Inheritance Tax

The settlements legislation is designed to ensure that where a settlor retains an interest in settled property, the income arising is treated as the settlor’s income for all tax purposes. A settlor will be treated as having retained an interest where the settlor, or their spouse or civil partner, can benefit from either the income or the underlying property.

In general terms, the settlements legislation may apply where an individual enters into an arrangement which diverts income to another person, resulting in a tax advantage. Such arrangements typically involve an element of “bounty” and are not fully commercial or made at arm’s length.

The legislation is particularly relevant where:

• there is an element of bounty, or
• the arrangement is not on commercial terms, or
• it is not at arm’s length, or
• in the case of a gift between spouses or civil partners, the gift consists wholly or substantially of a right to income.

However, there are a number of everyday scenarios where the settlements legislation will not apply. Following extensive case law in this area, HMRC guidance and judicial decisions indicate that where there is no element of bounty, or where there is an outright gift between spouses or civil partners that is not wholly or substantially a right to income, the legislation will not generally be applied.

The 7-year gift rule is still an available option for those making lifetime gifts, offering a way to potentially reduce Inheritance Tax (IHT) liability. Most gifts made during a person’s lifetime are not immediately subject to tax. These transfers, known as ‘potentially exempt transfers’ (PETs), become fully exempt if the donor survives for more than seven years after making the gift.

If the donor dies within three years of the gift, the transfer is treated for IHT purposes as if it were made on death. A tapered relief applies if death occurs between three and seven years after the gift. 

The effective tax rates on the amount exceeding the nil-rate band are:

• 0–3 years before death: 40%
• 3–4 years: 32%
• 4–5 years: 24%
• 5–6 years: 16%
• 6–7 years: 8%
• 7 or more years: 0% 

Tapered relief cannot reduce tax on lifetime chargeable transfers below the amount initially chargeable, so it does not benefit transfers within the nil-rate band.

It is strongly recommended to keep a record of all PETs, exemptions used, and details of any regular gifts made out of surplus income, ensuring accurate tracking for future IHT planning.

As a general rule, someone who inherits property, money or shares is not liable to pay tax on the inheritance itself. This is because any Inheritance Tax (IHT) due is normally paid out of the deceased’s estate before assets are distributed to beneficiaries. However, the recipient may be liable to Income Tax on any income generated after the inheritance (for example, dividends from shares) and to Capital Gains Tax on any increase in value of the assets from the date of inheritance.

An important exception applies to gifts made during a person’s lifetime. These are known as Potentially Exempt Transfers (PETs). Such gifts become exempt from IHT if the donor survives for more than seven years after making the gift. If the donor dies within three years, the gift is treated as part of the estate on death for IHT purposes.

Taper relief may apply where death occurs between three and seven years after the gift, reducing the amount of IHT payable. In some cases, individuals take out insurance policies, such as seven-year term assurance, to cover any potential IHT liability during this period.

The position is more complex where the donor retains some benefit from the gifted asset. For example, gifting a house but continuing to live in it rent-free is treated as a ‘gift with reservation of benefit’. In such cases, the asset may still be subject to IHT, even if the donor survives for more than seven years. Additionally, IHT may arise if inherited assets are placed into a trust and the trust is unable to meet the tax liability.

The government recently announced significant changes to the planned reforms to Agricultural Property Relief (APR) and Business Property Relief (BPR). The threshold for 100% relief will be increased from £1 million to £2.5 million when the changes take effect from 6 April 2026. The change will be introduced via an amendment to the Finance Bill 2025 with relief reduced to 50% on qualifying assets above the new level.

Spouses or civil partners will be able to pass on up to £5 million of qualifying agricultural and business assets between them free of inheritance tax, in addition to the existing nil rate bands. The transferable allowance will also apply to surviving spouses or civil partners who were widowed before the new policy was announced.

These changes adjust the reforms first announced at Autumn Budget 2024, which had attracted strong criticism from the farming community and rural businesses over the potential impact on small farms and family-owned enterprises. By raising the threshold, the government aims to significantly reduce the number of estates affected by higher inheritance tax charges, ensuring that the reforms are focused primarily on the largest estates.

The government estimates that around 85% of estates claiming APR in 2026–27, including those also claiming BPR, will pay no additional inheritance tax as a result of these changes.

Shares designated as “not listed”, such as those traded on AIM, will attract BPR at a flat rate of 50% (reduced from 100%) from April 2026. This measure was unaffected by the latest announcement.

The 2027 reforms will shift more responsibility to personal representatives, who may need to manage withholding arrangements and settle any IHT before pension benefits are released.

From 6 April 2027, most unused pension funds and death benefits will be included in IHT, meaning that more pension assets could be taxed when someone dies. This is a major change from the current rules, which largely exclude these funds from IHT.

Individuals with significant pension savings should review their estate plans carefully. Under the new rules, beneficiaries could face an IHT charge on inherited pension funds. Responsibility for reporting and paying this tax will fall on personal representatives, not the pension scheme administrators.

There are some important exceptions. Death-in-service benefits from registered pension schemes and dependants’ pensions from defined benefit or collective money purchase schemes will continue to be exempt from IHT.

It was announced as part of the Budget 2025 measures that from 6 April 2027, if a deceased person’s estate is expected to owe IHT, their personal representatives can instruct the pension provider to withhold 50% of taxable pension‑death benefits for up to 15 months. They must then pay any IHT due to the tax authorities before releasing the rest to beneficiaries. This does not apply to exempt benefits, small pots (under £1,000) or ongoing annuities. Personal representatives will also be discharged from liability for pensions discovered after they have received clearance from HMRC. 

Agricultural and business property relief changes that were first announced at Autumn Budget 2024 will come into effect from 6 April 2026. These measures will introduce significant reforms to Business Property Relief (BPR) and Agricultural Property Relief (APR), which provide Inheritance Tax (IHT) relief on qualifying business and agricultural assets. These measures have faced significant criticism for their potential impact on small farms and rural communities.

From April 2026, a new £1 million allowance will apply to the combined value of property in an estate qualifying for 100% BPR or 100% APR. This means that the existing 100% rate of IHT relief will only apply to the combined value of property in an estate qualifying for 100% BPR or 100% APR. The rate of IHT relief will be reduced to 50% for the value of any qualifying assets over £1 million. Accordingly, any assets receiving 50% relief will be effectively taxed at 20% IHT (the full rate being 40%).

The government has also confirmed they will reduce the rate of BPR available from 100% to 50% in all circumstances for shares designated as 'not listed' on the markets of recognised stock exchanges, such as AIM. The existing rate of relief will continue at 50% where it is currently this rate and will also not be affected by the new allowance.

The option to pay IHT by equal annual instalments over 10 years interest-free will be extended to all qualifying property which is eligible for APR or BPR.

The majority of gifts made during a person's life are not subject to tax at the time of the gift. These lifetime transfers are known as 'potentially exempt transfers' or 'PETs'. These gifts or transfers achieve their potential of becoming exempt from Inheritance Tax if the taxpayer survives for more than seven years after making the gift. There is a tapered relief available if the donor dies between three and seven years after the gift is made.

The effective rates of tax on the excess over the nil rate band for PETs is:

• 0 to 3 years before death 40%
• 3 to 4 years before death 32%
• 4 to 5 years before death 24%
• 5 to 6 years before death 16%
• 6 to 7 years before death 8%

HMRC’s internal Inheritance Tax manual states that subject to certain exceptions, a PET is a lifetime transfer of value that satisfies three conditions. They are that:

• the transfer is by an individual on or after 18 March 1986
• it would be a chargeable transfer apart from IHTA84/S3A (or, if only partly chargeable, is a PET to the extent that it would be chargeable), and
• it is a gift to another individual or to a specified trust.

The Ministry of Justice (MoJ) has confirmed that video witnessed wills in England and Wales will be made legal during the coronavirus pandemic. The change in law to introduce this measure is due to come into force later this month – the reforms will be backdated to 31 January 2020 – the date of the first confirmed coronavirus case in the UK.

This means that any will witnessed by video technology from that date onwards will be legally accepted. The change will remain in place until 31 January 2022, or as long as deemed necessary, after which wills must return to being made with witnesses who are physically present.

Currently, the law states that a will must be made ‘in the presence of’ at least two witnesses. The changes will amend the law to include video-witnessing.

The MoJ has stated that the use of video technology should remain a last resort, and people must continue to arrange physical witnessing of wills where it is safe to do so. Wills witnessed through windows are already considered legitimate in case law as long as they have clear sight of the person signing it.

Even with video witnessing, the Wills still need to be signed by two witnesses who are not its beneficiaries and electronic signatures will not be permitted.

Inheritance Tax (IHT) is levied on a person’s estate when they die and can also be payable during a person’s lifetime on certain trusts and gifts. The rate of Inheritance Tax payable is 40% on death and 20% on lifetime gifts.  IHT is payable at a reduced rate on some assets if an individual leaves 10% or more of the 'net value' to charity of their estate.

There is a nil-rate band, currently £325,000 below which no Inheritance Tax is payable. In addition, there is an IHT residence nil-rate band (RNRB) which relates to a main residence passed down to a direct descendent such as children or grandchildren. The RNRB of £175,000 (where available) is additional to the £325,000 Inheritance Tax nil-rate band.

Funds from the deceased estate are usually used to pay IHT. If there is a will, it is usually the executor who deals with paying any IHT due to HMRC. IHT can be paid from funds within the estate, or from money raised from the sale of the assets. Payment of any IHT due is often made using the Direct Payment Scheme (DPS) whereby some or all of the IHT is paid from the deceased person’s accounts directly to HMRC. The deceased may also have used a life insurance policy to fund the payment of some / all the IHT due.

Once the IHT and any outstanding debts are paid, the executor or administrator can distribute what remains of the estate. The beneficiaries of the will do not normally need to pay IHT on their inheritance, but there are exceptions.

It is possible for wealthier taxpayers to take advantage of the IHT exemption for gifts and payments that are paid as normal expenditure out of income. This is a very flexible exemption from IHT as there are no specific requirements, for example, making fixed, regular gifts to the same person. With proper planning this can be a particularly useful tool and could include helping grandparents pay school fees for their grandchildren.

However, careful consideration has to be given to ensure that these payments form part of the transferor’s normal expenditure and is made out of income and not out of capital. The person gifting the money must also ensure that they are left with enough money to maintain their normal standard of living. A gift must meet all of the conditions to qualify for the exemption and must not fall within any of the exceptions.

This relief is separate to the annual Inheritance Tax exemption of £3,000 for gifts. This exemption can also be carried forward to the following tax year if not used, to make a maximum gift of £6,000. Individuals can also give as many gifts of up to £250 per person as they want during the tax year but only if they have not used another exemption with the same person. There are also special allowances for gifts made at a wedding or civil ceremony.