A review of inheritance tax (IHT) rules has led to recommendations that the Government make it simpler for people to pass wealth on to future generations.
The review, carried out by the Office of Tax Simplification (OTS), initially examined the views of representative bodies, professional advisers, academics and the general public before making recommendations which covered the administrative aspects of Inheritance Tax. Its first report, released in November 2018, drew attention to the fact that fewer than 25,000 estates were liable for inheritance tax, representing less than 5% of deaths – although ten times that number of estates had to complete and submit forms.
The second report, released this month, looks at the design of Inheritance Tax and recommends changes that would make it easier to understand and operate. There are 11 recommendations in total which largely relate to lifetime gifts, the interaction between IHT and Capital Gains Tax (CGT), and businesses/farms. The main recommendations are as follows:
Currently there are a number of valuable allowances enabling gifts to be made during a person’s lifetime without impacting inheritance tax. With these allowances, it does not matter if the person makes the gift today and dies tomorrow – there is no IHT implication.
- £3,000 each tax year (the annual exemption which can be carried forward one year)
- £1,000 per person for wedding or civil ceremony gifts (£2,500 for a grandchild or great-grandchild / £5,000 for a child)
- Small gifts up to £250 per person (to as many people as you like, provided you haven’t used another allowance for them)
- Normal gifts out of disposable income
The last point on this list is an incredibly valuable allowance. It means you can give away any amount per year out of your excess income without IHT implications, provided your standard of living is unaffected.
The OTS believes these allowances are complex and create confusion. They can also require extensive record keeping in order for the person’s estate to claim them successfully. It therefore recommends:
- Replacing the annual gift exemption / marriage / civil partnership gifts allowances with an overall personal gift allowance.
- In consideration of the above, reconsidering the level of small gifts exemption.
- Reforming the exemption for normal expenditure out of income or replacing it altogether with a higher personal gift allowance.
The latter could be quite a blow to those with high earnings who can use this allowance for some highly effective inheritance tax planning. The impact will depend on how high the personal gift allowance is set but given that gifting under this allowance is effectively unlimited, it is likely those using it will lose out.
2. Taper relief
Where a gift is not covered by one of the above allowances it may attract inheritance tax if the donor dies within 7 years of making it. In fact, if the individual makes gifts into a trust, their executor may need to look back as far as 14 years before their death to see if IHT may be due. The OTS notes that often locating such records is difficult and further, that the later part of the 7 year period raises little tax. This is because gifts made between 3 and 7 years prior to death attract taper relief – meaning that rather than pay inheritance tax at 40%, a lower rate is due. However, taper relief is only relevant where the deceased has made lifetime gifts that total more than their nil-rate band.
The OTS therefore recommends that the 7 year period in which IHT may be due is reduced to 5 years. Further they recommend abolishing taper relief. Currently the reduced rate of 32% IHT is payable on gifts made within 3 to 4 years of death; while 24% is due on gifts made between 4 to 5 years of death. Under the proposals, a gift made between 3 and 5 years of death would attract the full 40% IHT rate.
However, estates affected by gifting within 5 years of death (who currently pay 16% within 5 to 6 years or 8% within 6 to 7 years) would pay nothing.
Perhaps a slightly more welcome proposal is the recommendation that the government remove the need to take account of gifts made outside of the 7 year period when calculating IHT (i.e. where the deceased has paid money into trusts in the past 14 years). This would simplify matters and reduce the amount of IHT paid for those affected.
3. Lifetime gifts
Lifetime gifts that do not fall under the above allowances may attract inheritance tax if the donor dies within 7 years. The gifts use up the nil rate band in order – so if Sam gives £325,000 to Tim one year and £325,000 to George the next year, Tim’s gift would be free from inheritance tax (covered by Sam’s nil rate band) while George’s may be subject to IHT at 40% if Sam then dies. It is unlikely that the person giving the gift would be aware of these rules – or even desire the outcome.
The OTS therefore recommend these are reformed. One suggestion is to allocate the nil rate band proportionately – so, in the example, Sam’s allowance would be split and applied equally to Tim and George’s gifts, leaving them each with the same IHT to pay (the donor can also specify that if IHT becomes due, it is paid out of their estate).
4. Capital gains tax
Currently there is no capital gains tax due on death. Where a person inherits an asset, they are treated as acquiring it at its market value at the time of their death, rather than the price the deceased originally paid for it. To illustrate, Sam buys an interest in a business for £50,000 which increases to £1 million. If he passes this on to Tim on death, no CGT is due and Tim is treated as if he acquired the business interest at £1 million.
Some property will be exempt for both IHT and Capital Gains (e.g. certain business property and agricultural property) and, as a result of this rule, the beneficiary can sell it shortly after death without capital gains or IHT liability. Consequently in the above example (assuming the interest in the business was eligible for business property relief), Tim acquires the interest free from IHT and CGT and can immediately sell it, realising a gain of £950,000 with no tax implications.
The OTS believe this distorts peoples’ decisions about when to pass on assets. They suggest that the beneficiary should be treated as if they acquired the asset at its base cost. In the above example, Tim would be treated as acquiring the asset at £50,000 (the amount Sam paid for it). If he then sold it for £1 million, capital gains tax would be due on the £950,000 gain.
5. Business property and agricultural property relief
Currently inheritance tax reliefs are available for certain business and agricultural property. This is to prevent the necessity to break up or sell the business on death in order to finance a large inheritance tax bill. However, the IHT rules as to these reliefs differ from the Capital Gains tax rules, and the OTS believe simplifying these could make it easier to decide what to pass on during a person’s lifetime and on death.
The OTS also recommend looking at whether furnished holiday lets should be treated as trading for inheritance tax purposes, subject to certain conditions (as they are under Income Tax and Capital Gains rules). This could bring investment properties under business property relief, offering a valuable IHT tax break.
6. Life insurance policies
Currently the value of a life insurance policy can be passed on free from inheritance tax, provided that it is written into trust. This allows donors to pass on thousands of pounds tax free, over their nil rate band personal allowance. However, few people are aware of the need to fill out a trust document and so the benefit is often missed. The OTS recommend that death benefits from such policies should be automatically IHT free, without the need for them to be written into trust.
7. Residence nil rate band
Currently in addition to the nil rate band, each person can pass on up to £150,000 to a lineal descendant free from tax in the form of a property. This means for example that with some tax planning, a couple can pass on up to £950,000 to their children or grandchildren, free from inheritance tax.
However, not everyone has children or grandchildren. Those wishing to benefit other family members cannot take advantage of the allowance as it is only available for lineal descendants. The OTS identify this as unfair. In addition, where an elderly couple decides to downsize later in life, the allowance can be claimed in relation to the value of the property they sell – but the rules are complicated. The OTS suggest that these could be simplified.
Further recommendations include:
- A review of the treatment of limited liability partnerships in relation to business property relief requirements.
- A review of how HMRC treat farmhouses for agricultural property relief, where the farmer has had to leave the farmhouse for medical treatment or care.
- A revision of HMRC’s guidance in relation to valuing businesses and farms.
- A review of the pre-owned asset tax rules which are complex and not widely understood.
- A review of the rules concerning taxation of trusts, which are highly complex.
Speak to our estate planning department about reducing your inheritance tax liability – call us now on Southport 01704 532890, Liverpool 0151 928 6544 or complete a Free Online Enquiry without obligation.