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Proposals for the simplification of Inheritance Tax

Simplification of Inheritance Tax (IHT)

Based upon the current rules, IHT applies primarily on death and gifts made to individuals within seven years of death.  However there are a number of exemptions and reliefs, such as the annual allowance for gifts and business property relief, meaning potentially that no IHT is due.

The government felt that the current IHT regime needed to be reformed and simplified.

Earlier this year, the Office of Tax Simplification (OTS) published their second report and made eleven recommendations which they felt would deliver a “more coherent and understandable structure to tax”.  We have set out the key recommendations of note below:

Reduction of the seven year rule to five years

This would mean that an individual only has to survive five years after making the gift to ensure that no IHT is due.   This would help with the administration of the estate.

Removal of taper relief

Currently, if an individual dies after three years but before seven years of making a gift, the amount of IHT payable is reduced.  Effectively, the closer to the seven years the less IHT will be payable.  By removing this taper relief, this has the potential to increase the amount of IHT payable.

Introducing a new personal gift allowance and removing the multiple lifetime gift exemptions

Currently there are a few gift allowances, such as the annual allowance (£3,000 per year), small gifts allowance (£250 per year) and gifts in consideration of marriage (the amount depends upon the relationship between the person making the gift and the person getting married).  Having one personal gift allowance would remove the administrative burden on the executors and would be welcomed.

Reforming the regular gifts out of income or potentially replacing this with the higher personal gift allowance

Regular gifts out of income is a very useful IHT exemption which allows individuals to make gifts out of the income without having to wait seven years or use up one of the gift allowances mentioned above.  There are a number of conditions attached to this, for example, the gift needs to be out of surplus income; the lifestyle of the person making the gift must not be reduced; and there must be a regular pattern of gifts to that individual.  If this were to be removed, then potentially more gifts would be subject to IHT.

Consider how the IHT nil rate band is allocated, and who is responsible for any IHT payable on lifetime gifts

At present, the IHT nil rate band (currently £325,000) is initially set off against any gifts that were made within the previous seven years, with the earlier gifts using up the allowance first before later ones.  The remaining IHT nil rate band is then applied to the estate.   The OTS felt that this was unfair, and that the IHT nil rate band should be allocated proportionately across all lifetime gifts made within seven years (this could be reduced to five if the first recommendation is implemented) of the date of death.   Currently, unless the person making the gift specifically states that the gift is free from IHT, the person receiving the gift is liable for any IHT payable.  These proposals would mean that any IHT payable is split proportionately rather than being due by one person or the estate.

Review the interaction between IHT and capital gains tax

For capital gains tax purposes, the person inheriting an asset is treated as acquiring it at the market value at the date of death, as opposed to what the deceased actually paid for the property.   The person receiving the asset can then sell the asset shortly afterwards without any capital gains tax being due.  This is regardless of whether any IHT is payable on death.  This could lead to situations where neither IHT nor capital gains tax is payable on death.  The OTS has therefore recommend that the capital gains position be amended, so that if no IHT is payable, then the person inheriting the property is treated as acquiring the property based upon what the deceased paid.  This could lead to significant capital gains tax liabilities arising at future dates.

Business Property Relief

One of the main IHT reliefs is business property relief, which, provided certain conditions are met, means that potentially the entire value of the business property is not subject to IHT.  This is quite a generous relief.  The OTS found that the definition of a ‘trading company’ differs for IHT and capital gains tax purposes.  The OTS stated that the tests for IHT purposes is of a lower standard than that for capital gains tax and has recommended that the same definition is applied to both taxes.  By aligning the definition for both taxes, this could mean that potentially, more IHT will be due.

Furnished holiday lets qualify for generous income and capital gains tax reliefs

However, they are treated as investments for IHT purposes.  The OTS have recommended aligning the treatment for IHT purposes, which would result in the businesses being eligible for IHT purposes.  This would be a welcome change.

To discuss any of the above in more detail, you shouldn’t hesitate to contact our Director of Tax, Aaron Phillips:

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Strength in Numbers Autumn 2019