IHT Review

The second report of the Office of Tax Simplification (OTS)'s review of inheritance tax (IHT) was finally published last week.

The OTS was asked to conduct the review in January 2018 by the Chancellor, Philip Hammond. Its remit (as the name suggests) was to focus on simplification but the scope of its investigations has inevitably strayed into matters of policy. Consequently, the latest report includes some fairly significant recommendations but it is important to remember that this is not a government consultation and that previous OTS proposals have been slow to evolve, if at all.

The government’s response to the report will depend on the agenda of the new Prime Minister, so we are unlikely to learn much more before the Autumn Budget at the earliest. In the meantime, it is too soon to plan on the basis of this report, but important to be aware of the key recommendations, explained below.

Lifetime gifts

We were pleased to see a quote from Boodle Hatfield’s consultation response in the report: “We think all of the exemptions should be increased to more meaningful amounts and this is long overdue.” The report confirms that these have not kept pace with inflation, (some gift allowances have not changed since 1975) and recommends that the government takes action to:

• reconsider the levels of the allowances, suggesting that there could be a de minimis allowance to replace the current £250 small gifts exemption, and that increasing this to £1,000 would only reduce IHT receipts by £100k p.a.
• replace the £3,000 annual gift exemption and the marriage exemption with a single gift allowance
• reform the ‘normal expenditure out of income exemption’ because of its complexity and uncertainty, or else replace it with a higher gift allowance (mentioning a figure of £25,000 in an example)
• reduce the seven-year period to five years so that outright gifts made more than five years before death are exempt from IHT
• abolish taper relief (which reduces the tax rate for gifts above the nil rate band if the donor survives at least three years)
• remove the need to take account of gifts made up to 14 years before death (e.g. where there is a combination of chargeable and potentially exempt transfers)
• allocate the nil-rate band proportionately across all lifetime gifts and then to the estate, rather than to the earliest lifetime gifts first
• restrict the executors’ liability for tax on lifetime gifts to funds they handle which are due to the beneficiary concerned and only when HMRC is unable to collect the tax from the beneficiary themselves.

Capital Gains Tax interaction

The OTS rejects the idea of replacing IHT with Capital Gains Tax (CGT) on the grounds that the two taxes serve different objectives; this would double the number of taxable estates; and it would raise only about a quarter of the current IHT revenue.

However, the report takes issue with the uplift in value of assets on death for CGT purposes. This is felt to distort taxpayer behaviour by encouraging donors to hold on to assets until death to avoid paying CGT on lifetime gifts. They recommend that the uplift is removed where no IHT is payable so that the surviving spouse or beneficiaries of relievable assets receive those assets at the deceased’s historic cost value.

Business and agricultural relief

The proposal here, justified as a simplification and widely anticipated, is to align the trading threshold for businesses across IHT and CGT. The report invites the government to consider whether it remains appropriate for the IHT level (over 50% trading) to be lower than the CGT level (80%+ trading). This would be a significant change and, if adopted, many businesses with significant investment assets may well face IHT in the event of a death. The OTS also question IHT relief for AIM shares, without making any specific recommendation.

The OTS does, however, recommend a review of indirect holdings in trading companies to give relief to group structures and to ensure that LLPs are treated appropriately for business relief purposes. Other recommendations include granting IHT relief for furnished holiday lets that qualify for income tax and CGT reliefs, and farmhouses where farmers need medical treatment or to go into care. Finally, there should be clearer guidance on the requirement for valuations of business and agricultural property.

Life policies

The recommendation is that term policies should be exempt from IHT whether or not they are written in trust. This seems sensible as many policies are taken out specifically to cover IHT and it is cumbersome to have to create a trust to ensure the policies are not themselves subject to IHT (although a trust may still be useful for other purposes).

Anti-avoidance rules

The OTS say the pre-owned assets income tax rules (introduced to bolster the gift with reservation rules) should be reviewed to see whether they work as intended and are still needed.

The report considers various other aspects of IHT but makes no formal recommendations on them for several reasons including:

• an extension of the spouse exemption to unmarried partners: this would be far reaching and is a matter for a wider government response to social change;
• reform of the complicated and arbitrary residence nil rate band: this is premature as it has not been in force long enough to assess;
• reform of the reduced rate of IHT for gifts to charity is another measure which is too new to review; and
• IHT on trusts, which is already under review by HMRC.

There is no doubt that some of these proposals could be significant, but, as with all ideas for reform, there will be winners and losers. At this stage it is too early to tell where the report will lead and, in the current political climate, nothing can be guaranteed.