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.

3.1. Meaning of closely inherited

The QRI in the deceased person’s estate must be “closely inherited”. IHTA 1984, s. 8J deals with what is meant by “inherited”, s. 8K with what is meant by “closely”.
In relation to the death of any person (“D”), something is “closely inherited” if (IHTA 1984, s. 8K) it is “inherited” by:

(a) a lineal descendant of D (i.e. children, grandchildren, great-grandchildren, but not collateral descendants such as nephews and nieces);

(b) a person who, at the time of D’s death, is the spouse or civil partner of a lineal descendant of D; and

(c) a surviving spouse or civil partner of a pre-deceasing lineal descendant (LD) who has not between LD’s death and D’s death become the spouse or civil partner of another person.

A step-child is treated at all times as the child of their step-parent; a foster child as the foster parent’s child; an adopted child as the child of both natural and adopted parents; and a guardian as the parent of a child where the appointment as guardian took effect when the child was under the age of 18.

Fred acquired a step-son, Doug, on his marriage to Doris. Doug has a child, Emma, who was born before Doug became Fred’s step-son.

Emma is treated as being a lineal descendant of Fred, on the basis that Doug is treated as being Fred’s child, and Doug’s lineal descendants are treated as Fred’s, even if born before Doug became the child of Fred (IHTA 1984, s. 8K(8)).

3.2. Direct descendants

In their Inheritance Tax Manual HMRC refer to the class of persons in 3.1 above as “direct descendants”, even though that is not a phrase used in the legislation. The same terminology is adopted in this paper.

The RNRB is, therefore, of no benefit to an individual who has no direct descendants, nor where an individual wishes to leave a QRI to persons others than direct descendants. A QRI passing to the deceased’s parents, siblings, nephews and nieces, is not closely inherited.

3.3. Inherited

The RNRB only applies to the deemed chargeable transfer made on death. It does not apply to lifetime transfers. This limitation is reflected in the requirement that the QRI must be “inherited”.

A person (“B”) must “inherit” from a person who has died (“D”). B inherits for these purposes if (IHTA 1984, s. 8J(2)):
(a) there is a disposition to B;
(b) of property which forms part of D’s estate immediately before D’s death;
(c) whether effected by will or intestacy or otherwise, e.g. survivorship.

If, therefore, B becomes absolutely entitled to a QRI, under D’s will or intestacy, or by survivorship, the QRI is inherited. In some circumstances, B is also treated as inheriting where D’s property becomes comprised in a settlement, in which B has an interest, on D’s death (see 3.9 below).

3.4. Residuary gifts

A QRI can be closely inherited, even though it was comprised in the residuary estate, rather than being a specific gift (see 8.7 below).
The QRI need not end up in the hands of D’s direct descendants. The personal representatives can sell the QRI as part of the administration of the estate, or at the request of direct descendants entitled thereto, and pass the sale proceeds to those direct descendants. Indeed, the QRI will be closely inherited even if the Will directs that the personal representatives should sell the QRI, so long as it provides that the sale proceeds be paid to a direct descendant.

However, an appropriation of a QRI to a direct descendant in or towards satisfaction of a legacy or share of residue is not a disposition of the QRI by D, and the QRI will not be closely inherited.

3.5. Gifts with a reservation of benefit

Where property forms part of D’s estate immediately before D’s death as a result of Finance Act 1986, s. 102(3) (gifts with reservation) in relation to a disposal made by D by way of gift, B inherits the property if B is the person to whom the disposal was made (IHTA 1984, s. 8J(6)). This makes sense as the gifted property is deemed to form part of D’s estate. For the purposes of calculating the IHT due on a death after 29 October 2018, B inherits the property if the property originally comprised in the gift became comprised in B’s estate on the making of the disposal.

Margaret gives her residence to her son, David, but continues to use it without pay.ing full consideration. Margaret has made a gift with a reservation of benefit, and her residence is deemed to form part of her estate on death.

The residence is deemed to be inherited by David. He is a direct descendant, and the RNRB is available. The same result should apply if Margaret settles her residence on a bare trust for David, reserving a benefit to herself in the residence.

However, B (a direct descendant) must be the person to whom the gift was made by D, subject to D’s reservation of benefit. This will not be the case where D makes a gift to a trust for the benefit of B (other than a bare trust).

Margaret gives her residence to trustees upon trust for her son, David for life, but continues in de facto occupation, thereby reserving a benefit. Margaret dies, and the residence is deemed to form part of her estate.

David is not the person to whom the gift was made: the recipients of the gift are the trustees. As David’s interest in possession arose on or after 22 March 2006, he is not treated as the beneficial owner by virtue of his interest in possession (IHTA 1984, s. 49(1A)). The residence is not, therefore, closely inherited by David. This is made explicit by an amendment made to s. 8J(6), by clause 65 of the Finance Bill 2019, with regard to a person’s death after 29 October 2018. The amended s. 8J(6) only applies where the gifted property becomes immediately comprised in the donee’s estate. A gift to a trust, in which the donor reserves a benefit, will, there.fore, only qualify if it is a gift to a bare trust or a disabled person’s trust for direct descendant(s).

3.6. Deed of Variation

Sue leaves her house to her partner, Terry, who executes a Deed of Variation, within 2 years of Sue’s death, containing an IHTA 1984, s. 142 election, redirecting the house to Sue’s grandson, Peter, absolutely.
Peter is deemed for IHT purposes to have inherited the house absolutely on Sue’s death. He is a direct descendant, unlike Terry. The house is, therefore, closely inherited. The RNRB will be available.

3.7. Family provision order

An order under the Inheritance (Provision for Family and Dependants) Act 1975 is retrospective to death for IHT purposes by virtue of s. 146 of that Act. An order which has the effect that a direct descendant inherits a QRI is, therefore, to be taken into account for the purposes of applying the RNRB.

3.8. Appointments out of relevant property trusts settled by will

The RNRB is not available where a QRI is left on discretionary will trusts, even if all the beneficiaries are direct descendants. However, advantage can be taken of IHTA 1984, s. 144, to appoint a QRI in a discretionary trust to a direct descendant within 2 years of death (see 8B below). The direct descendant will be treated as having inherited the QRI, as the gift of the QRI to the direct descendant will be treated as having been effected by the deceased on death.

3.9. Will trusts

3.9.1. Trust property closely inherited

The general rule is that property is not inherited, where it becomes comprised in a settlement on D’s death (IHTA 1984, s. 8J(3)(a)). However, there are exceptions to this rule.

Where the property becomes comprised in a settlement on D’s death, B inherits the property if (IHTA 1984, s. 8J(4)):

(a) B becomes beneficially entitled on D’s death to an interest in possession, being an IPDI or disabled person’s interest (“DPI”); or
(b) the property becomes on D’s death settled property:
(i) to which s. 71A or 71D applies (bereaved minor’s trust, or 18-25
trust, for children of D); or
(ii) held on trusts for the benefit of B (a bare trust).

To fulfil the additional requirement of being “closely” inherited, B must be a direct descendant of D. The RNRB can, therefore, apply where D leaves a QRI upon trust for:

(a) one or more direct descendants on IPDI or DPI trusts; or
(b) D’s children at 18, on bereaved minor’s trusts, or at an age up to 25 on 18-25 trusts.

A gift of a QRI to a discretionary trust for the benefit of direct descendants will not, therefore, be closely inherited.

3.9.2. Trusts on attaining a specified age

Children who become entitled to a QRI on attaining a specified age will not “inherit” if the child has failed to attain that age on the death of the testator, unless the trust is a bereaved minor’s trust, or an 18-25 trust. Furthermore, there can be no bereaved minor’s trust, nor an 18-25 trust, for a grandchild:
(1) Francesca leaves a QRI to her son, Miles, on attaining the age of 18. Miles is 5 when Francesca dies.
The trust qualifies as a bereaved minor’s trust. The QRI is closely inherited.
(2) Francesca leaves a QRI to her grandson, Paul, on attaining the age of 18. Paul is 20 when Francesca dies.
The QRI will be closely inherited. Paul is absolutely entitled on Francesca’s death.
(3) Francesca leaves a QRI to her grandson, Paul, on attaining the age of 18. Paul is 12 when Francesca dies.
The trust for Paul cannot be a bereaved minor’s trust, nor an 18-25, as such trusts can only benefit children, not grandchildren. The trust is a relevant property trust.
(4) Francesca leaves a QRI to her daughter, Bridget, subject to a proviso that, should Bridget fail to survive her, her estate should pass to any children of Bridget living at Francesca’s death on attaining the age of 18 in equal shares. Bridget fails to survive Francesca. Bridget has three children, one of whom, Paul, is below the age of 18 on Francesca’s death.
Paul’s 1/3 share in the QRI will not be closely inherited. He is only contingently entitled on attaining the age of 18. The trust, being one for a grandchild, cannot be a BMT, nor an 18-25 trust. This may not matter if the remaining 2/3 share which is closely inherited equals or exceeds the value of the RNRB.
As to the effect on Will drafting, see 8.4 below.

3.9.3. Close inheritance assessed at death

The legislation focuses on the position at death. Therefore, B will be treated as hav.ing “inherited” if B becomes entitled to an IPDI on D’s death, even if that IPDI is soon thereafter terminated.

Brian leaves a QRI, upon trust for his granddaughter, Clare, upon IPDI trusts. Clare’s IPDI is terminated, shortly after Brian’s death, in favour of Brian’s partner, Florence, giving rise to a deemed PET by Clare.

The QRI will be closely inherited, by virtue of Clare’s IPDI, even though Florence becomes entitled thereto after his death.

3.9.4. D has a qualifying interest in possession on death

Property may be inherited by B from D where D did not have an absolute interest, but a qualifying interest in possession, in a QRI on death. Where, immediately be.fore D’s death, the property was settled property in which D was beneficially entitled to an interest in possession, B inherits the property if B becomes beneficially entitled to it on D’s death (IHTA 1984, s. 8J(5)).

This necessarily implies that the QRI must be held either on pre-22 March 2006 trusts for D, or alternatively it must be held on IPDI trusts for D, otherwise the essential condition that the property must form part of the person’s estate before death would not be satisfied.

B will only become “beneficially entitled” to the property on D’s death if B becomes absolutely entitled, or has a beneficiary-taxed interest in possession. In order for the property to be “closely” inherited, B must be a direct descendant of D, such as D’s child or step-child. As to the consequences for Will drafting (see 8A below).

Meera, died leaving her half share in the matrimonial home, on trust for her husband, Raj for life (an IPDI) and subject thereto to their son, Rabinder, absolutely.

On Raj’s death, Rabinder will be treated as having inherited the settled half share because he acquires an absolute interest therein.
Raj has a life interest, but on his death, Rabinder becomes entitled to a life, rather than an absolute, interest.

Rabinder will only be treated as being beneficially entitled to the half share, if his successive interest in possession is a beneficiary-taxed interest in possession. In this context, this means that his interest must be a disabled person’s interest, unless his interest in possession was created by Raj pursuant to a general power of appointment, in which case it can be an IPDI.

3.10. QRI closely inherited

In summary, a QRI will be closely inherited on D’s death where:
(1) D was a joint tenant in equity in a residence, and D’s interest passes by survivorship to direct descendant(s);

(2) D dies intestate, and direct descendant(s) of D inherit D’s residuary estate, including a QRI, absolutely, or in the case of minor children, at 18 on be.reaved minor’s trusts;

(3) D makes a gift of a QRI to direct descendant(s), reserving a benefit therein at the date of D’s death;

(4) D has a beneficiary-taxed interest in possession on death in property which passes to D’s direct descendant(s) absolutely, or on disabled person’s trusts, on D’s death;

(5) D makes a Will leaving a QRI, or residue including a QRI, to direct descendant(s) absolutely, or on IPDI trusts, or other specified trusts (see 8.2 below).