Inheritance tax simplification
The Office of Tax Simplification (OTS) has recently published its second report considering the simplification of inheritance tax (IHT). We look at what the report does, and does not, include.
What is not recommended?
At the beginning of the report the OTS emphasises that it is concerned only with simplification of tax law and does not make policy recommendations. The report therefore does not consider whether IHT (which the OTS acknowledges is an unpopular tax) should be abolished or whether it should be replaced with a gift tax or by imposing capital gains tax on death. Many responding to the initial call for evidence will be disappointed that the OTS does not even recommend the abolition of the additional residence nil rate band. (The OTS takes the view that it has not yet been in force for long enough and more time is needed to evaluate its effectiveness.) Those advisers who have been grappling with the additional nil rate band’s intricacies since its introduction two years ago might argue that it has been in force long enough for it to be apparent that it is overly complicated and discriminates against those who have never had children.
What is recommended?
There are a number of proposals outlined in the report and in this article we concentrate on some of the major ones. A useful complete summary of all the changes suggested by the OTS can be found on page 18 of the report.
The OTS point out that there are a number of different smaller exemptions that apply to lifetime gifts, and these have not increased in line with inflation. For example, the annual gifts allowance of £3000 would be £11900 now had it increased over the years since its introduction. Other exemptions exist for small gifts (£250) and for gifts on marriage. Sensibly the OTS suggests that the annual gift exemption and the exemption on marriage gifts should be replaced with a single overall personal gifts allowance. In addition, it proposes that the normal expenditure out of income exemption should be reformed or replaced with this higher personal gifts allowance.
This latter recommendation may not be popular with some taxpayers as the normal expenditure exemption enables substantial gifts to be made which are immediately free from IHT if the person making them has a sufficiently large income enabling them to maintain their usual standard of living despite the gift. If this were subsumed within a personal gifts allowance this would remove the ability to make larger gifts with no IHT payable, however long the donor survives.
The cumulation period
At present gifts made within seven years of death are subject to IHT which can create practical difficulties for executors in identifying the gifts, particularly when only six years of bank statements are available. It is suggested that this should be reduced to a more practical five years and that in tandem with this change taper relief should be abolished.
Taper relief reduces the IHT due on a failed lifetime gift on a sliding scale when at least three years from the gift have elapsed but it is a much misunderstood relief. Some taxpayers believe that it is the value of the gift that is reduced rather than the amount of tax whilst others do not realise that taper relief is only of relevance if the initial gift is in excess of the donor’s available IHT nil rate band. Trading taper relief for a reduced cumulation period seems on the face of it to be a fair exchange.
The OTS points out that many taxpayers are confused about how the nil rate band is allocated in relation to lifetime gifts. Many are unaware, for example, that if they make gifts to their children on different dates the recipient of the first gift may benefit far more than their sibling by receiving the benefit of a greater amount of the nil rate band. Others are surprised that, unless a provision is included in their parent’s Will, they will be liable to pay any IHT due if their parent does not survive the required seven year period.
The OTS recommends that the government should consider options for clarifying and simplifying these rules. One suggestion is that the nil rate band should be allocated in chronological order as at present but applied proportionately across the total value of all lifetime gifts. More detail would no doubt be provided if this were to be adopted but at first sight this might create some difficulties in calculating the ongoing charges on relevant property trusts if the settlor’s available nil rate band were subject to change.
Exempt assets and capital gains tax
The OTS believes that the interaction between capital gains tax (CGT) and IHT is complex and can affect decision making. The report includes a number of recommendations with regard to the detailed operation of business and agricultural property relief. One of the major suggestions is that the CGT uplift on death that presently applies to all assets in an estate should not be available for those assets that are not subject to IHT due to a relief or exemption. At present the beneficiaries of business or agricultural property receive the assets potentially IHT free and if they sell them shortly after inheriting they are only liable to CGT on the gain in value since the date of death. If the suggested change is made the beneficiaries would instead be subject to CGT on the gain since the deceased acquired the asset, a potentially much bigger capital gain.
The OTS believes that this change would remove a disincentive preventing business owners and farmers passing on these assets during lifetime. This may be the case but introducing differing CGT treatment dependent on the reliefs received by the assets left on death does not simplify IHT. Encouraging lifetime giving could also be seen as a policy objective and the OTS explicitly states that it does not make policy recommendations.
Are these changes likely to come into force?
The OTS has made a number of recommendations for general tax simplification since it was first set up in 2010 and many of these have not been accepted or implemented. At present government resources are focussed on implementing Brexit, and if a change in the political complexion of the government occurs, other wholescale changes to IHT may occur, including its possible abolition and replacement by an alternative tax on inheritance. Advisers and their clients should therefore be aware of these recommendations but there is currently no certainty as to whether or not they will come into effect.