بِسۡمِ اللهِ الرَّحۡمٰنِ الرَّحِيۡمِ
In the last few months, it has become clear that some Western governments allocate taxpayer money to fund or financially support wars that many citizens deem unjust, it's understandable that individuals may feel reluctant to contribute to such endeavours through taxes. By employing legal methods to minimize tax payments, citizens can assert a form of conscientious objection, refusing to financially support actions that conflict with their moral compass. Redirecting funds away from war efforts allows individuals to allocate their resources towards causes they believe in, whether it's humanitarian aid, education, healthcare, or environmental conservation. It's a way for citizens to reclaim a sense of agency and actively shape the world according to their values, fostering a society driven by compassion and justice rather than perpetuating cycles of violence and conflict.
One tax which can be wholly avoided by careful estate planning is the inheritance tax. This tax is seen as being unjust by many as it is tax on money which has already been taxed. The inheritance tax landscape is intricate and requires careful planning in advance.
Objectives of an Islāmic Will
Since I became interested in Islāmic Succession law about 20 years ago the 3 components of an Islāmic Will in order of priority, in my view, have been:
- To try to ensure to ensure the estate of the testator is distributed according to Sharīʿa in a non-Islāmic state under all circumstances without being dependent on any external factors.
- The methodoloy used must be Sharīʿa compliant and within the confines of the law laws.
- Try to minimise taxes and expenses levied on the deceased's estate, namely inheritance tax in U.K. and estate tax in some jurisdictions.
Inheritance tax should be seen as a debt and paid as per local law. However, due to recent events and actions of the government one should try to put more weight on minimising IHT by all legitimate means. There are instruments available to allow individuals to do just that.
Key considerations regarding inheritance tax in U.K.
1. Inheritance Tax (IHT):
Inheritance in the U.K. pertains to the total value of a deceased individual's estate before distribution to heirs or beneficiaries, whereas estate tax is imposed on the individual beneficiaries who receive assets from the estate. Inheritance tax will need to be settled, if due, before the estate can be distributed amongst the beneficiaries.
It is important as Muslims that we pay any IHT due as it is seen as a debt. WE should not resort to deception or lying to avoid paying IHT, there are many legal ways to minimise IHT burden.
2. Inheritance Tax Applicability Depends on the Country of Domicile:
Inheritance tax applies to all assets (any “transfer of value”) of the deceased if UK domiciled. The domicile status applicable to succession may be different from “deemed domiciled” status for inheritance tax purposes. An individual, of non-U.K. domicile of origin, living in the U.K. for a very long time may elect to maintain a non-domiciled status purely for tax purposes.
If your permanent residence is abroad then IHT is paid on UK assets only. However, moving abroad in your final sickness will not allow you to avoid paying IHT on your foreign assets as you have to be permanently resident abroad for the last 3 years of your life.
3. Inheritance Tax Thresholds NRB and RNRB:
The current rate of inheritance tax is 40% on the amount above the threshold referred to as the nil rate band (NRB), currently £325,000.
With effect from April 2017, the UK government introduced the family home allowance or main residence nil-rate band (RNRB), which is worth an additional £175,000 per person if you pass your home or a share of it to your children or grandchildren (including adopted children, step-children or foster children).
4. Residence and Transferable Nil Rate Band TNRB:
RNRB allows married couples and civil partners to pass on assets worth up to £1m including the main residence to their direct descendants, without paying any UK IHT.
Spouses can transfer any unused NRB to the surviving spouse, thereby increasing the NRB to £650,000. This is referred to as the transferable nil rate band (TNRB). You may also be eligible for the residence nil rate.
CAUTION If you are married by nikah ceremony in UK without registering your marriage then you cannot benefit from transferring unused NRB/ RNRB.
CAUTION Parents often desire to transfer the family home to their children without burdening them with substantial tax obligations. In the UK, a couple can transfer a property valued up to £1 million to their direct descendants tax-free, while amounts exceeding this threshold are subject to a 40% tax rate. Similarly, a single individual with children can pass on a home worth half of that sum without incurring taxes. Consequently, parents may be tempted to transfer ownership of the family home during their lifetime to avoid inclusion in their estate for inheritance tax purposes. However, gifts are exempt from inheritance tax if the donor survives for seven years after making them. Yet, this strategy may fail if not executed properly. Living in the gifted property post-transfer is regarded as a "gift with reservation of benefit," rendering it ineligible as a genuine gift due to attached conditions.
CAUTION Attempting to circumvent regulations by selling one's home and gifting the proceeds to children for purchasing another property is not a viable strategy. Even if the children permit the parents to reside in the new property rent-free, there is a potential for encountering significant tax liabilities. Such arrangements may violate either the "reservation of benefit" rules, resulting in an inheritance tax obligation, or the "pre-owned asset" legislation, leading to an income tax assessment. Essentially, these regulations levy charges based on the perceived benefit received by the individual.
5. Inheritance Tax Also Applies to Overseas Assets:
Inheritance tax applies to all assets (any “transfer of value”) of the deceased if UK domiciled.
6. Inheritance Tax Rate:
The current rate of inheritance tax is 40% on the amount above the NRB.
7. Asset Valuations and IHT Formula:
Asset valuations entail determining the fair market value of assets owned by a deceased individual, comprising real estate, investments, personal property, and other assets. This valuation minus the current NRB cumulatively constitutes the taxable estate, serving as the foundation for calculating inheritance tax liabilities.
8. Gifts Made to Individuals and Inheritance Tax:
Small lifetime gifts within certain limits are exempt from IHT. Small gifts of up to £250 per recipient per year with an annual limit of £3,000.
Outright gifts made to another individual are exempt from IHT if the donor survives seven years after giving the gift. There is no reduction in IHT if the donor dies within three years of making the gift. After three years the IHT is reduced by a fifth from 40% every year (32%, 24%, 16%, 8% and 0%) until it becomes fully exempt after seven years.
Under Section 21 of the Inheritance Tax Act 1984, individuals can slash their IHT bill by making regular gifts out of income.
The gifts must meet three conditions in order to be deemed exempt from IHT.
- They must count as normal – that is “regular” – expenditure (so a one-off gift to help your child refurbish their kitchen wouldn’t qualify).
- They must be paid out of surplus income (not capital) – what’s left after you’ve paid all your outgoings.
- And they must not negatively impact your standard of living
If these three conditions are met the seven year rule does not apply.
Under Section 12 of the Mental Capacity Act 2005, an LPA may be allowed to make a gift to themselves, a family or friend, or “any charity to whom the donor made or might have been expected to make gifts” provided it’s given as part of a “customary occasion”.
CAUTION When making a gift, ensure proper and formal execution. Revenue & Customs may scrutinize gifts made within seven years preceding the giver's death, accessing extensive personal data through the Connect database.There is no statutory limitation on the tax authority's ability to initiate such investigations. Presently, unpaid inheritance tax accrues interest at a rate of 7.75%, with potential penalty additions contingent on the reason for the shortfall.
9. Exemptions from IHT:
i) Charitable giving is exempt from IHT. Any donations to a charity through a Will would be exempt from IHT.
ii) Funeral expenses are typically considered a liability of the deceased person's estate and are paid out of the estate before any inheritance tax liabilities are calculated. However, it's important to note that funeral costs can be deducted from the value of the estate before inheritance tax is calculated, which effectively reduces the amount of tax payable.
iii) The residence nil-rate band (RNRB) allows individuals to pass on a property to direct descendants tax-free, subject to certain conditions. As of 2024, the RNRB is £175,000 per person, and it can also be transferred between spouses. See details above item no. 4
iv) Enterprise Investment Schemes are exempt from IHT after holding such an investment subject to the Company being allowable under Business Property Relief.
v) Setting up trusts can be an effective way to pass on assets while minimizing inheritance tax liabilities. There are various types of trusts available, each with its own tax implications, so it's important to seek professional advice to determine the most suitable option.
vi) Selling one’s property to a home reversion plan, which is a type of equity release scheme and using the resulting income to fund a life insurance policy, written in trust for the beneficiaries, so as to replace the lost value of the property.
vii) Married couples can pool their inheritance tax allowances. While a single person has an allowance of £325,000, couples enjoy a combined allowance of £650,000 upon the death of the surviving spouse. Importantly, widows or widowers maintain their deceased spouse's inheritance tax allowance even upon remarriage. This means that upon remarriage, they can combine their allowance with that of their new spouse. For instance, a widower intending to leave a £1 million property to his children could do so tax-free. His new spouse, with her own £500,000 allowance, could also pass on a family home tax-free. Together, they can transmit an estate of up to £1.5 million without incurring inheritance tax.
viii) Pensions can serve as a tax-efficient method for transferring wealth to beneficiaries without incurring IHT.
ix) Reclaiming overpaid IHT
Inheritance tax is typically due within six months of a death and is calculated based on an estimate of the deceased's asset value at the time of death. Executors have the option to reclaim overpaid inheritance tax if they sell a property at a lower value within four years of the death. This refund is especially prevalent during periods of declining house prices, as the actual selling price may be lower than initially estimated. Additionally, refunds can be sought for shares and eligible investments sold at a reduced value within 12 months of the death.
CAUTION Despite not being deemed Sharīʿa compliant, many Muslims in the UK possess life insurance policies, often intended to provide financial support to their loved ones upon the policyholder's demise. However, improper setup of these policies may result in an unnecessary inheritance tax liability. By placing life insurance policies into trust, they are excluded from the policyholder's estate for inheritance tax assessment.
CAUTION Pensions serve as a tax-efficient method for transferring wealth to beneficiaries. If the pension holder passes away before reaching 75 years old, the pension can be inherited tax-free. However, if the pension holder is older, the beneficiary may be subject to income tax upon withdrawing funds from the pension. Unfortunately, many pension holders inadvertently compromise this tax-free status by unnecessarily withdrawing funds and depositing them into savings accounts. Once withdrawn from the pension, the funds become susceptible to inheritance tax. It's crucial to recognize that funds remaining in the pension upon the holder's death are typically exempt from inheritance tax, unlike savings accounts and most other investments.
CAUTION Married couples can pool their inheritance tax allowances. You must be married or in a civil partnership to be able to enjoy this benefit. A couple married with nikah but without a registered marriage would not be entitled to the allowance.
Related articles:
Halāl Wealth, Halāl Money and Succession
A. Hussain