ACCA Applied Skills · Taxation (UK)

Using Exemptions to Defer and Minimise Inheritance Tax

Inheritance tax is charged on lifetime gifts and on the estate at death. You cut or defer it by using exemptions (spouse, charity, annual, small gifts, marriage), the nil rate band and residence nil rate band, and by making potentially exempt transfers that become tax-free if the donor survives seven years.

What this chapter covers

This chapter pulls together the whole inheritance tax (IHT) toolkit. You start with the lifetime exemptions that remove gifts from charge. You then learn the nil rate band (£325,000) and residence nil rate band (£175,000), and how gifts are classed as potentially exempt transfers (PETs) or chargeable lifetime transfers (CLTs). Taper relief, exempt transfers on death and charitable gifts complete the picture.

The last topic is planning. Here you apply every earlier rule to advise a client how to reduce IHT. A good answer names the exemption, says how much it saves and states the condition attached, such as surviving seven years.

IHT links to other parts of TX-UK. Gifts of assets can also trigger a capital gains tax disposal, so you must watch for both taxes on one gift. It also appears in objective test cases and in a constructed response question, where you calculate tax on a gift or an estate and then advise.

IHT is a regular source of objective test questions and a common topic in the longer written questions. Many of the marks are mechanical: apply the exemption, use the nil rate band, calculate tax at 20% or 40%, then apply taper relief. Because objective test questions are all or nothing, you need exact rules and clean arithmetic. The advice parts reward short, precise points, so this chapter is very worth the effort.

The use of exemptions in deferring and minimising inheritance tax liabilities: topics in the order to study them

1Inheritance Tax Exemptions for Lifetime GiftsStart here because every gift is first tested for exemptions, and you cannot classify a gift until you know what is exempt.
2Nil Rate Band and Residence Nil Rate BandYou need the £325,000 and £175,000 bands before you can calculate any tax on a gift or an estate.
3Potentially Exempt Transfers, Chargeable Lifetime Transfers and Taper ReliefThis is the core calculation topic and it builds on exemptions and the nil rate band, with the seven-year rule and the 20% and 40% rates.
4Exempt Transfers on Death and Charitable GiftsOnce lifetime gifts are clear, you can see what is exempt in the estate, including spouse and charity gifts.
5Inheritance Tax Planning Using Exemptions and ReliefsPlanning comes last because it needs every earlier rule to be applied and compared in an advice answer.

How to prepare The use of exemptions in deferring and minimising inheritance tax liabilities

Learn the rules first, then drill the calculations in a fixed order until you do not have to think about the layout.

List each lifetime exemption with its limit and conditions, and test yourself until you can recite them without notes.
Memorise the nil rate band £325,000, residence nil rate band £175,000, rates of 20% lifetime and 40% death, and the taper table (3-4 years 20%, 4-5 years 40%, 5-6 years 60%, 6-7 years 80%).
Practise one fixed layout for a gift: value transferred, less exemptions, classify as PET or CLT, then add up gifts in the previous seven years to see how much nil rate band is left.
Do lifetime tax and death tax on the same set of gifts. Notice that tax on a CLT may change on death within seven years, and that taper relief reduces tax, not the value of the gift.
Practise the death estate: exempt items first, then nil rate band, residence nil rate band if it applies, then tax at 40%. Check carefully whether the home passes to direct descendants.
Write short planning answers, such as use the annual exemption, make gifts out of income, or leave assets to a spouse or charity. Give the saving and the condition each time.
Finish with timed objective test questions, then a constructed response question that mixes calculation and advice.

Common mistakes in The use of exemptions in deferring and minimising inheritance tax liabilities

Applying taper relief to the value of the gift instead of to the tax.
Fix: Work out the tax first, then reduce that tax by the taper percentage. Remember it only helps if the gift is above the nil rate band.
Forgetting to count gifts in the seven years before a gift when working out the nil rate band left.
Fix: List all chargeable gifts in the previous seven years and deduct them from the nil rate band before taxing the new gift.
Using the annual exemption in the wrong order or against the wrong gift.
Fix: Apply the current year's £3,000 first, then any unused amount from the previous year, to the earliest gift in the year.
Assuming the residence nil rate band always applies.
Fix: Check the home is left to direct descendants and look at the size of the estate, as a large estate can reduce or remove the band. State the conditions in your answer.
Treating all gifts as PETs.
Fix: Check who receives the gift. A gift into a trust is normally a CLT and may mean tax is payable at 20% in lifetime.
Writing vague planning advice with no figures or conditions.
Fix: For each suggestion, name the exemption or relief, give the amount saved and state the condition, such as survival for seven years.

Last-day revision: The use of exemptions in deferring and minimising inheritance tax liabilities

IHT nil rate band is £325,000 and the residence nil rate band is £175,000.
Tax on the excess is 20% on chargeable lifetime transfers and 40% on death.
A PET is only taxed if the donor dies within seven years of the gift.
A gift to an individual is usually a PET, and a gift into most trusts is usually a CLT.
Taper relief applies only after three years: 20%, 40%, 60% and 80% as the gap before death grows.
Taper relief reduces the tax, and only where the gift exceeds the available nil rate band.
Gifts to a spouse or civil partner and to charity are exempt, with no upper limit in the normal case.
The annual exemption is £3,000 and any unused amount can be carried forward for one year only.
Use the current year's annual exemption first, then the carried-forward amount, against the earliest gift.
Marriage gifts are £5,000 from a parent, £2,500 from a grandparent and £1,000 from anyone else.
Small gifts of up to £250 per person per year are exempt, but not to someone who also received the annual exemption.
Gifts made in the seven years before a transfer use up the nil rate band first.

The use of exemptions in deferring and minimising inheritance tax liabilities practice questions

The use of exemptions in deferring and minimising inheritance tax liabilities in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

The use of exemptions in deferring and minimising inheritance tax liabilities: frequently asked questions

What is the difference between a PET and a CLT?

A PET is a gift by an individual to another individual, and it is only taxed if the donor dies within seven years. A CLT is a gift into most trusts, and it is tested against the nil rate band at once, with tax at 20% on the excess. A CLT can also face extra tax at death within seven years.

How does taper relief work in the TX-UK exam?

Taper relief reduces the death tax on a gift made more than three years before death. The reduction is 20% for 3-4 years, 40% for 4-5, 60% for 5-6 and 80% for 6-7 years. It reduces the tax, not the value of the gift, and gifts that fall within the nil rate band have no tax to reduce.

Which IHT rates and bands are given in the exam?

ACCA gives the nil rate band of £325,000, residence nil rate band of £175,000, rates of 20% in lifetime and 40% at death, and the taper table. You must still know the exemptions and their conditions, so learn them rather than hoping to find them in the exam.

Can I carry forward the annual exemption?

Yes, but only unused annual exemption from the previous tax year, and only for one year. You use the current year's exemption first, then the carried-forward amount.