NOTE: This article was published in December 2018 and reflects the law as it stands on the date of publication and not at any later date. 

The paper can be downloaded as a PDF here.

1. Aim of legislation

The Government announced in the July 2015 Budget that an additional nil rate band (“RNRB”) would be introduced where a deceased person’s interest in their residence is “closely inherited” by their children and other descendants, on a death on or after 6 April 2017. The relevant legislation is contained in sections 8D to 8M of the Inheritance Tax Act 1984 (“IHTA 1984”), which came into force on 18 November
2015.

The objective was to meet the criticism that the estates of persons, who are by no means wealthy, were being dragged into the IHT net by virtue only of the historic rise in residential property prices. Why should an ordinary person, who has worked hard all their life, paying tax on income used to finance the purchase of their home, not be able to leave their home to their children free of IHT? One solution is to increase the value at which IHT is charged at a nil rate, provided that the deceased’s estate includes an interest in their home, and that interest is inherited by direct descendants.

Unfortunately, the legislation is of mind-blowing complexity and almost impossible, even for a lawyer, to decipher, let alone apply. It introduces a whole host of different terms, many of which are represented by symbols such as NV/100, TT or VT. As will be seen, there are many circumstances in which the RNRB is of little or no assistance, e.g. in the case of high-value estates, or conversely where the deceased’s residence is of low value, and also where the deceased has no direct descendants, or none whom he or she wishes to benefit.

It might simply have been better to have increased the standard nil rate band. Nonetheless, an attempt is made in this paper to unravel the complexities of the RNRB, and to give some guidance as to its impact on will drafting, and lifetime tax planning.

1.2. Summary of contents

This paper contains the following sections:

1. Introduction;
2. Residential enhancement;
3. Closely inherited;
4. Estates above £2m;
5. Brought-forward allowance;
6. Downsizing relief;
7. Residence nil rate amount;
8. Will drafting;
   8A. Life interest trusts for the surviving spouse;
   8B. 2-year discretionary trusts;
9. Lifetime planning.

1.3. HMRC Guidance

HMRC have published the following guidance:
(a) Inheritance Tax Manual, paras. 46000 to 46100;
(b) Inheritance Tax, how to apply the additional threshold with examples at: https://www.gov.uk/guidance/inheritance-tax-residence-nil-rate-band;
(c) Online calculator: https://www.tax.service.gov.uk/calculate-additionalinheritance-tax-threshold.

1.4. Downsizing relief

Under the original legislation, the RNRB was only available if the deceased person owned an interest in their residence, or former residence, immediately before their death. This prompted a concern that the introduction of the RNRB would penalise elderly persons who might not own a residence on death, or only one of minimal value. This could be a disincentive to those who might otherwise wish to downsize to a less valuable home, or to sell and move into a rented property or residential care.

Accordingly, the Finance Act 2016 contained additional provisions extending the RNRB to cases where the deceased had, on or after 8 July 2015, downsized from a “high value residence” to a lower value one, or disposed of their residence without owning another at death, provided that other assets are “closely inherited”. These downsizing provisions came into force on 15 September 2016 (see 6 below)

1.5. Nil rate bands

IHT is charged at 40% on the value of chargeable transfers in excess of the nil rate band. Prior to the introduction of the RNRB, two nil rate bands potentially applied for IHT purposes:

(a) The standard nil rate band (“SNRB”) frozen at £325,000 up to and including 2020/21, which applies to both lifetime and death transfers; and
(b) The transferable nil rate band (“TNRB”), if and to the extent that the SNRB was unused on the death of a predeceasing spouse or civil partner
(up to 100% of the SNRB). This applies so as to reduce the charge on death, including the charge on failed PETs.

In addition, the RNRB is now available in certain circumstances. The RNRB operates as a nil rate band: if the residence nil rate amount is greater than nil, the portion of the chargeable transfer on death that does not exceed that amount is charged at the rate of 0% (IHTA 1984, s. 8D(2)). A claim to the RNRB can be made on Form IHT435.

As the RNRB only applies to the value of a chargeable transfer on death, it does not apply to the value of failed PETs, or to the additional tax payable on death on chargeable transfers made in the 7 years prior to death.

1.6. Elements of RNRB

There are two elements to the RNRB:
(a) “The residential enhancement” applying on the death of an individual on or after 6 April 2017 (IHTA 1984, s. 8D(5)); and
(b) “The brought-forward allowance” also applicable on the death of such an individual, where the RNRB has not been fully used on the death of
a predeceasing spouse or civil partner, up to a maximum of two times the residential enhancement (IHTA 1984, s. 8G). This is, in effect, a
transferable RNRB.

The aggregate of a deceased person’s residential enhancement and the brought forward allowance is referred to as that person’s “default allowance” (IHTA 1984, s.8D(5)(f)).

1.7. Maximum RNRB

The maximum residential enhancement (IHTA 1984, s. 8D(5)(a)) is:
(a) 2017/18: £100,000
(b) 2018/19: £125,000
(c) 2019/20: £150,000
(d) 2020/21: £175,000
(e) 2021/22 and following: Increasing in line with CPI, unless the Treasury specifies an alternative value.

In addition, the amount of the RNRB can be increased, by as much as 100%, if the brought-forward allowance applies (see 5 below). It follows that the maximum nil rate band on a death of a surviving spouse or civil partner in 2020/21 is £1m:

(a) SNRB £325,000
(b) TNRB £325,000
(c) RNRB (residential enhancement) £175,000
(d) RNRB (brought-forward allowance) £175,000

The RNRB, therefore, gives rise to a maximum IHT saving in 2020/21 of 40% of £350,000, i.e. £140,000, or £70,000 in the case of a person who is not married, nor in a civil partnership. The total of all the nil rate bands, in the case of a married couple, in 2020/21, can be as much as £1m, giving rise to a potential saving of £400,000.

1.8. RNRB for benefit of estate as a whole

The RNRB applies for the benefit of the estate as a whole. It is not set against the value of the residence itself.
Peter dies in 2021, leaving his share in his residence, worth £200,000 to his son, Bert, subject to tax, and the residue of his estate, worth £600,000, to his partner, Ena. Peter’s estate is entitled to a RNRB of £175,000 on his death, and a SNRB of £325,000 (as Peter did not make any chargeable transfers in the 7 years prior to his death).
The estate of £800,000 is entitled to (in order of priority):
(1) RNRB: £175,000; plus
(2) SNRB: £325,000.
Total: £500,000.
Chargeable estate: £800,000
Deduct total NRBs: (£500,000)
Estate taxable at 40%: £300,000
IHT at 40% x £300,000: £120,000
IHT attributable to residence (2/8 x £120,000) £30,000
Bert’s entitlement (£200,000 – £30,000) £170,000
IHT out of residue of £600,000: £90,000

Even if the gift were free of IHT, the RNRB applies to reduce the IHT on the estate as a whole.

1.9. RNRB takes priority

The RNRB applies in priority to the SNRB and the TNRB (IHTA 1984, s. 8D(3)).
However, the SNRB and the TNRB apply to chargeable transfers made in the 7 years before death, whereas the RNB does not. The following steps should, therefore, be taken:
(1) apply the SNRB and any TNRB to chargeable transfers in the 7 years before death to calculate IHT on such transfers, and to determine whether there is any balance to be set against the value of the chargeable estate on death;
(2) deduct the RNRB (if any) from the value of the chargeable estate on death; and
(3) apply any remaining SNRB or TNRB to the remainder of the chargeable estate.

1.10. Limitations on RNRB

In practice, the RNRB may be less than the maximum amount, or even nil, because:
(a) The residential enhancement is withdrawn at a rate of £1 for every £2 above £2m if the deceased person’s estate exceeds £2m on death (see
4 below). There is no relief if the estate exceeds £2.35m (disregarding the brought-forward allowance), or £2.7m (including the brought-forward
allowance, if applicable).
(b) The brought-forward allowance will itself be subject to tapering, if the value of the estate of the predeceasing spouse or civil partner exceeds
£2m (see 5.5 and 5.6 below).
(c) Subject to downsizing relief, the deceased must have owned a “qualifying residential interest” at death. To qualify for downsizing relief in full, the deceased must have owned a sufficiently-valuable interest in a residence, which was disposed of on or after 8 July 2015. The RNRB will, therefore,
be of no use to someone who has never owned a qualifying residential interest, or who disposed of such an interest before 8 July 2015.
(d) The RNRB only applies where a qualifying residential interest is “closely inherited” by direct descendants (see 3 below). It does not apply where
such an interest is inherited by a spouse, a partner, sibling, or collateral relative.
(e) The brought-forward allowance does not apply in the case of individuals who have not been married or entered into a civil partnership.
(f) Where the value of the qualifying residential interest which is closely inherited is less than the maximum RNRB, the RNRB is limited to that
value.
(g) The RNRB cannot in any event exceed the value of the chargeable estate.