Is there a simple summary of the 36% rate?
The principle is simple: since 6 April 2012 the rate of IHT charged on the whole estate at death can be reduced by 4% from 40% to 36% where 10% of the estate is left to charity. This relief is only available for the gift made on death.
It gets more complicated, although in many cases in practice it is not. The best way of trying to get the 36% rate is to have a will which contains a “formula clause” that is specially designed to qualify for the relief. A variation of the estate after death might achieve the same thing but should not be relied on because the circumstances by the time of death might mean that, even if a variation can be done, it cannot achieve the relief.
Someone’s estate on death can consist of one to three “components”: (i) assets passing to a co-owner by survivorship; (ii) trust assets in which the deceased had a life interest; and (iii) their normal “free estate” (or “general component”). It is quite rare for anything apart from the free estate to be involved.
In order to calculate whether at least 10% is reached in respect of a component of the estate on death, the following 3 step calculation is done:
- the net taxable value of the estate component is calculated, including deducting the charity exemption;
- the available nil rate band (or the appropriate portion of it if there is more than one component) is deducted from step 1 above; and
- the charity exemption is then added back to the answer at step 2 – this gives you the “baseline amount”.
In respect of each component of the death estate, the 36% rate applies if the value of the gift to charity from that component is 10% or more of the baseline amount for that component.
Simple example – general component only
Adam was survived by his wife Belinda. Adam left all his estate to Belinda who died on 9 December 2020. She left:
(a) £200,000 to charity;
(b) £100,000 to her grandchildren; and
(c) The residue of £2,000,000 to her daughter Clare.
Belinda’s executors claim a double standard nil rate band because Adam’s nil rate band was unused. (The residence nil rate band is not relevant here.)
Belinda had no joint property (so the survivorship component is irrelevant) and no interests in any trust property (so that component is irrelevant too).
Belinda’s estate on death consists of just her standard free estate or general component. The baseline amount calculation is:
- £2,300,000 (the total value of this component ie (a), (b) & (c) above) minus £200,000 (the gift to charity) = £2,100,000
- £2,100,000 minus £650,000 (the double nil rate band) = £1,450,000.
- £1,450,000 plus £200,000 (the gift to charity) = £1,650,000.
The baseline amount is therefore £1,650,000. The 10% test requires the gift to charity to be 10% or more of the baseline amount, which it is because it is more than £165,000. Therefore the tax rate is 36%.
Two or more components can be merged by election so they are treated as one for the purpose of the relief. This means, for example, that a taxable survivorship component could get the benefit of the 36% rate even though the gift to charity continues to be paid out of the general component. In the absence of an election one component may pay tax at 36% but the other may still pay it at 40%.
If Belinda had owned joint property with her sister Bertha worth £50,000 the baseline amount would be £1,700,000 and the charitable gift of £200,000 payable from the general component would still be more than 10% of that merged value. Therefore the 10% test would be satisfied and the tax on the joint property that Bertha has inherited could be reduced too.
The people who can make a merger election are the deceased’s personal representatives (in respect of the free estate), the surviving co-owner (in respect of joint property) and the trustees (in respect of trust property). The election must be made within two years of the deceased’s death.
There can be added estate administration costs in order to achieve the 36% rate and elections to merge components can involve conflict of interest problems if the beneficiaries of different components are different people.
If an executor has paid 40% IHT when they should have paid at 36% can the tax be claimed back later?
Provided the baseline amount test was passed at the testator’s death without anything needing to be done to satisfy it (such as a deed of variation, which has to be done within two years of death), HMRC will make an IHT repayment.