On 5 July, the Office of Tax Simplification (OTS) published the second and final report on the Inheritance Tax (IHT) review ordered by the Chancellor in January 2018.
IHT is one of the most unpopular and disliked taxes in the UK, often generating news headlines and discussions It is regularly subject to political comment and proposals from both sides of the House of Commons (indeed this OTS report follows on from the more controversial overhaul mooted by Labour a few weeks before).
The OTS report has proposed a range of areas to make IHT more straightforward. If these suggestions are taken forward, the main areas that are likely to have an impact on the way people plan to provide legacies to future generations are:
1. Reducing the “seven year rule” to five years
Most people are familiar with the “seven year clock” that starts when larger gifts are given. This proposal is likely to be welcomed, as it is clearly shorter than the current rule, and it will help those dealing with estates, as it is often hard to trace back bank payments beyond six years.
2. The abolition of taper relief
Taper relief reduces the rate of IHT payable on gifts in excess of the IHT nil rate band (currently £325,000) on a sliding scale from three years after the gift is made. The suggestion of abolishing this will stop some of the confusion over this issue, but could be seen by some as a way of generating additional tax. Under this proposal, where substantial gifts are given, an individual will have to survive for more than five years to gain any IHT benefit.
3. The possibility that Term Assurance policies might not need to be held in trust to be exempt?
Currently, unless Term Assurance policies are written under a trust, the proceeds will form part of someone’s estate when they die, which could inadvertently cause or exacerbate an IHT liability. The proposals have said it would be “desirable” for there to be a standard rule that term life policies fall outside of a deceased person’s estate for IHT purposes whether these are in trust or not. This is an area where many people inadvertently find themselves with an IHT liability, and we believe this proposal will be welcomed. However, this could have an impact on the tax received by the exchequer and could cause further confusion in relation to non-term assurance life policies, which we can only assume would still need to be written under trust where appropriate.
4. AIM (Alternative Investment Market) Portfolios might not continue to benefit from Business Relief
At the moment, the application of Business Relief (often referred to as “BPR”) to holdings in certain AIM shares means that they are free from IHT after they are held for a period of 2 years. This has given rise to many fund houses creating AIM portfolio funds which provide IHT relief. However, the OTS report questioned whether these vehicles are in the spirit of the rules.
The rules were introduced over 40 years ago to prevent family farms and businesses being split up to pay IHT bills, and the OTS said that “BPR is not necessary to prevent the business from being broken up or sold in order to fund the payment of IHT … (and) … This raises a question about whether it is within the policy intent of BPR to extend the relief to such shares, in particular where they are no longer held by the family or individuals originally owning the business.” The OTS report called for a review into the treatment of indirect non-controlling holdings in trading companies.
Whilst still only in a proposal stage, this area is one that could cause the largest impact on individuals’ IHT planning, as there has been a huge amount of money added to AIM/BPR portfolios over recent years due to the attraction of relief after 2 years.
5. Changes to Gifting Exemptions
There were several changes proposed here, the key takeaways were as follows:
- Replace the £3,000 annual exemption and gift on marriage/civil partnership with one annual “personal gifting allowance”. The report did not say what the amount of this should be, but observed that the annual exemption had not changed since 1981, and had it been increased in line with inflation, this would now be £11,900. As an aside, the report also observed that the IHT nil rate band of £325,000 has been frozen since 2009, and if this too had been increased by inflation, this would now stand at £423,000.
- Gifts out of ordinary income (i.e. establishing a pattern of regular gifting, which is made from income not capital) to be changed. This is one of the simplest ways to help reduce your estate’s IHT burden, but is hardly used. Of 275,000 IHT returns, only 571 (or 0.2%) claimed this exemption, most of which, 321 (or 0.11%) were under £25,000). The proposal is to remove the need for this to be regular, but rather make the exemption a percentage of income or a higher “personal gifting allowance”.
The second of these is the most concerning, as not only does it highlight how underused a key (and arguably easy) IHT planning exemption is, but also that it could pay you to act sooner rather than later to make the most of this while it is still available.
6. A shake up in the way Capital Gains Tax (CGT) is treated on death
Under current rules, beneficiaries inheriting an asset do so at its market value on the date of death, rather than the amount it was bought for. This means the beneficiary can sell it shortly after the death without paying CGT. If the asset is a farm or business, and therefore exempt or relieved from IHT, the asset can effectively be inherited then sold without any tax at all.
The OTS report says that “this can put people off passing on assets to the next generation during their lifetime”, and “it distorts and can complicate the decision making process around passing on assets to the next generation.” With this in mind, the report stated that “The OTS has concluded that this distortion would be best addressed by amending the CGT rules rather than changing inheritance tax.”
The current rules encourage people to hold onto assets until they die, which restricts assets flowing through generations, and the rationale behind the proposal here will help this. However, the proposal itself would potentially give rise to future generations not fully benefiting from the growth in assets that have been wisely purchased and held onto, but rather them losing a proportion of this to additional revenue raised for the exchequer either through IHT or CGT.
The press comment relating to the report, and the general consensus of the professional community, is generally saying that the rationale behind the report is relatively sound. However, not all of the recommendations have received a warm welcome as briefly commented on above.
It should be remembered that the OTS is the independent adviser to government on simplifying the UK tax system, and as such, it makes recommendations for the government to consider only – the OTS does not implement changes. This most recent report comes in just ahead of there being a new Prime Minister, and when this happens, potentially Philip Hammond’s departure (as Chancellor) from the Treasury. It is therefore uncertain whether his successor, either appointed by one of the current Tory leadership contenders (or a Labour Chancellor in the event of an election and change of government) will take up its recommendations.
As a key part of many clients’ planning, we will be on hand with any updates in relation to this. However, I would suggest that if legacy planning is something that is important, the sooner you can start, the better, especially in terms of the “gifts out of income” exemption.
If you would like to discuss any of the above, please contact your usual Partners Wealth Management adviser, or call us on 020 7444 4030 for an initial conversation.
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