Last year, the Office of Tax Simplification (OTS) was asked by the Chancellor of the Exchequer to conduct a review into Inheritance Tax (IHT). The OTS’s findings are being published in two reports. The first was published at the end of November 2018 which covered administrative concerns. Information on the first report can be found on our previous article.
On 5 July 2019, the OTS released their second report which covers wider areas of technical concern. This report has made a number of recommendations and comments. The key areas covered are listed below and the full report can be found here.
Lifetime Gifts for Inheritance Tax
The report’s key recommendations relate to lifetime giving.
If a person currently wants to make lifetime gifts to reduce their IHT liability, there are a number of reliefs available to them:
- Annual exemption of £3000
- Small gift exemption of £500
- Gifts in consideration of a marriage/civil partnership
The OTS recommends replacing the annual exemption and gifts in consideration of a marriage exemption with one personal allowance. Doing this would remove the complexities caused by the number and interactions between different exemptions. The level of this allowance would need to be considered.
They also recommend keeping the small gift exemption separate from this new personal allowance as removing the small allowance could be complex. It would require all gifts, no matter how small, to be taken into account when considering if the personal allowance has been exceeded. They do recommend reconsidering the level of the small gift exemption.
Regular gifts out of income
In certain circumstances, regular gifts of surplus income could be seen as exempt from IHT.
The OTS comments that this exemption is often misunderstood, is overcomplicated and is too difficult to claim unless the deceased has made plans during lifetime. The OTS recommend either removing the need for gifts to be regular and introducing a limit to the exemption or replacing the exemption by making the personal gift allowance higher.
Currently, if a person makes a lifetime gift (for which no exemption applies) and they die within 7 years of the gift, the gift will become chargeable and be considered as part of their estate on their death.
The OTS recommends shortening this period from 7 years to 5 years as executors can find it difficult to obtain records of older gifts particularly for gifts older than 6 years old. They presume that due to this some older gifts are not reported to HMRC. Unsurprisingly, little inheritance tax is paid on gifts made more than 5 years before death currently.
In addition to the 7 year rule, there also a second rule known as the 14 year rule. It can become necessary to look back up to 14 years before death when, for example, there has been a gift to a trust followed by a gift to an individual and the giver then dies within 7 years of the gift. When considering the amount of NRB available at the date of the second gift, regard must be given to the amount already used against chargeable lifetime transfers made in the 7 years before the date of the gift. The OTS recommend removing this ‘confusing rule’.
If the gift becomes chargeable, there is currently taper relief available that applies to the value of any IHT due:
- Survives by 3-4 years: 20%
- Survives by 4-5 years: 40%
- Survives by 5-6 years: 60%
- Survives by 6-7 years: 80%
The OTS recommends abolishing the taper relief. They recognise that this creates a cliff edge as gifts made 5 years less one day before death would be chargeable at 40%, however they consider the merits of introducing the shorter 5 year period outweighs this.
Liability for payment and NRB
Under the current rules, the NRB on death is applied to a lifetime gift first and IHT is only payable if the gift is higher than the NRB. If a person has made multiple lifetime gifts, NRB will be applied to the earliest gift first. If there is any NRB leftover, it will then be applied to the next gift until NRB has run out. Any gift made on the same day will benefit from the NRB proportionately.
Unless the deceased’s Will specifies otherwise, the recipient of the gifts are liable for any IHT due on a lifetime gift.
The OTS recommends amending the rules so that IHT payable on lifetime gifts are paid by the estate rather than individuals and that the NRB is allocated proportionately to the gifts rather than in chronological order.
Interaction between Inheritance Tax and Capital Gains Tax
Under current rules, Capital Gains Tax (CGT) is not charged on the death of an owner. Instead, when a person inherits assets they are seen as acquiring those assets at the market value of those assets at the time of death. This is known as the capital gains uplift on death.
The OTS comments that the CGT uplift on death often distorts people’s decision making where there is an IHT relief available on death. Farmers and business owners are encouraged to hold assets until death due to the tax benefits when it may be more beneficial to sell or give the business away during lifetime.
The OTS recommends that where a relief or exemption from Inheritance Tax applies, the CGT uplift should not apply and instead the recipient of the gift will be treated as acquiring the assets at the value the deceased originally acquired them for CGT purposes.
Residence Nil Rate Band
The OTS recognise that the present rules are complex but as the Residence Nil Rate Band (RNRB) is still new, more time is needed to evaluate its effectiveness before recommendations can be made to simplify it.
The OTS has heard many comments about both the policy and the implementation of the RNRB. While encouraging and facilitating the passing on of the family home to children and grandchildren is a government policy decision, the way the present rules work is complex.
The OTS recommend that death benefit payments from life insurance policies are free of IHT regardless of whether the they are written into trust or not.