Family members who live together are not entitled to the same inheritance tax relief available to married couples and civil partnerships, the European Court of Human Rights ruled last week.

Joyce and Sybil Burden, who are sisters aged 90 and 82, were trying to avoid inheritance tax (IHT) on their £875,000 estate when one of them dies.

The Treasury estimates that 40,000 estates a year are subject to IHT charged at 40%. Assets are exempt from the tax if they are below £312,000.

The Civil Partnership Act 2004 granted the same rights that married couples have - including for inheritance tax - to gay and lesbian couples who enter civil partnerships.

The Burden sisters, who have lived together in Wiltshire all their lives, argued before the European court that UK laws that allow property to pass to a civil partner untaxed discriminated against cohabiting couples.

Next year, the inheritance tax-free allowance rises to £325,000, and again to £350,000 in the following year.

Changes announced in the government's 2007 budget in effect doubled the tax relief for married couples and civil partners, who can now pass their unused tax-free allowances to each other when they die.

Therefore, a couple's tax-free allowance is now £600,000, rising to £700,000 by 2010 - provided none of the allowance was used when the first partner died.

The European court, which found against the sisters by 15 to two, said: “The absence of such a legally binding agreement between... [the Burdens] rendered their relationship of cohabitation, despite its long duration, fundamentally different to that of a married or civil partnership couple.”

Upon the death of one, the surviving sister will have to pay inheritance tax of 40% on the value of the inherited half of the properties, once the £312,000 threshold is deducted.

Pauline Fowler, partner at the law firm Hughes Fowler Carruthers, said legislation was needed to clarify the status of cohabitees. “Cohabitation is not a state of affairs that is officially recognised, other than in social security legislation which is designed to protect the public purse.”

Government plans to change the law for cohabitees were shelved in March.

However, Mike Truman, editor of Taxation magazine, said the Burden decision was the right one. “If the European courts had found for the sisters, it would have opened the way for tax to be deferred indefinitely on property. For example, parents and children might buy a home together when the parents were older in order to avoid inheritance tax on the parents' share.”

Penny Bates of Menzies, the accountant, said: “In this case, the surviving sister has the option to pay a tenth of the tax liablity each year until she sells the property. We advise unmarried cohabitees to make provision for inheritance tax IHT in the future, either from savings or life insurance.”

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