The Office of Tax Simplification (OTS) last month, released the second part of its investigation into simplifying what now seems to be the highly unpopular IHT rules. The findings were reflected in its consultation which elicited an unprecedented level of engagement with nearly 3000 responses to an online survey, 500 emails from the public and 100 written responses.
IHT is payable after the death of a person but is not payable between husband and wife. It is the amount minus any liabilities such as a mortgage. The tax can also apply to some gifts and trusts made during your lifetime.
The first £325,000 of each person’s estate attracts no tax and this is known as the Nil Rate Band (NRB). Married couples can transfer their allowance to the second death making £650,000 in all. With the addition of the Residence Nil Rate Band (RNRB), which only applies to married couples with children, this become more complicated. The various rules have created a version which has earned the reputation of an undesirable tax.
The OTS’ report ‘Simplifying the design of inheritance tax’ puts forward 11 recommendations focused on three key areas;
- Lifetime gifts (including paying any tax due on those gifts)
- Interaction with capital gains tax (CGT)
- Businesses and farms
This package would be designed to create an overall personal gifts’ allowance and replace the annual and marriage/civil partnership gift exemptions. It recommends that the current myriad of exemptions be replaced with one allowance per person. Currently, individuals can give away £3,000 a year without paying IHT and unlimited gifts of under £250 to other people. Parents can give £5,000 towards the cost of a child’s wedding and grandparents, £2,500, IHT free. But, the OTS found the allowances were confusing and poorly understood. While the body did not suggest a level for such an allowance, it pointed out the £3,000 annual limit would now be £11,900 if it had risen in line with inflation. The body also floated the idea of a higher personal gift allowance to replace a tax rule used by those with surplus income.
Gifting period and taper
This suggests the reduction of the period before death in which lifetime gifts can become liable to tax at death. The OTS concluded that the seven-year rule made settling people’s financial affairs difficult for executors as bank statements were only available going back six years. The recommendation was to reduce the survival period of gifting from seven to five years and abolish taper relief (this is the relief given after surviving a gift for more than three years).
The tax can also apply to some lifetime gifts and trusts. Many more people fear having to pay IHT than do, although each year about 250,000 estates must submit IHT forms which result in no payment being required.
It would also remove the need to take account of gifts made up to 14 years before death in certain limited circumstances.
Review options to simplify and clarify liability to pay tax on lifetime gifts and allocation of the Nil Rate Band (NRB).
Interaction with Capital Gains Tax (CGT)
It recommends the removal of the capital gains uplift on death when relief or exemption (e.g. inter-spouse) from IHT applies, leaving the beneficiary treated as having acquired the asset at historic base cost of the deceased.
Businesses and farms
Amongst three other reviews, this package would consider if the level of trading activity for business property relief (BPR) should continue to be at a lower level than gift holdover relief or entrepreneurs’ relief. It would review the treatment of indirect, non-controlled holdings in trading companies and consider alignment of IHT treatment of furnished holiday lettings as trading (under certain conditions) at the same level as income tax and CGT.
Life assurance – Consider making death benefit payments from term assurance policies free of IHT on the death of the insured life without the policy having to be written under trust.
Pre-owned asset tax (POAT) – Review the POAT rules, how they interact with other IHT measurers and consider if they are working as intended or still necessary.
No changes recommended
In some key areas the report has not included specific recommendations for change.
The OTS noted the uncertainty surrounding the IHT treatment of benefits from pensions that were transferred shortly before death. As this subject is currently under appeal in the Supreme Court, it would expect HMRC to revise its guidance once the case is concluded.
Residence nil rate band
There were concerns around the complications of the downsizing provisions with RNRB. However, the OTS considers it too early to determine if the RNRB is operating as anticipated or requires simplification.
HMRC has been consulting on the taxation of trusts and evidence sent to OTS pointed out the serious complexities in relation to trusts around IHT. It would like evidence to be further considered.
The reduced rate of IHT available if 10% of an estate is left to charity has not been widely understood or taken up. This is a relatively recent relief so there were no specific recommendations on it.
There is no timeline on implementation of any of the recommendations. The Treasury said it would respond to the recommendations in due course.
Discussing IHT together
Inheritance tax is a matter we review at every annual client strategy meeting. If you feel you or your family might be affected by these issues, please do not hesitate to contact us.