What you need to know about the annual £3,000 exemption for Inheritance Tax (IHT) purposes.
Transfers are exempt from IHT up to a total of £3,000 in each tax year.
For gifts on different days in the same tax year, the annual exemption is applied in date order.
For multiple gifts on the same day the exemption is apportioned between them.
Any part of the annual exemption which is not used in the tax year is carried forward into the following tax year.
On 19 January 2018, Philip Hammond wrote to the Office of Tax Simplification requesting a review of the IHT regime.
An individual's lifetime transfers are exempt up to a total of £3,000 in each tax year.
The level of this “annual exemption” has remained unchanged since 1981.
The relevant legislation is comprised in the Inheritance Tax Act 1984 section 19.
If a transfer of value is more than the amount of the available exemption:
it is an exempt transfer up to the amount of the available exemption
the excess is the chargeable amount of the PET or immediately chargeable transfer
If the transfer qualifies for agricultural relief or business relief the annual exemption is deducted from the value transferred after reliefs have been granted.
Example of the annual exemption interacting with Business Property Relief (BPR)
Arthur makes a lifetime transfer of factory premises to the trustees of a discretionary trust. The property is valued at £300,000.
The transfer qualifies for 50% BPR.
The only exemption available is the annual exemption for the year.
The amount of the immediately chargeable transfer is:
Loss to estate
BPR @ 50%
Multiple transfers on different days
If the transferor has made transfers to more than one person on different days in the same tax year, then the annual exemption is applied “in date order”.
For example, on 1 July 2019 Bert gave £4,000 to Brenda. On 2 August 2019 Bert gave £8,000 to Bronwen. Bert died on 1 December 2019.
All of the annual exemption is applied against the gift to Brenda made on 1 July 2019.
Multiple transfers on the same day
If the transferor has made transfers to more than one person on the same day the exemption is apportioned between them.
For example, Colin makes transfers of £4,000 to Cora and £8,000 to Clare on 3 September 2019. The annual exemption is apportioned as follows;
4,000 ÷ 12,000 x £3,000 = £1,000 applied to the transfer to Cora
8,000 ÷ 12,000 x £3,000 = £2,000 applied to the transfer to Clare
Carry forward of unused allowance
Any part of the annual exemption which is not used in the tax year is carried forward (rolled-over) into the following tax year. It can only be carried forward to the next year and cannot be used in any later years. The annual exemption is applied in the following order
any part of the previous year's annual exemption not used in that year
Example of the one year carry forward rule
Xavier makes the following gifts:
1 March 2018 £1,600 to Lynne
2 June 2018 £2,200 to Laura
3 July 2019 £5,000 to Lucy
The gift of £1,600 is wholly covered by that year’s annual exemption. £1,400 is carried forward to 2018-19.
The gift of £2,200 is wholly covered by the current year’s annual exemption. The unused balance of £800 is carried forward to 2019-20. The surplus of £1,400 brought forward from 2017-18 is not used and so is “lost”.
The £3,000 for the current year and £800 carried forward from 2018-19 are available. Of the £5,000 gift, £3,800 is exempt. The balance of £1,200 is a potentially exempt transfer.
Attempts are sometimes made to exploit the annual exemption:
Transferring assets by way of sale, leaving the sale price unpaid and treated as a loan by the transferor which is then written off, year by year, utilising the annual exemption, and/or
annual transfers of portions of an asset - the portions being equal in value to the annual exemptions
HMRC will challenge such strategies in worthwhile cases. In most cases the costs of setting up and operating these arrangements outweigh the potential tax savings.
Inheritance tax simplification
The Office of Tax Simplification has been asked to review inheritance tax and has published its first of 2 reports. The first report covers day to day matters of concern to all those that responded to the consultation and deals with admin matters. The second report is due in Spring 2019 and will explore key technical and design issues.