The new Inheritance Tax Residence Nil Rate Band

The Summer Budget Finance Bill (the Finance (No. 2) Bill 2015) has now been published and it contains the draft legislation to implement the new Inheritance Tax (IHT) Residence Nil Rate Band (RNRB). So let’s take a look at the detail of what’s involved.

The RNRB can only apply in full if a person’s estate on death is £2 million or less. This figure is the ‘taper threshold’. The taper threshold will increase in line with the Consumer Prices Index (CPI) after tax year 2020/2021. The RNRB is reduced by £1 for every £2 that the estate exceeds the taper threshold.

A ‘person’s estate’ is defined in section 5 of the Inheritance Tax Act 1984 (IHTA 1984); essentially it is all the property to which a person is beneficially entitled the moment before death, less deductible liabilities. This definition includes property subject to a reservation of benefit for IHT purposes and a qualifying/estate interest in possession but does not include other types of interest in possession and excluded property.

The RNRB will first come into effect in tax year 2017/2018, increasing with each tax year thereafter. It is calculated with reference to the ‘residential enhancement’, as follows:

After tax year 2020/2021, the residential enhancement will increase in line with the CPI.

The residential enhancement is not the RNRB itself, partly because of the tapering that applies to the residential enhancement and the need to factor in brought forward allowance (see below).

The RNRB is available subject to the following conditions:

• There must be a Qualifying Residential Interest. As long as a person used a dwelling house as a residence at a time when he owned an interest in that dwelling house, there will be a Qualifying Residential Interest. So, even if the dwelling house has been sold by the date of death, it will count. Of course, those who have moved homes over the years will have more than one Qualifying Residential Interest on the basis of this definition and so the legislation makes clear that if a person has only one home at death, that home will be the Qualifying Residential Interest. If there are two residences owned at death (perhaps a London home and a country home), the person’s personal representatives (PRs) need to nominate which one is the Qualifying Residential Interest. In this case, the PRs will need to be careful that whichever home they nominate is going to a lineal descendant (see below). Evidentially, it may be difficult to put a value on a residence that is no longer owned.
• The Qualifying Residential Interest must be closely inherited. For these purposes, to inherit something means that the beneficiary takes by will or intestacy. If assets pass to a will trust after death instead, the beneficiary must take an interest in possession in that trust (for example, the beneficiary could take an immediate post death interest). Discretionary will trusts should be reviewed but hopefully reliance on the operation of section 144 IHTA 1984 will mean that they do not have to be abandoned necessarily. The requirement for the interest to be closely inherited means that it must pass to a lineal descendant. This appears to bear its natural meaning, i.e. children, grandchildren etc., and the legislation makes clear that stepchildren, adopted children and fostered children are included. However, it seems that a person or couple without children who, on death or when the survivor of the couple dies, wants to leave a home to their nephews and nieces, for example, will not benefit from any RNRB. If only a portion of the Qualifying Residential Interest will be closely inherited, only a percentage of the RNRB will be available. The need for lineal descendant inheritance means that those with wills leaving assets to anyone other than just direct descendants should ensure that the will’s administrative powers are sufficiently wide to enable the PRs to allocate the Qualifying Residential Interest to the right beneficiary in order to secure the RNRB. This is probably more practical than having a will leaving a certain property to a certain individual, which can become out of date or inappropriate unless regularly kept under review.
• The available RNRB (or the amount that can be brought forward if on the first death of a married couple (see below)) cannot exceed the value of the Qualifying Residential Interest at death. In other words, the RNRB cannot ‘spill over’ onto other assets in the estate to relieve them of the burden of IHT.

Like the transferable nil rate band, married spouses (which includes civil partners here) can carry forward any RNRB that remains unused on the first death, as long as the first spouse to die’s estate was not in excess of the taper threshold at the first spouse’s death (in which case tapering operates on the amount that can be carried forward). If a surviving spouse has more than one predeceased spouse, only an amount equivalent to the residential enhancement figure in the tax year of the surviving spouse’s death can be carried forward – it is no good collecting predeceased spouses! The second death must also occur after 6 April 2017. Also, if the first death occurred pre- April 2017, the carry forward percentage will always be the full 100%, unless the first-to-die's estate breached the taper threshold. Generally the carry forward allowance must be claimed by the PRs within two years of the end of the month of the survivor’s death; it will not be applied automatically.

Therefore, if married couples and civil partners have a fully available transferable nil rate band and qualify for the RNRB in full (because, among other things, the first death occurred after 6 April 2017), they will be able to leave these amounts free of IHT if the second death also occurs after 6 April 2017:

• £850,000 (2017/2018)
• £900,000 (2018/2019)
• £950,000 (2019/2020)
• £1,000,000 (2020/2021)

As the RNRB is whittled away by £1 for every £2 that the value of the estate exceeds the taper threshold, the RNRB will cease to be available nearer to the £2 million mark in 2017/2018 than in 2020/2021 and beyond as the residential enhancement is that much smaller in the earlier years. For example, if, for a married couple, the first death occurred before 6 April 2017 and the second death occurred in tax year 2017/2018 with a full RNRB brought forward allowance available, the RNRB would be reduced to nil if the survivor’s estate was in excess of £2,400,000 but if the second death occurred in 2020/2021, the RNRB is nil only if the survivor’s estate was in excess of £2,550,000.

Those individuals or couples with estates, or combined estates, in the £2-3 million bracket may wish to consider whether it would be appropriate for them to reduce the estate to below the taper threshold but note, for married couples, that it needs to be below the threshold both on the first and the second death, or the carried forward allowance will also be tapered.

Brits are notoriously obsessed with their property ownership but they or their advisers will need a high degree of attention to detail to make the most of these complicated new rules. Non-doms should be able to benefit from these changes too, as long as their UK property has been used as a residence.