The Cumulative Principle

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    The system of Inheritance Tax charging in the UK is based on a cumulative method which assesses the addition of successive transfers in order to determined the rate of tax applied to the most recent.

    While many still see IHT as a ‘death charge’ the tax can also apply to lifetime transfers either immediately or retrospectively after death. The calculation of IHT uses a seven year cut off period so that the latest transaction is aggregated with any chargeable transfers made within that seven year period. A chargeable transfer is one that is not exempt (under the spousal exemption or annual exemption for example) and that involves a transfer of value from the transferor’s estate. This is further complicated by Potentially Exempt Transfers (PETs) which only become chargeable transfers if the transferor dies within seven years. These are therefore excluded from the cumulative total when assessing the tax rate applied to lifetime chargeable transfers.

    On death however the cumulative total will include all chargeable transfers in the last seven years. This includes any failed PETs.

    Because this alters the cumulative list of transfers the total must be recalculated and each transaction assessed again. This means that it may be necessary to look at any chargeable transfers made within the previous 14 years. To assess a failed PET made just inside the seven year period it will be necessary to look back at any chargeable transfers made in the seven years preceding the gift.

    The following example shows how a cumulative total is ascertained on death after a number of lifetime transfers have
    been carried out:

    The deceased made the following transfers:

    Year 1 Gift to Trust Chargeable
    Year 3 Gift to X PET
    Year 5 Gift to Company Chargeable
    Year 7 Gift to Y PET
    Year 9 Gift to Trust Chargeable
    Year 11 Gift to Z PET
    Year 13 Transferor Dies

    When the transferor dies the PETs made in years 7 and 11 become chargeable so that the estate is cumulated with the gifts in years 7, 9 and 11. The PET in year 11 is now a chargeable transfer and is cumulated with the gifts in years 5, 7 (as this is now chargeable) and 9.

    The gift to trust in year 9 is cumulated on a revised basis with the gift in year 5 and the failed PET in year 7 (but not the PET in year 3 which does not become chargeable as it is outside of the seven year period).

    Similarly the PET in year 7 is now cumulated with the gifts in years 1 and 5.

    The effects of re-calculation can be far reaching; beyond the effect on the tax of the death estate. More tax can become due on the lifetime transfers and the settlement into trust in year 9 may now have increased exit charges due to the cumulative total at the time of settlement being higher.

    The complexity of Inheritance Tax means that any lifetime planning should be carried out by an expert. If you have
    clients looking to reduce their potential IHT liability the use of trusts and careful planning can help. (example taken from ‘Practical Inheritance Planning’ – Tottel Publishing)

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    Matt Walkden Will Writer

    About Matt Walkden

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