Learning Outcomes
After studying this article, you will be able to explain how inheritance tax applies to lifetime transfers and transfers on death, including how assets are valued, what constitutes a transfer of value, and how exemptions and reliefs affect tax liability. You will be able to apply these rules to practical scenarios, identify common pitfalls, and answer SQE1-style questions on this topic.
SQE1 Syllabus
For SQE1, you are required to understand inheritance tax on lifetime transfers and on death, with a focus on valuation and transfer of value. In your revision, pay particular attention to:
- the principles for valuing assets for inheritance tax purposes (including open market value, joint ownership, and shareholdings)
- the definition and calculation of a transfer of value
- how lifetime transfers (PETs and CLTs) and transfers on death are treated for IHT
- the aggregation of transfers and the effect of previous gifts
- the main exemptions and reliefs relevant to valuation and transfer of value
- the impact of anti-avoidance rules on valuation and transfer calculations
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.
- What is the statutory basis for valuing assets for inheritance tax purposes?
- How is the value of a minority shareholding in a private company determined for IHT?
- What is a transfer of value, and how is it calculated for lifetime gifts?
- How are previous lifetime transfers taken into account when calculating IHT on death?
- Name two key exemptions or reliefs that can affect the value transferred for IHT.
Introduction
Inheritance tax (IHT) applies to both lifetime transfers and transfers on death. For SQE1, you must understand how assets are valued for IHT, what constitutes a transfer of value, and how the rules differ for various types of transfers. Correct application of these principles is essential for calculating IHT liability and advising clients on estate planning.
Valuation Principles for Inheritance Tax
The starting point for IHT is to determine the value of the property transferred. The law sets out clear rules for this process.
Key Term: open market value The price an asset might reasonably be expected to fetch if sold on the open market at the relevant time, ignoring any forced sale or special purchaser.
Statutory Valuation Rule
Section 160 of the Inheritance Tax Act 1984 (IHTA 1984) requires all property to be valued at its open market value at the time of the transfer. This means the price a willing buyer would pay to a willing seller, with neither under compulsion, and with full knowledge of the relevant facts.
Jointly Owned Assets
Where property is owned jointly, the value of a fractional interest may be discounted to reflect the difficulty of selling a part interest. For residential property, a discount of 10–15% is commonly accepted for minority holdings, but this is a question of fact in each case.
Key Term: joint tenancy A form of co-ownership where each owner has an equal, undivided share, and the interest passes automatically to the survivor(s) on death.
Key Term: tenancy in common A form of co-ownership where each owner has a distinct share, which can be unequal and is passed by will or intestacy.
Related Property Rules
Where the transferor or their spouse/civil partner owns related property, the value of the asset may be increased to reflect the enhanced value of combined ownership. This prevents undervaluation through artificial fragmentation of ownership.
Key Term: related property Property owned by the transferor and their spouse/civil partner (or certain charities or companies) that, when combined, increases the value of the asset for IHT purposes.
Valuing Shares
The valuation of shares depends on whether they are quoted or unquoted.
- Quoted shares: Valued at the price they might fetch on the Stock Exchange at the relevant date, usually using the quoted price plus one-quarter of the bid-ask spread.
- Unquoted shares: More complex; factors include net assets, earnings, dividend capacity, and any restrictions on transfer. Minority holdings are often discounted for lack of control and marketability.
Special Valuation Issues
- Restrictions on sale are generally ignored for valuation purposes, but the effect of such restrictions on price is considered.
- If a special purchaser would pay more for the asset, this is taken into account.
- For jointly owned land, the value of a share may be discounted, but not if related property rules apply.
Debts and Liabilities
Debts incurred for full consideration are deductible from the value of the estate, but certain anti-avoidance rules restrict deductions where the debt is linked to excluded property or relievable property.
Transfer of Value: Lifetime and Death Transfers
IHT is charged on the value transferred by a chargeable transfer. The rules differ for lifetime gifts and transfers on death.
Key Term: transfer of value Any disposition that reduces the value of the transferor’s estate, measured by the difference in value before and after the transfer.
Lifetime Transfers
There are two main types of lifetime transfers:
- Potentially Exempt Transfers (PETs): Gifts to individuals that are exempt if the donor survives seven years. If the donor dies within seven years, the value of the gift is aggregated with the death estate.
- Chargeable Lifetime Transfers (CLTs): Transfers into most trusts or companies, immediately chargeable if they exceed the nil-rate band. The lifetime rate is 20%.
Key Term: potentially exempt transfer (PET) A lifetime gift to an individual that is exempt from IHT if the donor survives seven years, but becomes chargeable if the donor dies within that period.
Key Term: chargeable lifetime transfer (CLT) A lifetime gift (usually to a trust or company) that is immediately chargeable to IHT if it exceeds the nil-rate band.
Transfers on Death
On death, IHT is charged at 40% on the value of the estate above the nil-rate band, after deducting exemptions and reliefs. Previous lifetime transfers within seven years are aggregated with the death estate, and the nil-rate band is applied to the earliest transfer first.
Aggregation and Grossing Up
When calculating IHT on death, all chargeable transfers in the seven years before death are aggregated. If the estate bears the burden of IHT on a specific gift, the tax must be grossed up to reflect the true value passing to the beneficiary.
Exemptions and Reliefs Affecting Value
Several exemptions and reliefs can reduce the value transferred for IHT:
- Spouse or civil partner exemption: Transfers between spouses/civil partners are exempt if both are UK domiciled.
- Annual exemption: Up to £3,000 per tax year can be given away free of IHT.
- Small gifts exemption: Gifts of up to £250 per person per year are exempt.
- Normal expenditure out of income: Regular gifts out of income, not affecting the donor’s standard of living, are exempt.
- Business property relief (BPR): Up to 100% relief on qualifying business assets.
- Agricultural property relief (APR): Up to 100% relief on qualifying agricultural property.
Worked Example 1.1
Worked Example 1.1
Aisha owns 30% of the shares in a private company, XYZ Ltd. The company’s net assets are valued at £1,000,000. How should Aisha’s shares be valued for IHT if she dies, and what discount might apply?
Answer: The starting point is Aisha’s proportionate share of net assets (£300,000). However, as a minority holding in a private company, a discount (commonly 10–15%) may be applied to reflect lack of control and marketability. If a 15% discount is accepted, the value for IHT would be £255,000.
Worked Example 1.2
Worked Example 1.2
Ben gifts £400,000 to his daughter in June 2017. He dies in August 2022. How is the gift treated for IHT, and what relief may apply?
Answer: The gift is a PET. As Ben died within seven years, the gift is aggregated with his estate for IHT. Taper relief applies as more than five but less than six years have passed, reducing the tax payable on the gift.
Worked Example 1.3
Worked Example 1.3
Clara and her brother jointly own a house worth £500,000 as tenants in common (50% each). Clara dies, leaving her share to her son. What value is used for IHT?
Answer: Clara’s 50% share is valued at open market value, but a discount (typically 10–15%) may be applied to reflect the difficulty of selling a half share. If a 10% discount is accepted, her share is valued at £225,000 for IHT.
Exam Warning
For SQE1, be careful to distinguish between the value of an asset for IHT and its value for other taxes. Always apply the statutory open market value rule, and consider discounts or related property rules where relevant.
Revision Tip
When revising, practise applying the valuation and transfer of value rules to different types of assets and scenarios. Focus on the statutory wording and the order of calculations.
Key Point Checklist
This article has covered the following key knowledge points:
- The open market value rule is the basis for valuing assets for IHT.
- Jointly owned assets may be discounted for minority interests, unless related property rules apply.
- Shares are valued differently depending on whether they are quoted or unquoted.
- A transfer of value is measured by the reduction in the transferor’s estate.
- PETs and CLTs are the main types of lifetime transfers for IHT.
- Previous lifetime transfers are aggregated with the death estate for IHT.
- Exemptions and reliefs can reduce the value transferred for IHT.
- Anti-avoidance rules may restrict deductions or affect valuation.
Key Terms and Concepts
- open market value
- joint tenancy
- tenancy in common
- related property
- transfer of value
- potentially exempt transfer (PET)
- chargeable lifetime transfer (CLT)
