQE1 Syllabus

For SQE1, you are required to understand the IHT exemptions and reliefs for lifetime transfers and transfers on death, with a focus on the following syllabus points:

• the spouse/civil partner exemption and its limits (including non-domiciled spouse cap and election)
• the exemption for gifts to charities and political parties (including qualifying party conditions)
• the annual exemption and small gifts exemption for lifetime transfers, and how they interact
• the exemption for normal expenditure out of income (tests and practical evidence)
• the rules for gifts in consideration of marriage/civil partnership
• business property relief and agricultural property relief (including qualifying conditions and excepted assets)
• the distinction between general exemptions and reliefs that apply only to lifetime transfers
• the order of applying exemptions and reliefs and the interaction with PETs and LCTs
• 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. The practical approach is to identify the transfer of value, determine its amount, apply exemptions and reliefs, and only then compute any tax due. In doing so, note that spouse/civil partner and charity/political party exemptions are general—they can apply both in lifetime and on death—whereas the annual and small gifts exemptions are lifetime only. BPR and APR are reliefs: they reduce the value transferred for IHT purposes and can apply either in lifetime or on death, provided strict conditions are met.

Key Term: spouse/civil partner exemption
A complete exemption from IHT for transfers between spouses or civil partners, available in lifetime and on death; if the recipient spouse/civil partner is not UK domiciled, the exemption is capped (currently £325,000) unless a deemed domicile election is made.

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

Key Term: political party exemption
An exemption from IHT for gifts to a qualifying political party. A party qualifies if it meets statutory representation/vote share criteria (e.g. a minimum number of MPs or a specified national vote share at the last general election).

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. Where the recipient spouse/civil partner is not UK domiciled, the exemption is limited to a lifetime and death cumulative cap (currently £325,000). To access the unlimited exemption, a non-UK domiciled spouse/civil partner can elect to be treated as UK domiciled for IHT purposes. That election has consequences: it can bring the electing spouse’s worldwide assets within the UK IHT net (subject to deemed domicile rules) and has time-bound rules governing effectiveness while UK resident.

A common pitfall is overlooking the recipient’s domicile. If a UK-domiciled transferor leaves substantial assets to a non-domiciled spouse on death, only £325,000 is exempt unless the election is in place; the balance may need to be covered by the transferor’s nil-rate band or other planning.

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 unless an election is made.

Gifts to Charities and Political Parties

Gifts to UK-registered charities are exempt from IHT, whether made during lifetime or on death. The same exemption applies to gifts to qualifying political parties and certain national institutions. In addition to the exemption, note a related rate reduction: if at least 10% of the net baseline amount of an estate is left to charity on death, the IHT rate on the taxable portion of the estate may reduce from 40% to 36%. That reduced rate is not an exemption but can materially affect the final liability when the charitable bequest threshold is met.

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

Key Term: political party exemption
An exemption for gifts to parties meeting statutory representation/vote-share thresholds; applies to 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, and must be used after the current year’s allowance (maximum £6,000 in one tax year if none used previously). The annual exemption applies to the earliest gifts made in the tax year and reduces those transfers before any PET (potentially exempt transfer) is established. It can be used alongside the marriage/civil partnership exemption for the same donee to cover any excess, but it cannot be combined with the small gifts exemption for the same recipient in the same tax year.

Practical points:

• use the current year’s £3,000 before any carry-forward from the previous year
• apply the exemption to the first gifts chronologically
• the small gifts exemption does not apply where the same recipient benefits from the annual exemption in that 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 (current year’s must be used first).

Small Gifts Exemption

Unlimited gifts of up to £250 per recipient per tax year are exempt from IHT, provided that recipient does not also benefit from the annual exemption (or other lifetime exemption) in the same tax year. The small gifts exemption cannot cover any amount above £250: if the gift exceeds £250, none of that specific gift qualifies under this exemption, though the annual exemption may be available.

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 in the same tax year.

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. The tests are cumulative:

• the gift must be part of a pattern of normal expenditure (regularity is important; a single gift may qualify if it forms part of an established arrangement or a demonstrable intention to make repeated gifts)
• it must be made out of income (assessed net of tax and after usual living expenses)
• the donor must retain sufficient income to maintain their normal lifestyle

Good evidence matters. Donors should keep records showing income levels, living costs, and the regular gifts (e.g. standing orders for family support or premiums on life policies for another’s benefit). If the donor’s income varies, the pattern and intention can still be established provided the core conditions are met and the gifts are not drawn from capital.

Key Term: normal expenditure out of income exemption
An exemption for regular gifts made out of income, provided they form part of normal expenditure and 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

The gift must be made in consideration of the marriage/civil partnership and should be conditional upon it taking place (typically before or on the date; late gifts given very long after the ceremony may not qualify unless clearly arranged in connection with it). These limits apply per donor per recipient and can be combined with the annual exemption to cover any excess.

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, education, or care of a spouse, civil partner, child under 18 (or over 18 while in full-time education or training), or dependent relative are generally exempt, provided they are reasonable in amount and purpose. Typical examples include school fees paid by a parent, support for a dependent relative’s living costs, or maintenance payments between spouses. The exemption applies to amounts that meet genuine maintenance/education needs; excessive or capital-augmenting transfers fall outside it.

Key Term: family maintenance exemption
An exemption for gifts made for the maintenance, education, or care of a spouse, civil partner, child (with conditions), 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, key conditions include:

• the business must be a trading business (i.e. not mainly investing in securities, land, or letting activities)

• the relevant property must have been owned for at least two years before the transfer, or be replacement property with combined ownership of two years

• no binding contract for sale should exist at the time of transfer

• excepted assets (assets not required for the business, e.g. surplus cash or investments held in the company) do not attract BPR

• 100% relief applies to:

  • a business or interest in a business (including a partnership interest)
  • shares in an unlisted trading company

• 50% relief applies to:

  • shares in a quoted trading company if the transferor had voting control (over 50% of votes on all resolutions)
  • land, buildings, machinery or plant owned by the transferor personally but used for business purposes by a partnership in which the transferor is a partner, or by a company controlled by the transferor

Ownership tests look at the transferor’s period of ownership; on death, BPR is assessed at the point of transfer. In lifetime planning, watch the withdrawal rules: where BPR was claimed on a lifetime transfer and the transferor dies within seven years, BPR may be withdrawn unless the transferee still owns the business property at the date of the transferor’s death (or, if earlier, their own death). Relief is not available for businesses mainly carrying on investment activities (e.g. property investment/letting companies).

Key Term: business property relief (BPR)
A relief reducing the value of qualifying business assets for IHT by 100% or 50%, subject to trading status, ownership period, control and excepted asset conditions.

Agricultural Property Relief (APR)

APR reduces the agricultural value of qualifying agricultural property for IHT purposes by 100% or 50%. Agricultural value is the value of the property assuming a perpetual covenant restricting use to agriculture; this may be lower than market value where there is development potential. The relief applies to farmland, farm buildings, and in appropriate cases farmhouses occupied for agricultural purposes and of a character appropriate to the property.

Ownership and occupation conditions:

• 100% relief typically applies where the transferor had the right to vacant possession (e.g. owner-occupied) or the property was let on a qualifying tenancy (commencing on or after 1 September 1995)
• 50% relief applies in other cases (e.g. older tenancies without vacant possession rights)

In addition, either:

• the property must have been owned and occupied for agricultural purposes by the transferor for at least two years; or
• owned by the transferor for at least seven years and occupied throughout that period for agricultural purposes by them or by another

APR focuses on agricultural use. Non-agricultural elements embedded in a farm’s value (e.g. development uplift) do not attract APR, although BPR may be available for some business-use components if conditions are met.

Key Term: agricultural property relief (APR)
A relief reducing the agricultural 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. A practical approach is:

• identify the transfer (on death, deemed transfer of the estate; in lifetime, any disposition reducing the donor’s estate)
• value the property transferred (open market value; for lifetime gifts, the loss to the donor’s estate)
• apply general exemptions first (spouse/civil partner; charity/political party)
• apply reliefs (BPR and APR) to reduce the value transferred
• apply lifetime-only exemptions where relevant (annual, small gifts, marriage, normal expenditure out of income, maintenance)
• calculate tax after nil-rate band and any rate reductions (e.g. 36% rate where charitable giving threshold is met)

Remember:

• the annual exemption reduces the earliest gifts in the tax year; carrying forward is one year only
• the small gifts exemption cannot be used for a recipient who also benefits from the annual or marriage exemption in the same tax year
• normal expenditure out of income requires a pattern and retention of sufficient income for the donor’s lifestyle
• in lifetime BPR transfers, check withdrawal if the donor dies within seven years and the transferee no longer owns the property

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.

Worked Example 1.4

A UK-domiciled transferor dies leaving £800,000 to a non-UK domiciled spouse and £50,000 to a qualifying charity. No election to be treated as UK domiciled has been made by the spouse. How do the exemptions operate?

Answer:
The charity gift is fully exempt. The spouse exemption is capped at £325,000 for transfers to a non-UK domiciled spouse. Therefore, £325,000 is exempt and the remaining £475,000 is potentially chargeable. The deceased’s nil-rate band can cover up to £325,000 of that remainder; any balance above the nil-rate band is liable at the applicable rate (subject to any further planning).

Worked Example 1.5

In May, a donor gives £200 each to 10 different friends, and in October gives £500 to one of those same friends. How do the lifetime exemptions apply?

Answer:
The £200 gifts to each friend qualify under the small gifts exemption. The later £500 gift to the same friend exceeds £250, so that specific £500 gift cannot use the small gifts exemption. The annual exemption can be applied to the £500 (subject to availability), but note that once a recipient benefits from the annual exemption in that tax year, further small gifts to that recipient in the same year would not be exempt under the small gifts exemption.

Worked Example 1.6

A donor sets up a standing order of £400 per month to a child at university, funded entirely from surplus income. The donor’s net income after living costs exceeds the monthly transfers by a comfortable margin. Does the normal expenditure out of income exemption apply?

Answer:
Yes, provided the payments form part of the donor’s normal expenditure, are made out of income (not capital), and the donor retains sufficient income to maintain their usual standard of living. The regular standing order evidences normality; the donor’s surplus income and maintained lifestyle evidence the other tests.

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.

Additional pitfalls to watch:

• small gifts exemption cannot be combined with the annual exemption for the same recipient in the same tax year
• normal expenditure out of income requires a demonstrable pattern and must be out of income, not capital
• BPR is not available for investment businesses; check for excepted assets within trading companies

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. For normal expenditure out of income, keep a simple schedule of income, living costs, and regular gifts to evidence the exemption.

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 unless a deemed domicile election is made.
• Gifts to UK-registered charities and to qualifying political parties are exempt from IHT; charitable giving of at least 10% of the net baseline on death can reduce the IHT rate to 36% (rate reduction, not an exemption).
• The annual exemption (£3,000 per year) and small gifts exemption (£250 per recipient) apply only to lifetime gifts; the small gifts exemption cannot be used for a recipient who also benefits from another lifetime exemption in the same tax year.
• The normal expenditure out of income exemption applies to regular gifts made out of surplus income, provided the donor retains sufficient income to maintain their usual standard of living.
• Marriage/civil partnership exemption applies to gifts made on marriage or civil partnership, with limits depending on the donor’s relationship to the recipient; it can be combined with the annual exemption.
• Family maintenance payments are exempt if reasonable in amount and purpose, covering spouses/civil partners, children (with conditions), and dependent relatives.
• Business property relief (BPR) and agricultural property relief (APR) reduce the value of qualifying assets for IHT, subject to strict conditions, ownership periods, use tests, and excepted asset rules.
• Exemptions and reliefs can be combined and must be applied in the correct order to reduce or eliminate IHT in practical scenarios; check withdrawal of BPR on lifetime transfers if the donor dies within seven years and the transferee has disposed of the property.

Key Terms and Concepts

• spouse/civil partner exemption
• charity exemption
• political party 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)