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Inheritance Tax Proposals by the Office of Tax Simplification

Radical reforms of IHT proposed by Office of Tax Simplification

A major review of Inheritance Tax (IHT), published on 5 July 2019, recommends significant changes to IHT, some radical and even controversial. The Office of Tax Simplification (OTS), the semi-independent body which sits in the Treasury, followed its first report on the process of accounting and paying the tax, producing its 2nd report on “simplifying the design of IHT”.  There are always winners and losers in any tax reform, so we aim here to flag up some changes that may be good or bad for specific clients, but these ideas certainly look to make the tax genuinely simpler. 

The OTS looked at 3 key areas:

Lifetime Gifts

The major headline is a proposal to replace the normal expenditure out of income exemption with a new higher gift allowance. While the OTS do not recommend specific figures, they do say e.g. £25,000 would cover 55% of normal expenditure claims. The losers here could be high earners who can put substantial amounts into, say, trusts for grandchildren.  Anyone making such gifts might wish to get them in while they can.

The range of exemptions, and the way they operate is currently too complex. In place of the £3,000 annual exemption and the marriage gifts, it’s proposed there should be an overall gifts allowance and a reviewed amount for the small gifts exemption (currently £250 per person per tax year). Some reform here is reasonably easy to achieve, if the government wanted to simplify IHT with some “quick wins”. The concern always is that they “cherry pick” a plum target like normal expenditure.

Yet there’s more radical reform proposed, in the 7 year period for lifetime gifts, which if you survive you avoid paying more tax on death, which could be reduced to 5 years in return for the removal of the much misunderstood “taper relief”; and the removal of a complex “14 year rule” whereby gifts can be taken into account for this longer period if made to trusts. 

More significantly still, the liability for any extra tax payable on lifetime gifts (if you do die in that 5 or 7 year period) could be moved from the recipients to the estate. The change in the liability for IHT, while a real simplification, could have a significant effect on estates where different people receive such gifts compared with those who inherit on death. Some further careful consideration is needed to the details of how this would work. While it’s clearly simpler for HMRC in collecting the tax, it may add significant complications for some estates and make the task of some executors much more complex.  

Interaction with Capital Gains Tax (CGT)

One major proposal is that the current “CGT uplift”, whereby any gains are wiped out on death, shouldn’t apply where a relief or exemption applies on death. There seems to be a logic in that the CGT uplift applies because there’s an IHT charge on death, so you don’t pay both taxes – and if you aren’t paying the IHT, then why get relief from CGT? If there were a spouse exemption, either with an outright gift to a spouse or one to a trust giving the right to income, you wouldn’t get the CGT uplift. It's not as simple as it seems.

Likewise, Agricultural Property Relief (APR) and Business Property Relief (BPR), often at 100% is a huge benefit to farms and businesses, couldn’t be combined with the capital gains being wiped out. This would avoid the tendency there can be for owners of farms or businesses to hold on to them until they die, rather than pass on to their family in their lifetime. The double benefit of CGT uplift and no IHT to pay can thus be counter-productive, especially as the original purpose when the 100% relief was announced was to encourage passing businesses etc. down to the next generation. This is, in practice, a proposal for a major policy change, rather than a “simplification”!

Business and Farms APR/BPR

A further major policy proposal, which is again not a simplification, is the idea that the government should consider the level of trading activity required to qualify for BPR. At present a business needs to be not “mainly” engaged in investment, such as letting out property for rental income – it needs to be mainly trading.  The test of the extent of trading or investment activity is measured by a number of criteria, including the turnover, profit and management time, as well as the capital value of the different parts of a mixed business. If you manage to get more than 50% trading on this basis, you get a full 100% BPR, whereas coming just under 50% means no BPR. It’s a difficult cliff edge. 

The proposal is that the BPR test should be brought into line with the very different test for Holdover Relief or Entrepreneurs Relief for CGT, which is an 80% threshold. This would have major implications for businesses with a mix of trading and investment, including farms and others where land is let out to produce some steady rent to compliment the vagaries of the market within which they are trading. This needs a great deal of further detailed attention, before it could be put into place, but could be “cherry picked “ by politicians seeing a chance to use this report to raise more tax.

We’ll keep close attention to these proposals, and any response from HMRC/The Treasury, and will be pleased to help client’s consider appropriate planning should these proposals affect them.

Published: July 2019

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July 2019

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Anthony Nixon