Are there changes to inheritance tax ahead?
Are there much-needed changes to inheritance tax ahead? A review of the recent OTS report
The Office of Tax Simplification has published a report, suggesting significant tax reforms, with a focus on inheritance tax and capital gains tax (‘IHT’ and ‘CGT’), lifetime gifting, agricultural property relief (‘APR’) and business property relief (‘BPR’).
Thousands of professionals and practitioners provided their views and the OTS have provided quite an interesting review and proposals.
I have highlighted here some of the most interesting:
I will start with one of the most well-known of the inheritance tax rules – known as the ‘seven-year rule’.
The seven-year rule dictates that assets given away during someone’s life are exempt from IHT if the person lives for at least seven years after making the gift. (It is important that all the conditions attached to the exemption are also satisfied – for example, the exemption would not apply if you make a gift you continue to receive a benefit from).
When the gift is made it is known as a ‘potentially exempt transfer’ (a ‘PET’). The gift can be exempt regardless of its amount and notably the nil rate band of £325,000 has no bearing on an exempt gift, meaning that a gift of £10m could be completely exempt from IHT if it is made over 7 years before death.
If you die within three to seven years of making the gift, there is a form of ‘relief’ known as taper relief whereby the tax payable is tapered on a sliding scale.
It can be extremely difficult, not to mention administratively costly and burdensome, to obtain evidence of lifetime gifting going back seven years. Indeed, most banks will only provide statements from the past six. The seven-year rule has remained unchanged for years.
Consequently, the OTS have proposed it is replaced with a five-year rule. They believe the change would not reduce government revenue as minimal tax is raised for this five to seven-year period.
Whilst this is a step in the right direction, I would have liked to have seen perhaps a three-year rule proposed.
The OTS have also suggested the removal of taper relief which would counterbalance the welcome reduction of the seven-year rule, however it is noted that this change may have transitional rules attached so gifting before the rule is brought in could still benefit from the taper relief. Likewise, gifts made before the five-year rule is brought in may also benefit so there could be no advantages to delaying!
The OTS also noted that the £3,000 annual gift exemption (notably a cumulative total) would now be £11,900 if it had risen with inflation.
A suggested overall ‘personal gifts allowance’, in substitution for the existing rules, has been lauded by many, however it could result in huge IHT bills for wealthy families. We could see a dramatic withdrawal of support for the younger generations who may more than ever need help with, for example, deposits for houses and financial assistance with further education.
Capital Gains Tax:
Notably, the OTS have suggested removing the capital gains tax uplift on death.
Currently (and, interestingly, since the 1970s,) an asset is ‘rebased’ at the date its owner dies; meaning that the beneficiary who inherits the asset, inherits at the new date of death market value. That beneficiaries’ gains or losses are of course subsequently calculated on the rebased value instead of the acquisition value of the deceased.
Consequently, the OTS have adroitly pointed out that individuals often delay in passing business or agricultural assets to the detriment of the business as if the asset is gifted during the lifetime of the donor, the recipient is likely to receive at a lower base cost than if the parties had waited until the donor died.
The OTS report found that some beneficiaries are hit by both CGT and IHT on the same estate while others paid neither. A good example of the latter is where a spouse receives an asset IHT-free due to the spouse/civil partner exemption, or an individual receiving an asset eligible for APR or BPR: a beneficiary receiving such an asset may choose to sell it soon after death, paying no CGT or IHT.
The OTS suggests this is a loophole which ought to be closed and is ‘distorting people’s decision-making’; however, removing the uplift will surely lead to some very high CGT bills making it hard for spouses to divest.
However, if the current rules are preventing people from moving assets down the generations, it could be a welcome change for many – and a positive reinvigoration for business.
The CGT uplift has certainly been an extremely popular rule – and we all know what happens when the taxpayer is given too much cake.
BPR and trading businesses, amongst other matters:
The OTS suggests increasing the threshold of ‘trading activity’ required for BPR to match that used for holdover relief and entrepreneurs’ relief (both CGT reliefs) – in other words, no longer would the test be ‘wholly or mainly’ (i.e. above 50% trading), but instead be upwards of 80% trading as suggested by HMRC’s definition of “substantial trading activity”. This could see a dramatic reduction in qualifying businesses…
They also advocate reviewing the treatment of holiday lets. I must admit, this would be extremely welcome given the confusion arising from much of recent case law. The OTS has sensibly suggested an alignment of treatment whereby the IHT treatment matches that of income tax and CGT.
The report also advocates:
- A review of the position whereby a farmer moves out and goes into care a few months before death, often rendering a hugely disadvantageous position for APR purposes.
- Scrapping the taper relief due to its complexity.
- Allowing all life assurance policies to be IHT-free whether or not they are written into trust.
- A review of the pre-owned asset charge (POAT).
- A review of ‘gifting out of surplus income’ which can be an extremely beneficial tax planning exercise – the OTS’s proposals have drawn heavy criticism from experts. Surely as income has been taxed often at the higher rate individuals should be free to gift what income they do not need, at no further tax!
- Shifting the responsibly of the tax bill on recipients of a ‘failed’ gift, to the estate of the person who made the gift.
- A much-needed review of the residence nil rate band rules as these are complex.
- The OTS also suggests scrapping the oft-forgotten ‘fourteen-year rule’ which comes into play with trusts.
We must now await the government’s response to these proposals.
To be continued…
This paper is intended to be a brief note for clients and other interested parties. The information is believed to be correct at the date of publication but should not be relied upon as a substitute for professional advice. Please speak to a member of our team – email@example.com