Scope of Inheritance Tax (IHT)

Inheritance Tax (IHT) is a tax on wealth transfers, primarily charged on death but also relevant to certain lifetime gifts. Recent legislative changes have significantly altered who is within the scope of UK IHT, making it more important than ever to understand how the rules apply to your circumstances.

From domicile to long-term residence

Prior to 6 April 2025, an individual’s exposure to UK IHT depended largely on their country of domicile. Domicile is a complex legal concept, broadly referring to a person’s country of natural, permanent or ultimate home, and it does not necessarily change simply because someone moves abroad.

However, Finance Act 2025 introduced a fundamental change. The scope of IHT is now based on whether an individual is a long-term resident (LTR) of the UK.

An individual is treated as a long-term resident if they have been UK resident for at least 10 out of the previous 20 tax years.

IHT exposure under the new rules

Long-term residents (LTRs)

Individuals who are classed as long-term residents are subject to UK IHT on their worldwide assets. This includes:

• UK property and investments
• Overseas property
• Foreign bank accounts and investments
• Business interests and other non-UK assets

In practice, this brings many internationally mobile individuals firmly within the UK IHT net, even where they would not previously have been considered UK-domiciled.

Non-long-term residents (non-LTRs)

By contrast, individuals who are not long-term residents are subject to UK IHT only on their UK assets. Non-UK assets held by non-LTRs fall outside the scope of UK IHT.

This distinction makes residence history critically important, particularly for individuals who have moved to or from the UK over their lifetime.

Leaving the UK – the “tail” of IHT exposure

For long-term residents who leave the UK, their non-UK assets do not necessarily fall immediately outside the scope of UK IHT.

Instead, the number of years for which worldwide assets remain within the IHT net depends on how long the individual was UK resident before departure.

The rules operate as follows:

• If the individual was UK resident for 13 years or less, their non-UK assets remain within scope for 3 years after leaving the UK
• For each additional year of residence beyond 13 years, one extra year is added to this period
• The maximum “tail” is 10 years

Example

If an individual had been UK resident for 17 years before leaving the UK, they would remain subject to UK IHT on their worldwide assets for 7 years after departure.

This extended exposure is a crucial consideration for internationally mobile individuals and highlights the importance of early IHT planning, particularly where overseas assets are involved.

IHT tax rates and thresholds

The standard rate

Inheritance Tax is charged at 40% on the value of an individual’s estate on death, together with certain lifetime gifts made in the seven years preceding death, to the extent that these exceed available allowances.

Nil rate band (NRB)

For 2025/26, the nil rate band (NRB) is £325,000. This is the amount that can be transferred on death without incurring IHT.

Importantly:

• Any unused NRB can be transferred to a surviving spouse or civil partner
• This means that married couples and civil partners can potentially have a combined NRB of up to £650,000 on the second death

The residence nil rate band (RNRB)

In addition to the standard NRB, a residence nil rate band (RNRB) may be available where a qualifying home is passed to direct descendants.

Conditions for the RNRB

The RNRB applies where:

1. The property has been the deceased’s main residence at some point; and

2. The property is left on death to a direct descendant, such as children, grandchildren, or their spouses or civil partners

Amount of the RNRB

• For 2025/26, the RNRB is £175,000
• Like the standard NRB, any unused RNRB can be transferred to a surviving spouse

As a result, a married couple or civil partners may be able to pass on up to £1 million free of IHT (£325,000 × 2 plus £175,000 × 2), subject to the conditions being met.

Tapering of the residence nil rate band

The RNRB is subject to tapering for larger estates.

• The taper applies where the value of the estate exceeds £2 million
• The RNRB is reduced by £1 for every £2 by which the estate exceeds £2 million
• Estates valued at £2.35 million or more receive no RNRB at all

The value of the estate for tapering purposes is calculated before reliefs and exemptions, which means that some estates may lose the benefit of the RNRB even where significant reliefs are available elsewhere.

Downsizing addition

Where an estate does not qualify for the full RNRB, it may still be entitled to relief through the downsizing addition, provided certain conditions are met.

This relief is designed to help individuals who have sold or downsized their home but still wish to leave assets to their descendants.

Conditions for the downsizing addition

All of the following must apply:

1. The deceased disposed of a home on or after 8 July 2015 and either downsized to a less valuable property or ceased to own a home altogether

2. The former home would have qualified for the RNRB if it had been retained

3. At least some of the estate is inherited by direct descendants or their spouses

Where these conditions are satisfied, additional relief may be available to compensate for the lost RNRB.

Lifetime gifts and IHT planning

Making gifts during your lifetime

One of the most effective ways to reduce IHT is to gift assets during your lifetime.

• Lifetime gifts generally fall outside the IHT net after seven years, provided the donor does not retain a benefit in the gifted asset
• If death occurs within seven years, the gift may still be chargeable, but relief may apply

Taper relief

Where death occurs more than three years after making a gift, the amount of IHT payable on that gift is reduced on a sliding scale, depending on how long the donor survived after making the gift.

Capital Gains Tax considerations

While lifetime gifting can be effective for IHT, it may give rise to Capital Gains Tax (CGT).

• Some assets are CGT-exempt, such as cash and gilts
• Other assets may trigger CGT on disposal at market value

Balancing CGT and IHT considerations is therefore essential when planning lifetime gifts.

Gifts out of surplus income

A particularly valuable and often underused IHT exemption applies to regular gifts made out of surplus income.

• Such gifts are immediately exempt from IHT
• The exemption applies even if death occurs within seven years

To qualify:

• The gifts must be regular
• They must be made from income, not capital
• The donor must retain sufficient income to maintain their normal standard of living

Documentation is critical

HMRC may scrutinise claims for this exemption, so it is vital to retain clear documentation showing:

• The source of income
• That the gifts were regular
• That the donor could afford the gifts without reducing their lifestyle

Other IHT reliefs and exemptions

In addition to gifting strategies, individuals should consider making use of other available IHT reliefs and exemptions, including:

• The annual £3,000 gifting exemption
• Small gifts exemptions
• Spouse and charity exemptions
• Business and agricultural reliefs (subject to recent and forthcoming restrictions)

Final thoughts

The changes introduced by Finance Act 2025 represent a major shift in the UK’s IHT regime, particularly for internationally mobile individuals. The move from domicile-based rules to a long-term residence test makes forward planning more important than ever.

While IHT remains a complex and often emotive area of tax, careful planning during lifetime, combined with a well-structured will, can significantly reduce the tax burden on death. Professional advice should always be taken to ensure that strategies are appropriate, compliant and aligned with wider financial and family objectives.