Inheritance tax residence nil rate band downsizing provisions

Finance Bill 2016 clause 82

The residence nil rate band (RNRB) was introduced in the Finance (No 2) Act 2015 giving additional relief from inheritance tax on the death of an individual after 5 April 2017 provided the residence is closely inherited. Closely inherited means that the residence has to be inherited by the deceased’s lineal descendants which includes children, grandchildren, stepchildren, adopted children, foster children and children of whom the deceased was guardian. It also includes the lineal descendants of the above and the spouse or civil partner of the lineal descendants.

The RNRB is transferable to the surviving spouse or civil partner to be used on the second death of the couple in much the same way as the nil rate band.

The RNRB will be £100,000 from 6 April 2017 increasing in £25,000 tranches to £175,000 from 6 April 2020. It is tapered at the rate of £1 for every £2 the estate is over £2m and cannot be more than the value of the residence. It is because of this restriction that the downsizing provisions were announced such that if the deceased has downsized on or after 8 July 2015 then provided all other conditions are met the value of the former residence can be used when calculating the value of the RNRB.

The downsizing provisions are included in clause 82 of Finance Bill 2016 heaping yet more complexity on already complex provisions; we have prepared a briefing paper on this clause, ICAEW REP 93/16.

When transferring the nil rate band or the RNRB, the value of the band available is calculated using a percentage rather than an absolute amount, so if the bands increase in value the amount available will also increase proportionally. The downsizing provisions however freeze the relief that can be claimed at the time of the downsizing rather than expressing it as a percentage of the RNRB.

This is best illustrated by an example: John owns his own house which is far too big for his needs so decides to downsize and rent a property. The house at the time he disposes of it is worth £100,000. When he dies his estate qualifies for up to the maximum residence nil rate band of £175,000. The house from which he downsized is worth £150,000 at that time but the executors can only claim the £100,000 as the relief was frozen at the time he downsized.

The policy does not achieve its aims where a person owned more than one interest in a property, for instance the person owned part of the property outright and the other part was owned through a life interest trust. Under subsection 8H(4C)(b) only one property interest can be nominated on which to claim the downsizing relief.

We have consistently recommended that instead of the RNRB, the nil rate band should be increased. The increase could be tapered for larger estates in just the same way as for the RNRB so only the “smaller” estates benefit and the rate of taper and the level of the increase in the NRB could be adjusted to make this change fiscally neutral. If this suggestion was adopted the complexity would go as would the discrimination introduced by this policy; it discriminates, amongst others, against those without children, those who have chosen to invest in assets other than their own home, and those who live in the north of the country where the value of the property may be well below the maximum £350,000 available for a married couple.

To enable lay executors to manage probate for their family members it will be essential for HMRC to provide comprehensive guidance in plain English.

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