9 potential Inheritance Tax changes to look out for
Last month, the Office of Tax Simplification (OTS) published its review into the rules surrounding Inheritance Tax (IHT).
Following an 18-month consultation period, the OTS has set out a series of measures designed to make IHT both easier to understand for taxpayers, and easier for HMRC to operate.
While the OTS is not a policy-making body, their review could well influence future legislation. So, we highlight nine of the most important recommendations made by the report and identify what changes could potentially be coming.
- Introducing a single annual personal gifts allowance
The OTS recommend that a single annual personal gifts allowance should replace the current £3,000 annual exemption and the exemption for gifts on marriage.
There is a suggestion that this allowance might even include an amount to replace the more complex ‘gifts from income’ exemption. This has always been slightly problematic as it has been hard to establish exactly what level or frequency of gifting is classed as ‘normal’ expenditure, and executors have often found it hard to make a claim for this allowance.
Bill Dodwell, OTS Tax Director, says: “We recommend replacing the multiplicity of lifetime gift exemptions with a single personal gift allowance, to be set at a sensible level, and incorporating an increased lower threshold for small gifts. The exemption for regular gifts should be reformed or replaced with a higher personal gift allowance.”
My view: Whilst these changes could provide more clarity and even opportunity for you to make gifts, this would not be good for our clients given that may of our clients rely on the ‘normal income’ exemption and could therefore be restricted in the amount they gift. I recommend therefore reviewing the level of gifting that you are currently making to make best use of this valuable exemption whilst available.
- Reducing the ‘seven-year’ rule to five years
Currently, any gift you make in the seven years before your death is considered when calculating your estate’s IHT liability.
The OTS report has recommended that this period is cut to five years because:
- They believe it is too long based on the amount of tax raised
- It will help executors with record-keeping
Standard Life say that, over a 20-year period, this could result in a potential IHT saving of £130,000.
My view: Clearly this is a positive step from a planning perspective, as it would also allow you to make gifts up to the nil rate band (currently £325,000) every five years rather than every seven.
- Clarifying who is liable for paying any IHT that is due
Currently, the nil rate band (£325,000) is used in chronological order against lifetime gifts first with any remainder being used against the estate. This has caused issues when beneficiaries of the estate discover that there is little or no nil rate band left and that there is a substantial amount of IHT to pay.
There may also be tax due on the lifetime gifts, which the recipient is primarily responsible for paying.
The OTS report considers that there may be alternative options here; for example, by making the estate responsible for any IHT on lifetime gifts.
My view: We have often suggested to clients that their will clearly states this, and so a formal change in this regard seems sensible.
- Removing any potential IHT liability on the proceeds of term assurance policies
When we advise clients, we recommend that anyone taking out a life term assurance policy places the policy in trust. This ensures that any proceeds don’t form part of their estate for IHT purposes, and it also avoids the need to wait for a grant of probate.
The OTS has recommended that all death benefits from term assurance policies are not subject to IHT, even if they are not in trust.
My view: Considering the new requirement to register all trusts could deter people from using them, this seems a sound suggestion. It may still make sense to use a trust – speed of payment is a benefit – but as these policies are generally to protect families it appears fair to take the proceeds out of the IHT equation.
- Abolish taper relief
Currently, the tax on lifetime gifts reduces by 20% for each year the donor survives the gift after year three. However, there is frequently no tax to pay on a lifetime gift anyway, as it is covered by an individual’s nil rate band.
As this relief is often misunderstood – many believe the taper reduces the value of the gift rather than the tax, with more IHT payable as a result – the OTS believe it should be abolished.
Bill Dodwell from the OTS says: “We recommend…abolishing the tapered rate of Inheritance Tax (which many find works in a counter-intuitive way). Data made public for the first time shows the tax paid on gifts six or seven years before death is low.”
My view: This could result in a higher tax bill for some individuals. However, shortening the gifting period to five years (see above) would potentially balance this change.
- Remove the Capital Gains Tax uplift if the assets benefit from exemptions
It has become generally accepted that, when someone dies, there is no Capital Gains Tax (CGT) charged on their assets, just IHT. This ‘market uplift’ means the beneficiaries essentially acquire the assets at the market value on the date of death
There have been concerns that where an asset is subject to IHT relief or an IHT exemption, neither CGT nor IHT is payable.
Consequently, the OTS has recommended that the CGT uplift that assets receive on death should be removed if those assets benefit from business property relief (BPR), agricultural property relief (APR) or the spousal exemption.
There would still be no charge on death but, instead, assets would be transferred on a ‘no gain, no loss’ basis. The beneficiaries would acquire the assets at the cost to the deceased.
My view: This would be a significant change. The change is designed to ensure that the objectives of BPR and APR are maintained, so that businesses can be transferred easily as going concerns. Without it, business owners may be tempted to retain control of the business until their death to benefit from both BPR/APR and ‘market uplift’. However, this could create a real issue for clients with second properties with pregnant gains, and a significant issue for executors who would struggle to establish the purchase price of many assets and investments purchased by the deceased, leading to greater complexity.
- Removing the availability of BPR to general investors on the AIM Summary of the OTS findings
Business Property Relief (BPR) was primarily intended to prevent the break-up of smaller businesses on the retirement or death of an owner. Consequently, the OTS report questions the availability of this relief to investors in shares on the Alternative Investment Market (AIM).
In recent years, investing in AIM shares has become a popular IHT planning tool, as the availability of BPR after two years is a quicker way of reducing a potential liability.
My view: This is one of the OTS’ more controversial recommendations. Withdrawing this benefit may be unpopular as smaller businesses could find it harder to raise finances. It could also have a negative effect on AIM share prices and remove a valuable IHT mitigation tool. The good news is that this would make investors consider purchasing AIM stock for investment reasons rather than for IHT benefits with the tax tail wagging the investment dog.
- Abolishing the 14-year rule
When a Potentially Exempt Transfer (PET) becomes chargeable because of death within seven years of making a gift, IHT must be paid as if that gift was chargeable at the time it was made. So, it must take account of any chargeable transfers in the seven years before it.
The OTS wants to abolish this confusing ’14-year’ rule that is difficult to monitor. The advantages are clear, as it would reduce the need for careful record-keeping and ease the job of the executor.
My view: Some common sense here: too many people are unaware of the need to look back a further seven years and this can lead to some significant errors for individuals who don’t take advice.
- Clarity on pension transfers
While the OTS report does not make any recommendations regarding pensions, it highlights the issues that clients and
advisers face in relation to pension transfers.
Government policy has encouraged consumers to use Pension Freedoms to move benefits between schemes to reduce costs and to take advantage of Flexible Drawdown. However, if a member dies within two years of a transfer, HMRC can theoretically claim that the transfer is subject to IHT unless it can be proved that the transfer was not done to benefit someone else.
My view: In practice, it shouldn’t make too much of a difference as, for many, the pension benefits would pass to a spouse on death. I welcome the request for additional clarity that the OTS have made, as it would provide much needed certainty on the consequences of a pension
transfer for all.
Summary of the OTS findings
It’s important to remember that the OTS is an advisory body and that these recommendations are not government policy.
However, it demonstrates the current thinking on how IHT could be simplified, and how future legislation might look.
If you’re concerned about a potential Inheritance Tax liability,please get in touch. As Chartered Financial Planners we can take a holistic view of your financial situation and give you advice on methods to mitigate any liability.
Clients can call or email their Private Client Director or send us a message via the HFMC Wealth website or call us on 020 74004700.