The UK’s Office of Tax Simplification (OTS) has published a report on potential reforms to the country’s inheritance tax. Inheritance tax applies primarily on death, but also to gifts made to individuals within seven years of death and to lifetime gifts other than to individuals, charities and qualifying political parties.
The OTS report contains 11 recommendations to deliver a more coherent and understandable structure of the tax. Four main areas are grouped as packages, where some elements have an Exchequer cost and others raise money. They are: the taxation of lifetime gifts; looking at who pays tax where lifetime gifts are taxable; simpler exemptions for lifetime gifts; and a review of business exemptions to ensure they are focused on the policy goals and are consistent across different taxes.
There are several exemptions from inheritance tax relating to lifetime gifts, which haven’t changed since the 1980s. These are exemptions for the first £3,000 given away each year, for individual gifts of up to £250, gifts to someone getting married or entering a civil partnership and regular gifts out of a person’s disposable income. This regime was described by the OTS as ‘widely misunderstood and administratively burdensome’.
The OTS has suggested 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.
The seven-year period should be shortened to five years (significantly reducing the workload on executors), and the tapered rate of inheritance tax should be abolished. Data made public for the first time shows the tax paid on gifts six or seven years before death is low.
Where there is inheritance tax to pay on lifetime gifts, the OTS recommends the government explores options for simplifying and clarifying the rules on who is liable to pay this tax, and how the £325,000 threshold is allocated between different recipients.
The OTS consultation also highlighted complexity in the interaction between inheritance tax and capital gains tax, as well as in relation to the reliefs available for businesses and farms. Aspects of the regime distort the decisions families face when passing assets to the next generation, where there are different tests applying to what is broadly the same activity. The report makes recommendations to address these distortions and reduce complexity and asks the government to consider whether the reliefs are targeted most effectively at the policy objectives.
on the recommendations contained in the proposals, the ICAEW’s tax faculty technical manager Sue Moore said: “The inheritance tax system is a complex area for professional accountants to navigate, let alone grieving families, and the piecemeal additions to the original 1980s legislation make it more confusing.
“The OTS has come up with some sensible proposals to simplify the system, although some are controversial. The recommendation to combine the various gift allowances into one personal allowance is positive as many people are baffled by the various exemptions currently in place. More contentious is the suggestion that the normal expenditure out of income rules be abolished and included within a higher personal gift allowance.
“Reducing the seven year survival period for gifts to five years is a very practical solution to the problem of obtaining bank statements that are more than six years old. Taper relief is much misunderstood: the taper applies to the tax payable but most people think it applies to the value of the gift. As most lifetime giving is below the nil rate band, the taper relief doesn’t kick-in very often so abolition of this relief – combined with a reduction in the survival period to five years – would probably mean more people would win than lose.
“The recommendation to remove the capital gains tax (CGT) free uplift on death where an asset qualifies for relief from inheritance tax (IHT) could, if adopted, encourage earlier gifting of businesses which may be beneficial. Many business owners defer gifting their business to their children for fear of losing out on the CGT free uplift on death. However, to exclude the CGT uplift when the spouse exemption is claimed seems unjust as the taxman will get his slice of the IHT on the death of the surviving spouse.
“There are some areas that require further thinking: moving the liability for tax on lifetime gifts payable after death from the gift recipient to the estate could be challenging if the estate is left to a different beneficiary.
“The UK Government now collects over £5bn from IHT, up from about £0.5bn in 1980, so it is an increasingly important tax affecting more and more people. However only around 5% of deaths result in IHT being paid, so more people are worried about IHT than actually have to pay it.”