Inheritance Tax: Time for simplification of the rules?.

The Government has recognised that the Inheritance Tax rules have become overly complex over the years and as such the Chancellor has instructed the Office of Tax Simplification (“OTS”), an independent organisation, to review and consider the options for simplifying the Inheritance Tax rules and processes with a view to making them both more coherent and easier to understand.

The OTS has recently published their second report on Inheritance Tax containing 11 recommendations concentrating on three key areas:-

  1. Lifetime gifting;
  2. The interaction between Inheritance Tax and Capital Gains Tax; and
  3. Businesses and farms.

Lifetime Gifting

The first big proposal of the OTS relates to lifetime gifting. There are presently an array of different gift exemptions, each with their own thresholds and their own set of rules, making the exemptions unnecessarily complex and administratively burdensome for individuals to understand. A lot of individuals are not aware of the different gift exemptions available and those that are aware do not always understand the rules correctly, which can result in issues and problems arising during both an individual’s lifetime and on their death.

Under current legislation, if you make a gift which does not fall within one of the gift exemptions, you are required to survive 7 years from the date you make the gift in order for the value of the gift to fall outside of your estate for Inheritance Tax purposes. This period can increase to 14 years where gifts have been made into a trust. This is deemed to be unduly cumbersome given it can mean keeping records for up to 14 years and with most banks and building societies not keeping records beyond 6 or 7 years, it can make the job of the Executors extremely difficult when it comes to disclosing lifetime gifts to HMRC on death.

In addition, where an individual survives more than 3 years but less than 7 years from the date of the gift and the gift does become taxable for Inheritance Tax purposes, taper relief must be considered.

The OTS has also considered who should be liable for the payment of Inheritance Tax on lifetime gifts. At present, the liability falls on the recipient of the lifetime gift.

The OTS has proposed the following solutions:-

  • To replace the various gift exemptions with an overall personal gift allowance incorporating an increased lower threshold for small gifts;
  • To reduce the period in which gifts are taken into account from 7 years to 5 years and, to balance this, abolish taper relief;
  • Inheritance tax on lifetime gifts to be paid by the donor’s estate or from the recipient’s share of the donor’s estate;
  • Changing how the Nil Rate Band is allocated to gifts, from chronological order to a proportional allocation across all gifts.

The interaction between Inheritance Tax and Capital Gains Tax

When an individual passes away, the individual inheriting the asset is treated as acquiring the assets at date of death value rather than at the acquisition value of the deceased. This is highly beneficial as it means that the individual inheriting the asset can dispose of the asset soon after the deceased’s death without incurring any Capital Gains Tax liability. In some instances, the individual inheriting the asset can receive and dispose of the asset without the payment of either Inheritance Tax or Capital Gains Tax.

The OTS is concerned that these rules stop individuals from passing on their assets during their lifetime through fear of missing out on the valuable Capital Gains Tax uplift.

In solution to this the OTS has proposed that the Capital Gains Tax uplift be removed where a relief or exemption for Inheritance Tax applies so that the individuals inherit the assets for Capital Gains Tax purposes at the deceased’s historic base cost.

Businesses and Farms

Business Property Relief (“BPR”) and Agricultural Property Relief (“APR”) are two extremely valuable Inheritance Tax reliefs which are not to be wasted. It is recognised that the reliefs were brought in to prevent the sale or break up of businesses and farms where there is Inheritance Tax to pay following an owner’s death.

The concern here is that the requirements surrounding the “trading activity” of the business for BPR are different and less favourable than the requirements for gift holdover relief and entrepreneur’s relief. This makes it difficult for business owners to make decisions as to whether to transfer their business during their lifetime or on their death. In addition, the OTS recognised that furnished holiday lets are not treated consistently.

The OTS has proposed the following solutions:-

  • That the level of “trading activity” for BPR be reviewed and be set at a lower level than gift holdover relief or entrepreneurs relief;
  • That the treatment of indirect non-controlling holdings in trading companies be reviewed; and
  • Consider aligning the treatment of furnished holiday lets for Inheritance Tax purposes with the treatment of furnished holiday lets for Income Tax and Capital Gains Tax.

In addition, the OTS has suggested looking at the following:-

  • Classifying Limited Liability Partnerships in the same way as Limited Companies to ensure fair treatment when it comes to the BPR trading requirement;
  • The eligibility of farmhouses for APR; and
  • Clarity on how businesses or farms are valued. 

Other areas of review

(a)        Life Assurance

Under current regulations, if you have a life assurance policy, unless it is written into trust, the policy will be subject to Inheritance Tax.  The OTS has suggested removing the requirement that the policy be written in trust to qualify for tax exemption.

(b)        Pre-Owned Assets Tax (“POAT”)

POAT rules apply an income tax charge to gifts where the donor continues to enjoy an indirect benefit. The report recommends a review of the POAT rules generally to consider their function and whether they are still necessary given that they are very complex and largely misunderstood.

Summary

The OTS has made a number of recommendations and proposals in the hope that it will simplify the Inheritance Tax position. There are certainly some eye-catching proposals; namely the amendment to the 7 year rule and removing the Capital Gains Tax uplift where Inheritance Tax is not paid on death.

Some of the recommendations do appear sensible and are as expected, however many practitioners had hoped that the report would tackle the matter of the Residence Nil Rate Band which has been the subject of much criticism both for its complexity and perceived unfairness. The report acknowledges the issues raised by practitioners however, in view of its relatively recent introduction they have determined that the relief will need to operate for a few more years before they can accurately evaluate its effect.   

We are yet to see if any of the recommendations will be implemented by the government but at the recent Conservative Party Conference, the Chancellor Sajid Javid revealed that he is considering whether Inheritance Tax, which is branded as the “most hated tax”, should be scrapped altogether.

Labour has also recently reported on the scrapping of Inheritance Tax in their Land for the Many policy paper. In that paper, they advocate that Inheritance Tax should scrapped altogether and replaced with a lifetime gift tax levied on the recipient.

Scrapping Inheritance Tax altogether would be enormously expensive for the Treasury who collected receipts totalling £5.4bn last year but it is a consideration for both the Conservative and Labour Party.

Whatever direction the government takes in the coming months it seems that the rules on Inheritance tax will be subject to change in one form or another. If you wish to discuss your personal situation then please contact one of our team.

If you would like further information please contact Kerry Sawyer or Jeremy Duffy.

The contents of this newsletter are intended as guidance for readers. It can be no substitute for specific advice. Consequently we cannot accept responsibility for this information, errors or matters affected by subsequent changes in the law, or the content of any website referred to in this newsletter. © Mundays LLP

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