Proposed changes to inheritance tax – how might it affect me?
Anyone who wants to undertake estate planning to ensure they are not exposed to any unnecessary inheritance tax charges should be mindful of the ongoing review by the Office of Tax Simplification (“OTS”).
The OTS published its second report on simplifying the design of inheritance tax (“IHT”) in July but whilst the proposals are intended to simplify the inheritance tax regime, the proposal may actually cause complications elsewhere.
The report focused on a number of areas of the regime and how these could be simplified, the main ones being:
- Lifetime gifts
- The interaction of inheritance tax and capital gains tax (“CGT”)
- The ‘Seven year rule’
- Business Property Relief and Agricultural Property Relief
At present, generally speaking, gifts made within the seven years prior to death are included in calculating whether any inheritance tax is due (subject to certain exemptions and reliefs). The range of exemptions and reliefs available is fairly wide (although the amounts themselves can be limited).
The OTS is proposing to replace the annual exemption (a sum that each individual can give each tax year and which can be rolled over if not used – currently £3,000) and the exemption for gifts made in consideration of marriage with a ‘single personal gift allowance’. However, what that fixed sum will amount to has not been suggested. The OTS has also suggested that the £250 limit for the small gifts exemption (the amount one can give to each individual each tax year) is reviewed.
The OTS has also focused on a very generous relief which allows individuals to make gifts out of excess income without incurring any inheritance tax problems. The current regime does require individuals to keep quite detailed records and the OTS has suggested either limiting the exemption to a fixed percentage of a person’s annual income; or setting the proposed ‘single personal gifts allowance’ at a higher figure to ‘include’ the relief given by the exemption.
Whilst these proposals will simplify the regime to some extent, they could have an adverse effect on individuals with high levels of income as the current exemption will be withdrawn and present different tax planning problems for higher earners. Consequently, those with excess income should try and make the most of the current exemption now.
The interaction of inheritance tax and capital gains tax
As the OTS’ report notes, “at a theoretical level, inheritance tax and capital gains tax are quite different and are underpinned by separate policy rationales”. However, in reality, there is a strong connection between the two.
When a beneficiary inherits an asset from a person’s estate, for capital gains tax purposes, that person is treated as acquiring the asset at the value at the date of death. This results in a generous ‘rebasing’ of assets for capital gains tax purposes meaning that any gain accruing to the period before death is effectively forgotten. The rule for lifetime gifts is different – such gifts are usually chargeable disposals for capital gains tax purposes.
Because the two events are treated differently, the OTS has suggested that the capital gains tax treatment in both circumstances is unified; and that the free ‘uplift’ on death is replaced with the beneficiary acquiring the asset at the deceased’s acquisition value. This will have the obvious result of the beneficiary becoming liable for a charge to capital gains tax on gain they have not benefitted from when they come to sell the asset.
The ‘Seven year’ rule
Gifts made in the 7 years before death (or possibly 14 years if gifts are made into trust) are included in working out any inheritance tax liability on death. If those gifts are chargeable to inheritance tax, taper relief applies to reduce the tax bill.
The OTS has recommended that the seven year period is reduced to five years; and the 14 year rule relating to gifts into trust is abolished. Both of these are welcome recommendations. However, the flip side is that the OTS has also recommended abolishing taper relief, meaning that (assuming their other recommendations are adopted) if a gift made within five years of death is brought back into account, the full amount of tax will be due. This potentially means greater premiums for those who insure against the potential tax liability as the liability will not taper away (the premiums of which are often ‘tax free’ as gifts out of excess income but which could become potentially chargeable gifts if the OTS’ other recommendations are taken up).
Business Property Relief (“BPR”) and Agricultural Property Relief (“APR”)
Both Business Property Relief and Agricultural Property Relief are very valuable tools when it comes to estate planning; and can help significantly reduce an inheritance tax liability, although they are complex areas on which specialist advice should always be sought.
The OTS has again suggested that there should be some harmony between the Capital gains tax rules and the inheritance tax rules which could result in more inheritance tax being paid. However, this could also mean a welcome reduction in inheritance tax for those owning furnished holiday lets.
Given the uncertainty of whether these recommendations will be implemented or other changes will be made as a result of the OTS report, it is important for individuals to consider whether a review of their current circumstances warrant taking any action now. Everyone’s circumstances are different and each situation is likely to present particular issues.