Learning Outcomes
After studying this article, you will be able to explain how inheritance tax (IHT) interacts with capital gains tax (CGT), income tax, and stamp duty land tax (SDLT) in England and Wales. You will understand the tax consequences of lifetime gifts, death, and business property relief, and be able to identify when multiple taxes may apply to the same transaction. This knowledge is essential for SQE1 exam scenarios involving estate planning and tax liabilities.
SQE1 Syllabus
For SQE1, you are required to understand the interaction between inheritance tax and other taxes, and how this affects estate planning, lifetime gifts, and business succession. In your revision, focus on:
- The relationship between inheritance tax and capital gains tax on lifetime gifts and death
- The impact of inheritance tax on income tax during estate administration
- The effect of business property relief on inheritance tax and its practical requirements
- The circumstances where stamp duty land tax may arise in connection with inheritance or related transactions
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 capital gains tax consequence of a lifetime gift of an asset to an individual?
- How does the value of an asset for CGT purposes change when it passes on death?
- When might SDLT be payable in connection with an inheritance?
- What are the main conditions for business property relief to apply for inheritance tax?
Introduction
Inheritance tax (IHT) is a tax on the transfer of wealth, typically arising on death or certain lifetime gifts. However, IHT does not operate in isolation. Its interaction with other taxes—especially capital gains tax (CGT), income tax, and stamp duty land tax (SDLT)—can have significant consequences for individuals, beneficiaries, and personal representatives. Understanding these interactions is essential for effective estate planning and for answering SQE1 questions on tax liabilities arising from gifts, death, and business succession.
Inheritance Tax and Capital Gains Tax
Lifetime Gifts
When an individual makes a lifetime gift of an asset (such as property or shares) to another individual, two taxes may be relevant: IHT and CGT.
Key Term: Potentially Exempt Transfer (PET)
A gift to an individual that is exempt from IHT if the donor survives seven years from the date of the gift.Key Term: Chargeable Lifetime Transfer (CLT)
A transfer of value (such as a gift to most trusts) that may be immediately chargeable to IHT.
For IHT, a gift to an individual is a PET. If the donor survives seven years, no IHT is due. If the donor dies within seven years, the value of the gift may be included in the donor's estate for IHT.
For CGT, a lifetime gift is treated as a disposal at market value. The donor may have to pay CGT on any gain, even if no money is received.
Key Term: Disposal at Market Value
For CGT, a gift is treated as if the donor sold the asset at its current open market value, potentially triggering a CGT liability.
Death
On death, IHT is charged on the value of the deceased's estate. For CGT, death is not a disposal. Instead, assets pass to personal representatives or beneficiaries at their market value at the date of death. This "rebases" the asset for CGT, so any gain during the deceased's lifetime is wiped out.
Key Term: CGT Re-basing on Death
On death, assets are treated as acquired by the estate at their market value at the date of death for CGT purposes.
When the asset is later sold by the estate or beneficiary, CGT is only charged on any increase in value from the date of death to the date of sale.
Worked Example 1.1
A client gifts a second home to her daughter. She bought the property for £100,000; it is now worth £300,000. What are the tax consequences?
Answer: For IHT, the gift is a PET. If the client survives seven years, no IHT is due. For CGT, the client is treated as disposing of the property at £300,000, so a gain of £200,000 may be subject to CGT.
Worked Example 1.2
A client dies owning shares purchased for £10,000, now worth £50,000. The shares are inherited by his son, who sells them a year later for £60,000. What taxes apply?
Answer: For IHT, the shares are valued at £50,000 in the estate. For CGT, the son is treated as acquiring the shares at £50,000. If he sells for £60,000, CGT is due only on the £10,000 gain since death.
Inheritance Tax and Income Tax
Estate Administration
During the administration of an estate, the personal representatives may receive income (such as rent or dividends) from estate assets. This income is subject to income tax, separate from any IHT due on the estate's value at death.
Key Term: Estate Income
Income arising from estate assets after death and before distribution to beneficiaries, taxable under income tax rules.
The personal representatives must account for income tax on this income before distributing the estate.
Specific Asset Types
- Pension Funds: Lump sums from pension funds may be free from IHT if the deceased was under 75, but withdrawals by beneficiaries may be subject to income tax.
- ISAs: Individual Savings Accounts lose their tax-free status on death. The capital value is included in the estate for IHT, and any income generated during administration is taxable.
- Life Insurance: If written in trust, proceeds may be outside the estate for IHT, but income from investing the proceeds may be taxable.
Worked Example 1.3
During estate administration, a rental property generates £5,000 in rent. What taxes apply?
Answer: The rental income is subject to income tax, payable by the personal representatives. The property itself is included in the estate for IHT at its value at death.
Inheritance Tax and Business Property Relief
Business property relief (BPR) can reduce or eliminate IHT on certain business assets, but does not affect CGT or income tax directly.
Key Term: Business Property Relief (BPR)
A relief reducing the value of qualifying business assets for IHT, potentially to nil.
BPR is available at 100% for a business or interest in a business, and for unquoted shares in a trading company. It is available at 50% for certain other assets, such as land or buildings used by a business.
To qualify, the business must be a trading business (not mainly investment), the asset must have been owned for at least two years, and there must be no binding contract for sale.
Worked Example 1.4
A client owns 100% of an unquoted trading company worth £1 million and leaves it to her son. What is the IHT consequence?
Answer: The shares qualify for 100% BPR, so their value is reduced to nil for IHT. No IHT is payable on the transfer.
Stamp Duty Land Tax and Inheritance Tax
SDLT is not charged on assets passing by inheritance on death. However, SDLT may arise in certain situations involving property transfers connected to inheritance or gifts.
Key Term: Stamp Duty Land Tax (SDLT)
A tax on the purchase or transfer of land and property in England and Northern Ireland.
If a beneficiary inherits property and assumes responsibility for a mortgage, SDLT may be payable on the amount of debt taken on. If a deed of variation is made after death and consideration is given, SDLT may also arise.
Worked Example 1.5
A beneficiary inherits a house worth £400,000 with a £100,000 mortgage and takes over the mortgage. Is SDLT payable?
Answer: SDLT may be due on the £100,000 debt assumed by the beneficiary, even though the property was inherited.
Key Point Checklist
This article has covered the following key knowledge points:
- Inheritance tax interacts with capital gains tax, income tax, and stamp duty land tax in various scenarios.
- Lifetime gifts may trigger immediate CGT for the donor, even if exempt from IHT as a PET.
- On death, assets are re-based for CGT, wiping out gains accrued during the deceased's lifetime.
- Income arising during estate administration is subject to income tax, separate from IHT on the estate's value.
- Business property relief can reduce or eliminate IHT on qualifying business assets, subject to strict conditions.
- SDLT is not charged on inheritance, but may arise if a beneficiary assumes a mortgage or consideration is given in a deed of variation.
Key Terms and Concepts
- Potentially Exempt Transfer (PET)
- Chargeable Lifetime Transfer (CLT)
- Disposal at Market Value
- CGT Re-basing on Death
- Estate Income
- Business Property Relief (BPR)
- Stamp Duty Land Tax (SDLT)
