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Table of contents
The Recommendations of the Office of Tax Simplification
The Political Background
Planning for the Future

The current Inheritance Tax regime has largely been in place for over 30 years. Yet the winds of political change are blowing. Once Parliament has time to consider matters besides Brexit, it seems possible – at least more so than at any time in the recent past – that the tax might be fundamentally reformed. With the Office for Tax Simplification (OTS) having now published its review of the tax, we consider its recommendations. We also look at the different paths that politicians might tread, and the estate planning steps perhaps worth taking sooner rather than later.

The Recommendations of the Office of Tax Simplification

The Chancellor Philip Hammond commissioned the OTS to provide an independent review of Inheritance Tax in January 2018. He acknowledged the “particularly complex” nature of the tax as well as the administrative burden many taxpayers encounter in relation to it.

Following a consultation that received an unprecedented level of response, the OTS published the first part of their review last November. That review focused on administrative aspects, such as the paperwork and record-keeping involved. It recommended that HMRC develop its systems to allow all probate applications and Inheritance Tax accounts to be filed online. That would allow forms tailored to the circumstances of the estate, which might especially help the 95% of estates where no Inheritance Tax is due. It also recommended that HMRC improve its online guidance for taxpayers and its responsiveness when dealing with the executors of estates.

The OTS has now also published the long-awaited second part of their review. This recommends a number of ways Inheritance Tax could be simplified, including:

 

  • Consolidating various gift exemptions into a simpler overall gift allowance (set at a higher level than the current annual exemption of £3,000), with a wider disregard for small gifts to limit the record-keeping required.

 

  • Abolishing the normal expenditure out of income exemption, under which unlimited gifts of surplus income are immediately exempt[1].

 

  • Having ‘potentially exempt’ gifts become exempt after five years rather than seven, while abolishing taper relief[2] and the ‘14 year rule’ anomaly[3]’.

 

  • Where possible, shifting the burden of any tax on failed ‘potentially exempt’ gifts to the estate, rather than the recipient of the gift.

 

  • Removing the capital gains tax (CGT) relief on death where assets are exempt or relieved for Inheritance Tax purposes, to avoid assets escaping both taxes.

 

  • Ensuring that death benefit payments from term life insurance are not subject to Inheritance Tax, even where not written in trust.

 

Besides its recommendations, the OTS also noted that the Inheritance Tax status of AIM shares could be regarded as anomalous. It acknowledges that the residence nil rate band introduced in April 2017 is a major source of complexity, but argues it is too early to recommend changes. And it also defers commenting on the complicated Inheritance Tax regime applying to some trusts, pending a separate and ongoing OTS review of the taxation of trusts in general.

The Political Background

Any fundamental changes to Inheritance Tax will require the government to introduce new legislation, and gain the approval of Parliament. In other words, the recommendations of the OTS are advisory only, and it is for the government to decide how to proceed, if at all. While Philip Hammond may have been keen to do so, his days in Number 11 may be numbered, as the next Prime Minister will probably appoint a new Chancellor. So it is possible that the OTS report simply gets kicked into the long grass, as has been the fate of many independent reviews in the past.

That said, a new Chancellor may come with his or her own ideas for Inheritance Tax. Jean-Baptiste Colbert (French Minister of Finances under Louis XIV) once said that “the art of taxation consists in so plucking the goose as to procure the largest quantity of feathers with the least possible amount of hissing”. Yet Inheritance Tax raises relatively little (£5.2 billion in the 2017/18 tax year, just 0.7% of all tax) for the fear and loathing it garners[4], not least as many with larger estates can reduce their liability through careful planning and taking advice[5]. Arguably Inheritance Tax is thus ripe for reform, even leaving aside its complexity.

Boris Johnson and Jeremy Hunt have promised other tax cuts without mention of Inheritance Tax, but they may be tempted by the votes that Conservative promises to cut Inheritance Tax have won in the past. Gordon Brown famously backed away from calling a snap election in 2007 after George Osborne promised to raise the Inheritance Tax threshold to £1m (for married couples). Then David Cameron won a surprise outright majority in 2015, partially on the promise “to take the family home out of Inheritance Tax”. Those promises ultimately led to the complicated residence nil rate band legislation. Might the next Chancellor be tempted to simplify matters by abolishing the residence nil rate band and just increasing the nil rate band instead?[6]

At the last general election, Labour’s manifesto promised to reverse the introduction of the residence nil rate band, but there are signs that their position may be evolving. While Labour maintains its “constructive ambiguity” on official party policy, a recent report (published with party branding) endorsed think tank proposals to abolish Inheritance Tax and replace this with a tax-free lifetime gift allowance of £125,000 per beneficiary. Above that, further gifts received would be assessable to income tax (though there would remain some exceptions, such as for spousal transfers, for small gifts each year, and for businesses and farms). Shifting the tax from the donor to the donee might quieten those who complain of ‘double taxation’ and ‘death taxes’, yet might also increase the tax raised considerably (perhaps to £15 billion per year).

Planning for the Future

We welcome many of the recommendations of the OTS, particularly those in relation to gifting. If enacted, these changes would help to simplify a complicated tax and improve public understanding of it.

The OTS has understandably steered clear of recommending changes that might meaningfully affect the Exchequer’s overall tax take, but we stress that there would still be winners and losers. Many might benefit from a simpler and higher annual gift allowance, and any excess becoming exempt after five years rather than seven. However, we would draw attention to those who might lose out from the abolition of the normal expenditure out of income exemption, the removal of taper relief, and not all assets being rebased for CGT purposes on death.

Finally, we view it as a shame that it is too soon for the OTS to provide recommendations on the residence nil rate band and the 60% effective rate of Inheritance Tax that this creates for a band of wealth, and we continue to look forward to the simplification of trust taxation.

More generally, with the future of Inheritance Tax now somewhat uncertain, our view is that clients with a potential Inheritance Tax liability should make the most of the current known environment. Any new legislation is highly unlikely to be retrospective.

For example, those capable of immediately exempt gifts, and particularly regular gifts out of surplus income, might wish to proceed sooner rather than later. Those capable of large gifts of capital may want to proceed before taper relief is abolished, and especially before Labour’s ideas of a lifetime gift allowance per beneficiary see the light of day. And those considering AIM shares must remember that the success of such a strategy relies upon business relief still being available at the time of death, and that, once again, this has been called into question.

If you would like to review your estate planning strategy, please get in touch and we’d be delighted to provide you with a no-obligation, free financial health check.

 

 

[1] For example, an individual with income after tax of £100,000 and expenditure of £60,000 can make immediately exempt gifts of £40,000 each tax year using this
exemption, providing they do so on a regular and habitual basis. However, OTS analysis of HMRC data suggested that the exemption was only claimed by 579 estates
in the 2015/16 tax year (less than 0.1% of estates).
[2] Where potentially exempt transfers exceed the available nil rate band (up to £325,000), the excess is chargeable to Inheritance Tax if the donor does not survive
seven years. Currently, taper relief reduces the effective rate of tax charged on such gifts if death is between three and seven years, so an Inheritance Tax saving is
possible even if surviving only three years. The OTS proposals would mean that such gifts between three and five years of death would be charged at the full rate.
[3] The ’14 year rule’ means that it is possible for gifts to specific types of trusts up to 14 years before death to affect the Inheritance Tax payable on later gifts.
[4] Interestingly, Fabian Society research published in 2015 found that voters of all political inclinations, occupational backgrounds and ages were almost unanimously
opposed to Inheritance Tax, at least in its current form. Fabian Society, The Tax Detox, 2015: https://www.fabians.org.uk/wp-content/uploads/2015/12/The-Tax-Detox.
pdf
[5] OTS analysis of HMRC data for the 2015/16 tax year suggests that those with estates between £2m and £9m generally paid the highest effective Inheritance Tax rates
(around 20%). By comparison, estates worth £10m or more paid a much lower effective Inheritance Tax rate of around 10%, in large part due to the reliefs available for
unlisted businesses and agricultural land and property.
[6] The OTS estimates that if the residence nil rate band were abolished, the nil rate band could be increased to c£376,000 for all on a tax neutral basis.

About The Author

John Hill
John joined Saunderson House in 2011 after graduating with a first-class honours degree in European Social and Political Studies ...
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