Inheritance tax: Changes Afoot?
Whilst it has never been particularly popular, inheritance tax (IHT) can at least console itself that it is dependable, having gone through few significant changes since 1984 save for the odd closing of a loophole here and there.
Recently however, discussion as to how to modernise our IHT regime has become a regular talking point. Indeed, we may be about to see the most radical overhaul to the estate tax regime for more than a generation.
Any changes are unlikely to be retrospective; by reviewing your affairs now, it might be possible to pre-empt such changes. Our article below sets out the main proposals, and the steps you could take to protect your position.
IHT is often perceived as unfair for many reasons, including the significant and unexpected effects it can produce at a most sensitive time for bereaved families. The system itself is complex and largely unchanged since the 1980s. High property prices in many parts of the country in combination with an IHT threshold that has been frozen for a decade have together meant that more families have been caught by the net (although, it should be noted that at current rates, 96% of estates do not have to pay the tax). Government IHT receipts for the tax year 2018-2019 were the highest on record and a study by London based UHY found that the UK and Ireland currently take the highest proportion of inheritance taxes of any major world economy.
Two key reports – The Office of Tax Simplification's 'Inheritance Tax Review' and the Labour Party's paper 'Land for the Many' outline a number of proposals which if effected could represent the most radical shake-up to the estate tax regime for decades.
Office of Tax Simplification
The Office of Tax Simplification has made the following suggestions:
One single personal gift allowance
IHT was ultimately designed with lifetime giving in mind and in light of that, there are numerous complex lifetime gift exemptions currently available for different scenarios, including small gifts, annual allowances, gifts on marriage, maintenance payments and regular gifts from income, to name a few. The trouble is that many of these exemptions are limited in value, and those values were set out in 1984. Inflation has not been kind.
In addition, some of the exemptions are complex. For example, the exemption for regular gifts from disposable income requires tight record keeping and even then the scope of the exemption is disputed.
The OTS recommends replacing this collection of small exemptions with a single annual gift allowance.
Higher annual gift allowances would benefit a huge number of people, but the loss of the regular gifts from income exemption would be significant, as there is no limit to the amount given away (provided the gifts do not reduce your standard of living). In addition, such gifts immediately fall out of your estate for IHT purposes.
It would therefore be prudent to review your lifetime gift plans.
Reduce the 7 year period to 5 years and abolish the tapered rate of IHT
Currently, surviving 7 years from the date of a lifetime gift means that in most cases the gift falls out of your estate entirely for IHT purposes. However, it can be difficult for executors to locate records going back 7 years.
Dying within 3 to 7 years from the date of the gift also gives rise to 'tapering relief' whereby the IHT due on the gift reduces by 20% each year. The latter part of the 7 year period raises very little tax, despite demanding considerable record keeping. Tapering relief is also widely misunderstood by the public.
For these reasons, the OTS recommends reducing this 7 year period to 5 years and abolishing tapering relief entirely. Although this doesn’t produce much tax, a small group of shorter term (3 to 5 year) survivors would be left with a larger tax bill. The effects of this should be mitigated however with the shortening of the 7 year period to just 5 years before the gift falls completely out of the net.
It is of course impossible to know whether you will be affected by this rule change. However, it is certain that the earlier a gift is made, the more likely is it you will survive long enough to reduce IHT on your estate and again, it would be wise to review your IHT position.
Businesses and farms
The owners of businesses and farms often enjoy significant exemptions from IHT on the value of those assets, through Agricultural Property Relief and Business Property Relief.
The rationale for these reliefs is to reduce the need for the break up or sale of businesses and farms to meet the IHT bill following the death of an owner.
For example, in respect of a business, and depending on certain variables (in particular whether a business can be said to be 'trading' as opposed to 'investing'), relief from IHT can be available at either 50% or 100%. These reliefs are significant and well-explained in policy terms, however they are also sometimes criticised for inviting abuse for those seeking to aggressively mitigate their IHT liability, through purchasing either farmland or AIM shares and waiting for the pre-requisite ownership period to pass before the reliefs take effect.
The OTS report has focused on whether or not it continues to be appropriate for the level of trading activity for BPR to apply to be set at a lower level than for various Capital Gains Tax reliefs.
The differing definitions within the trading and investment tests between Capital Gains Tax and IHT can produce a distortive effect on whether businesses and farms are transferred during life or on death. Aligning the two regimes would be a simplification; having one test would be easier to understand for taxpayers and would reduce the scope for distortions to HMRC's decision-making on a case by case basis. This may in all likelihood however reduce the availability of these reliefs.
It would be sensible for business owners to review their IHT plans accordingly.
Whilst not representing a complete overhaul of the system, rather a simplification of current procedure in areas that have produced distorted effects through their complexity, these suggestions do also appear to generally have the effect of reducing the scope of the current reliefs available. Reviewing affairs prior to any changes could mean more favourable outcomes for clients are possible if they act now.
Land for the Many
The Labour party recently published a policy proposal titled "Land for the Many". Although primarily concerned with reforms to land use, ownership and governance, the report does contain several recommendations as to the taxation of land, including proposals to reform IHT.
Going further than the OTS report which seeks to modify the existing regime, Labour's suggestions (based on proposals by think-tanks Resolution and IPPR) would represent a radical shift in approach to estate taxes. At the heart of the change would be a move from an estate tax to a gift tax.
The report is based on a Labour government setting a lifetime allowance of £125,000 per person, with any gifts received in excess of this (whether in the form of lifetime gifts, or an inheritance) being added to a person's income for the tax year. Income tax would then apply, which at current rates could reach 45%. It is not inconceivable that the highest income tax rates could be even higher under a future Labour government, which could result in a significant increase in tax payable on inheritances, which of course tend to consist of a large lump sum on death.
According to projections, the newly structured tax could raise in excess of £15bn from 2020/21 - a £9.2bn increase on what is earned by the current system.
Business and agricultural property would likely still be protected by exemptions - tax could still be deferred until assets were sold or a business ceased to exist as a trading entity and became an investment entity. The paper does highlight that further reviews might need to be undertaken in this area on the basis that tax shelter driven investment into farming and forestry is providing a method of IHT mitigation that is open to exploitation. It is also expected that a full spouse exemption would still operate if these measures were to be implemented.
Comparisons to the existing system are difficult, but it is clear that these proposals would significantly increase the amount of tax payable on inheritances and there would be a considerable reduction in the level of tax planning that is possible for many households.
Described by Conservative Party vice-chairman Marcus Jones as a 'siege on homeowners', discussion in response to the paper has raised concern that children (of a generation where the relative perks enjoyed by their parents during the boom years already feel that the financial drawbridge has been raised) would not only be taxed for financial assistance given to them during their lifetimes, they would also face higher tax pressures on inheritances.
In terms of knock on effects, we might expect to see increased demand for life insurance products as it becomes more difficult to mitigate tax, increased demand for more bespoke tax planning solutions and increased investment in and use of the business and agricultural property relief exemptions, whilst these are still available.
Labour has reiterated that this is not yet formal policy but a consultation to be considered alongside other ideas to improve the taxation function.
Whilst the various proposals are still in the consultation stages, it would nonetheless be sensible for people who are exposed to IHT to review their affairs now and perhaps accelerate any plans that would be affected by any changes to the rules.