Inheritance tax - Eligibility criteria

Learning Outcomes

This article outlines inheritance tax eligibility and key reliefs relevant to SQE1, including:

• Nil-rate band and residence nil-rate band (RNRB), transferred allowances, and tapering
• Lifetime transfers: potentially exempt transfers (PETs) and chargeable lifetime transfers (CLTs)
• The seven-year rule, taper relief, and the 14-year interaction affecting the nil-rate band on failed PETs
• Gifts with reservation of benefit (GWR) and anti-avoidance treatment
• Main exemptions: spouse/civil partner, charity, annual and small gifts, marriage/civil partnership, and normal expenditure out of income
• Business property relief (BPR) conditions: qualifying property, trading status, control, excepted assets, two-year ownership, replacement property, and the binding contract for sale rule
• BPR rates and application to personally owned assets used by controlled companies or partnerships
• Agricultural property relief (APR): scope, agricultural value, occupation requirements, and interaction with BPR
• Domicile, deemed domicile, and excluded property rules
• Interaction between inheritance tax and capital gains tax (CGT), including hold-over relief
• Trading versus investment business classification and excepted assets
• Common traps and basic planning considerations for typical SQE1 scenarios

SQE1 Syllabus

For SQE1, you are required to understand inheritance tax eligibility criteria and the application of key exemptions and reliefs (including BPR and APR), with a focus on the following syllabus points:

• The circumstances in which IHT is chargeable on death and on lifetime transfers.
• The operation and calculation of the nil-rate band and residence nil-rate band.
• The eligibility requirements for business property relief (BPR) and agricultural property relief (APR).
• The types of property and businesses that qualify for relief.
• The effect of lifetime gifts and the seven-year rule.
• The interaction between IHT and other taxes (e.g., capital gains tax).
• The main exemptions and reliefs available for business and agricultural assets.
• The spouse/civil partner exemption, charity exemption, and the reduced 36% rate where at least 10% of the baseline amount passes to charity.
• PETs versus CLTs, including the immediate 20% lifetime charge on CLTs above the nil-rate band and subsequent charges on death within seven years.
• Taper relief and the 14-year interaction where earlier CLTs affect the NRB available to later PETs on death.
• Gifts with reservation of benefit and the effect on the taxable estate.
• Domicile and deemed domicile for IHT, and excluded property rules.
• BPR conditions: trading status, control, excepted assets, two-year ownership, replacement property, and the binding contract for sale rule.
• APR scope, agricultural value, occupation requirements, and interaction with BPR.
• Trusts and relevant property: how CLTs to discretionary trusts are assessed, and application of reliefs to trust assets.

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 current nil-rate band for inheritance tax, and how does it apply to spouses or civil partners?
2. Which of the following assets may qualify for 100% business property relief? a) Shares in a quoted investment company b) Shares in an unquoted trading company c) A buy-to-let residential property d) An interest in a partnership carrying on a trading business
3. True or false? A binding contract for the sale of a business will prevent business property relief from applying.
4. How long must a person have owned a business asset before it can qualify for business property relief?

Introduction

Inheritance tax (IHT) is a tax charged on the value of a person's estate when they die, and in some cases on certain gifts made during their lifetime. The eligibility criteria for IHT and the main reliefs—especially business property relief (BPR)—are essential for SQE1. This article explains the main rules, key terms, and common scenarios you may encounter in the exam. In assessing IHT, consider the composition of the estate, applicable exemptions and reliefs, the donor’s domicile status, and the timing of lifetime transfers. Reliefs such as BPR and APR can significantly reduce exposure where qualifying business or agricultural assets are involved, while the nil-rate band and residence nil-rate band determine how much of an estate can pass free of IHT.

Key Term: inheritance tax (IHT)
A tax charged on the value of a person's estate on death, and on certain lifetime transfers, subject to exemptions and reliefs.

Inheritance Tax: Basic Eligibility

IHT is generally payable on the value of a deceased person's estate above a certain threshold, known as the nil-rate band. It may also apply to certain gifts made during a person's lifetime, depending on the timing and nature of the gift. A UK-domiciled (or deemed domiciled) individual is liable on worldwide assets; a non-UK domiciled individual is generally subject to IHT only on UK assets, with specific rules for excluded property. Transfers can be exempt (e.g., to a UK-domiciled spouse or charity), PETs (which become chargeable if the donor dies within seven years), or CLTs (which are immediately chargeable in lifetime if above the nil-rate band).

Key Term: domicile
A common law concept determining IHT scope: UK-domiciled (or deemed domiciled) individuals are taxed on worldwide assets; non-UK domiciled individuals are generally taxed only on UK assets.

Key Term: deemed domicile
For IHT, a person may be treated as UK domiciled if they meet statutory residence thresholds or have been UK resident for a sufficient number of tax years (e.g., long-term UK residency), bringing worldwide assets into IHT.

Key Term: excluded property
Property excluded from IHT, such as non-UK assets owned by individuals who are not UK domiciled, and certain trust property where the settlor was not UK domiciled when the trust was created.

The estate on death includes assets owned by the deceased and certain property treated as part of the estate under anti-avoidance rules (for example, gifts with reservation of benefit). Personal representatives are responsible for reporting and paying IHT, and the mainstream death rate is 40%, potentially reduced to 36% where a sufficient charitable legacy is made.

The Nil-Rate Band

The nil-rate band is the threshold up to which no IHT is charged. The standard nil-rate band is currently £325,000 per individual. Any value above this threshold is usually taxed at 40% on death. The NRB is used in priority against lifetime transfers made within seven years of death before being applied to the death estate.

Key Term: nil-rate band
The amount of an estate that is not subject to IHT, currently set at £325,000 per person.

The nil-rate band is shared across lifetime and death transfers on a cumulative basis. PETs do not use the nil-rate band at the time of the gift; instead, if the donor dies within seven years, PETs are brought into the calculation and the NRB is set against those failed PETs first. CLTs use the NRB at the time they are made (with immediate lifetime charges if above the NRB). Earlier CLTs within the seven years before a PET can reduce the NRB available to that PET on death—this 14-year interaction is a frequent trap.

Transferable Nil-Rate Band

If a person leaves their estate to their spouse or civil partner, any unused nil-rate band can be transferred to the survivor, potentially doubling the threshold to £650,000. The transferred portion is calculated as a percentage of the NRB unused on the first death and applied to the NRB in force at the time of the second death. The personal representatives of the second spouse must claim this transfer with evidence of the first spouse’s estate value and allowances used.

Residence Nil-Rate Band

An additional residence nil-rate band may apply if a main residence is left to direct descendants (children, grandchildren, etc.). This allowance is currently up to £175,000, but is tapered for estates exceeding £2 million. RNRB can be transferred between spouses in a similar percentage manner, and a downsizing addition may preserve RNRB where the deceased sold or downsized the main residence and left the proceeds to direct descendants.

Key Term: residence nil-rate band
An extra IHT allowance for estates passing a main residence to direct descendants, subject to tapering for large estates.

The RNRB applies only to a qualifying residential interest, typically a property that has been the deceased’s residence. Certain trusts (e.g., immediate post-death interest trusts for descendants) may be eligible for RNRB. The allowance tapers by £1 for every £2 that the estate exceeds £2 million. Administration requires careful identification of qualifying descendants and property interests, and claims must be supported by valuation and estate composition evidence.

Key Term: downsizing addition
An addition that preserves some or all of the RNRB where a person sold, gifted, or downsized their residence and leaves equivalent assets to direct descendants.

Lifetime Gifts and the Seven-Year Rule

Certain gifts made during a person's lifetime may be subject to IHT if the donor dies within seven years of making the gift. These are known as potentially exempt transfers (PETs). If the donor survives seven years, the gift is exempt from IHT. Transfers to individuals (other than spouse/civil partner) are commonly PETs; transfers into most trusts are CLTs and may be immediately chargeable.

Key Term: potentially exempt transfer (PET)
A lifetime gift that is exempt from IHT if the donor survives seven years from the date of the gift.

Key Term: chargeable lifetime transfer (CLT)
A lifetime gift that is immediately chargeable to IHT (usually transfers to discretionary or other relevant property trusts); taxed at 20% above the NRB, with further tax payable if the donor dies within seven years.

If the donor dies within seven years, taper relief may reduce the tax on the gift depending on how long the donor survived after making it. Taper relief does not reduce the value of the gift; it reduces the tax payable on the failed PET or CLT.

Key Term: taper relief
A reduction in the IHT payable on lifetime gifts that become chargeable on death, applicable where the donor dies between three and seven years after the gift; relief increases over time.

CLTs in the seven years before a PET can reduce the nil-rate band available to that PET on death, even if the CLT was made more than seven years before death. This can result in unexpected tax on a failed PET and is often examined.

Exemptions include the annual exemption (£3,000 per tax year, with one year carry-forward), the small gifts exemption (£250 per donee per tax year), marriage/civil partnership gifts (up to £5,000 from a parent, £2,500 from a grandparent, and £1,000 from others), and gifts to charities or political parties. Regular gifts out of surplus income can also be exempt if criteria are met.

Key Term: normal expenditure out of income
An IHT exemption for habitual gifts made from surplus income, where the gifts form part of normal expenditure and do not reduce the donor’s standard of living.

Anti-avoidance rules bring certain gifted property back into the death estate where the donor retains benefits.

Key Term: gift with reservation of benefit (GWR)
A gift where the donor retains enjoyment or benefit (e.g., giving away a home but continuing to live there rent-free); the property is treated as part of the donor’s estate for IHT.

A reduced IHT rate of 36% applies where at least 10% of the net baseline amount is left to charity. This requires a specific calculation and can significantly reduce IHT on the remainder of the estate.

Business Property Relief (BPR): Eligibility Criteria

Business property relief is a key relief that can reduce or eliminate IHT on the transfer of qualifying business assets, either on death or on certain lifetime gifts. It is designed to allow businesses to pass between generations without an IHT charge leading to forced sales.

Key Term: business property relief (BPR)
A relief from IHT that reduces the value of qualifying business assets for IHT purposes, often by 100% or 50%.

Qualifying Conditions for BPR

To qualify for BPR, the following main conditions must be met:

• The asset must be relevant business property (see below).
• The deceased (or donor) must have owned the asset for at least two years before the transfer.
• The business must be a trading business, not mainly an investment business.
• There must be no binding contract for sale at the time of transfer.

Key Term: relevant business property
Assets that may qualify for BPR, including shares in unquoted trading companies, interests in partnerships, and certain business assets.

In addition, BPR is not available on the value of excepted assets within a business.

Key Term: excepted assets
Assets held within a business or company not used wholly or mainly for the purposes of the business (e.g., surplus cash or investments). The portion of value attributable to excepted assets does not qualify for BPR.

Where qualifying property has been replaced by other qualifying property, ownership periods can be aggregated, preserving eligibility.

Key Term: replacement property
New qualifying business property that replaces other qualifying property; ownership periods may be added together for the two-year requirement.

Levels of Relief

• 100% BPR applies to:
  • A business or interest in a business (e.g., sole trader or partnership interest).
  • Shares in an unquoted trading company (including AIM-listed companies).
  • Shares in a holding company of a trading group (where the group is mainly trading).
• 50% BPR applies to:
  • Shares in a quoted company where the transferor had control.
  • Land, buildings, or plant and machinery used in the business but owned personally and used by a company or partnership controlled by the transferor.

Key Term: control
For BPR on quoted shares, generally a holding conferring more than 50% of voting rights or the ability to control company decisions; factual control is assessed by voting power and constitutional rights.

Where personally owned assets are used by a company or partnership, BPR is limited to 50% if the transferor controls the company or is a partner. Note that the availability of BPR may be reduced if the asset is only partly used for business or if the rent charged is not at arm’s length in certain contexts; however, personal ownership and business use are the key criteria.

Trading Requirement

The business must be wholly or mainly trading (i.e., more than 50% of its activities are trading, not investment). This assessment considers factors such as the nature of assets, income sources, employee time, and the overall purpose of the business. A property investment company or a company dealing mainly in securities or land as investments will not qualify. Mixed businesses require careful analysis; where the trading activity predominates, BPR may be available.

Key Term: trading business
A business whose main activity is trading goods or services, not holding investments.

Ownership Period

The asset must have been owned for at least two years before the transfer (death or gift). Ownership can include periods where property was held through a succession of qualifying assets (replacement property). If assets were received on the death of a spouse and held until the second death, the deceased’s period may be aggregated to meet the requirement.

Binding Contract for Sale

If there is a binding contract for sale of the business or shares at the time of transfer, BPR will not apply. Offers, heads of terms, or options to buy or sell (e.g., cross-option arrangements in shareholder agreements) typically are not binding contracts for sale and so do not disqualify BPR. The key is whether the parties are legally committed to sell at the relevant time.

Excluded Assets

BPR does not apply to:

• Businesses or shares dealing mainly in securities, stocks, land, or buildings as investments.
• Assets not used in the business in the two years before transfer (excepted assets).
• Assets subject to a binding contract for sale.

Companies that hold substantial non-business assets (e.g., surplus cash) may see the BPR restricted to the portion attributable to the trading business. For group structures, the qualifying status of the group as a whole must be trading, not investment-led.

Lifetime Transfers and BPR

BPR can apply to lifetime gifts of business assets. For CLTs (e.g., transfers to discretionary trusts), BPR reduces the value chargeable in lifetime, potentially removing the immediate IHT charge. For PETs to individuals, BPR is relevant only if the donor dies within seven years: the asset must still qualify and generally still be owned by the recipient or replaced with qualifying property, otherwise the relief may be lost. Where the donee sells the asset before the donor’s death and does not replace it with qualifying property, BPR is likely unavailable for the failed PET.

Interaction with Agricultural Property Relief (APR)

Agricultural property relief (APR) may apply to agricultural land and buildings. APR and BPR can sometimes be claimed together, but APR is claimed first. Where APR covers the agricultural value, BPR may apply to any excess value attributable to business use (e.g., a farmhouse used for agricultural activity) provided the business is trading and other conditions are met. APR rates can be 100% or 50% depending on occupation and tenure; occupation requirements are critical, and only the agricultural value is relieved.

Key Term: agricultural property relief (APR)
A relief from IHT for agricultural land and buildings, reducing their value for IHT purposes.

Where business assets are transferred in lifetime, consider CGT implications. Hold-over relief can be used to defer gains on gifts of qualifying business assets, aligning CGT and IHT planning.

Key Term: hold-over relief
A capital gains tax relief allowing deferral of gains on certain gifts of business assets.

Worked Example 1.1

Worked Example 1.1

Aisha owns 80% of the shares in an unquoted trading company and has held them for five years. She dies, leaving the shares to her daughter. The company is not an investment company. Will business property relief apply to reduce the inheritance tax on the shares?

Answer:
Yes. The shares are in an unquoted trading company, Aisha owned them for more than two years, and there is no binding contract for sale. 100% business property relief will apply, so the shares will be exempt from IHT.

Worked Example 1.2

Worked Example 1.2

Ben owns a commercial property personally and rents it to his own trading company. He has owned the property for three years. On his death, can business property relief apply to the property?

Answer:
Yes, provided the company is a trading company and Ben controls it. The property is used in the business and owned for more than two years. 50% business property relief may apply.

Worked Example 1.3

Worked Example 1.3

Clara gives her partnership interest in a trading business to her son. She survives for ten years after the gift. What is the IHT position?

Answer:
The gift is a potentially exempt transfer. As Clara survives seven years, the gift is exempt from IHT. Business property relief would have applied if she had died within seven years, provided the partnership interest still qualified at her death.

Worked Example 1.4

Worked Example 1.4

Dylan dies with an estate worth £2.4 million, including a main residence worth £500,000 that he leaves to his granddaughter. He had previously left everything to his spouse, who has since died and did not use any RNRB. What RNRB is available and how does tapering apply?

Answer:
The maximum RNRB is £175,000, and Dylan can also claim the transferred RNRB from his late spouse, making the potential RNRB £350,000. However, tapering applies since the estate exceeds £2 million. The excess is £400,000, so the taper reduces the RNRB by £200,000 (£1 for every £2 above the threshold), leaving £150,000 available (350,000 – 200,000). The residence left to a direct descendant qualifies up to that amount.

Worked Example 1.5

Worked Example 1.5

Emma made a CLT of £200,000 to a discretionary trust eight years before death and a PET of £300,000 to her son four years before death. How is IHT calculated on the failed PET?

Answer:
The CLT (eight years before death) falls outside the seven-year window for charge on death, but it was made within seven years before the PET. Therefore, it reduces the nil-rate band available to the PET when Emma dies. The PET of £300,000 fails, and the NRB (£325,000) is first reduced by the earlier CLT £200,000, leaving £125,000 NRB to set against the PET. The chargeable amount is £175,000 (£300,000 – £125,000). Taper relief applies to the failed PET at 4–5 years (40% reduction of the tax on the gift), but remember taper relief reduces the tax, not the gift value.

Worked Example 1.6

Worked Example 1.6

Farah gifts her home to her adult son but continues to live there rent-free. She dies six years later. Does the gift reduce her IHT estate?

Answer:
No. This is a gift with reservation of benefit (GWR). Farah retained enjoyment of the property, so it is treated as part of her estate on death for IHT. The seven-year rule does not make the gift effective while the reservation continues.

Worked Example 1.7

Worked Example 1.7

Gareth owns 60% of the shares in a quoted trading company. He dies, leaving the shares to his spouse. The company holds substantial surplus cash not needed for its trade. What BPR applies?

Answer:
The controlling holding in a quoted trading company can attract 50% BPR. However, BPR does not apply to the portion of value attributable to excepted assets (e.g., surplus cash not used mainly for the business). The share value must be apportioned, and BPR applies only to the non-excepted portion. The spouse exemption will in any case remove the IHT charge on this transfer, but BPR analysis is relevant for future planning.

Worked Example 1.8

Worked Example 1.8

Hannah owns a working farm including agricultural land, buildings, and a farmhouse. She leaves the farm to her son who actively farms the land. How do APR and BPR interact?

Answer:
APR is claimed first on the agricultural value of the land and agricultural buildings, potentially at 100% if occupation and tenure conditions are met. The farmhouse may attract APR where it is of a character appropriate to the agricultural land and occupied for agricultural purposes. Any value in excess of agricultural value that relates to trading business use may be covered by BPR if the farm is a trading business and other conditions are satisfied.

Exam Warning

Exam Warning For SQE1, be careful to distinguish between trading businesses (which may qualify for BPR) and investment businesses (which do not). Also, remember that a binding contract for sale will prevent BPR from applying. Do not confuse taper relief with a reduction in the value of gifts: taper relief reduces the tax on failed PETs/CLTs, not the gift value. Watch the 14-year interaction where an earlier CLT reduces the nil-rate band available to a later PET on death. Gifts with reservation of benefit are treated as part of the estate—survival for seven years does not help if the reservation continues.

Revision Tip

Revision Tip When answering SQE1 questions, always check the two-year ownership rule and whether the business is mainly trading. Watch for mixed-use businesses and ensure you apply the correct percentage relief. For RNRB, identify direct descendants, the qualifying residential interest, and apply the taper correctly. In lifetime transfers, classify gifts accurately as PETs or CLTs, apply the annual and small gifts exemptions, consider the normal expenditure out of income exemption, and check for GWR. For CLTs to trusts, factor in immediate lifetime charges and the potential additional tax if death occurs within seven years. Align IHT planning with CGT using hold-over relief where available.

Key Point Checklist

This article has covered the following key knowledge points:

• The nil-rate band is the threshold up to which no IHT is charged; currently £325,000 per person.
• The residence nil-rate band may provide an additional allowance for passing a main residence to direct descendants; it tapers for estates over £2 million and can be transferred and preserved via the downsizing addition.
• Transfers are exempt (e.g., to spouse/civil partner or charity), PETs, or CLTs; PETs are free if the donor survives seven years, and CLTs may be immediately chargeable.
• Taper relief reduces tax on failed PETs/CLTs where death is between three and seven years after the gift; it does not reduce gift value.
• A 36% IHT rate can apply if at least 10% of the baseline amount is left to charity.
• Gifts out of normal expenditure from surplus income can be exempt if habitual and do not reduce the donor’s standard of living.
• Gifts with reservation of benefit are treated as part of the donor’s estate on death.
• Business property relief (BPR) can reduce or eliminate IHT on qualifying business assets; excepted assets are excluded from relief.
• To qualify for BPR, the business must be mainly trading, the asset must be owned for at least two years (aggregating replacement property periods where relevant), and there must be no binding contract for sale.
• BPR applies at 100% or 50% depending on the type of asset and whether the transferor has control in a quoted company; personally owned assets used by a controlled company or partnership can attract 50% BPR.
• Agricultural property relief (APR) may also apply to agricultural land and buildings; APR is claimed first, with BPR potentially covering excess value attributable to business use.
• Lifetime gifts of business assets may qualify for BPR if conditions are met and the asset still qualifies at death where the donor dies within seven years; hold-over relief can defer CGT on qualifying gifts.
• Domicile and deemed domicile determine the extent of IHT; excluded property rules remove non-UK assets of non-domiciled individuals from IHT.

Key Terms and Concepts

• inheritance tax (IHT)
• nil-rate band
• residence nil-rate band
• downsizing addition
• potentially exempt transfer (PET)
• chargeable lifetime transfer (CLT)
• taper relief
• gift with reservation of benefit (GWR)
• business property relief (BPR)
• relevant business property
• trading business
• control
• excepted assets
• replacement property
• agricultural property relief (APR)
• hold-over relief
• domicile
• deemed domicile
• excluded property
• normal expenditure out of income