The second report of the Office of Tax Simplification (OTS) on its review of IHT, entitled Simplifying the design of inheritance tax, looks in detail at the more complex issues raised in its call for evidence between April and June 2018. The first report, published in November 2018, made recommendations covering administrative aspects of IHT. The OTS highlighted in that report that while around half of all estates each year are required to submit an IHT account, less than 5% of all deaths result in IHT becoming payable.
This second report explores complexities and technical issues around gift exemptions, lifetime gifts, and distortions in the way business property relief and agricultural property relief operate. It makes eleven main recommendations, grouped into three key areas:
Lifetime gifts and exemptions
The first four recommendations are concerned with lifetime gifts and exemptions.
Recommendation 1 is presented as a package of interrelated changes to:
The OTS does not make any recommendation as to the level of the proposed personal gift allowance, although it does suggest taking account of inflation since the original limits were set. The normal expenditure out of income exemption is described as ‘anomalous’, ‘confusing’ and ‘difficult to document’. Two options are suggested:
James Ward, head of private client at Kingsley Napley LLP, described the proposal to remove the normal expenditure out of income exemption as the ‘sting in the tail’ of this package. Although the exemption is not widely used or even known about, Ward said, ‘for high earning individuals it can be a way to pass substantial money down without running the risk of dying within seven years. High earners should be looking now to make such gifts as if this proposal is followed this exemption will be removed’.
Recommendation 2, also a package of changes, suggests:
Responses to the call for evidence indicated that it can be difficult for executors to obtain records going back as far as seven years, which requires considerable record keeping, but raises little tax.
The call for evidence also found that taper relief for gifts made more than three years before death is ‘poorly understood’, particularly the fact that the tapered rate only applies to very large gifts or those made late which take the total of gifts over the nil rate band. A suggested alternative approach could be to taper the value of the relevant gift rather than the rate of tax. This would mean applying taper to all such gifts and not just those exceeding the nil rate band.
James Ward commented: ’Clearly the stand out proposal from the OTS must be the reduction of the seven-year gifting rule to five years. This is a welcome proposal. However, it does come with the removal of taper relief which means that substantial gifts will see no tax deduction after three years and will need to have a survival rate of the full five years to have any inheritance tax benefit’.
John Bunker, chair of the CIOT’s succession taxes sub-committee, commented: ‘Reducing the seven-year period for lifetime gifts to five years, while scrapping taper relief, would be a significant simplification, reducing the bureaucracy involved in complying with IHT rules for many affected’.
Recommendation 3 would remove the ‘14-year rule’ which requires a small number of individuals who have made gifts into trust to take account of gifts made outside of the seven-year period.
It may be necessary to look back up to 14 years before death when a lifetime gift into trust is followed by a lifetime gift to an individual, after which the person who has made the gift dies within 7 years.
Recommendation 4 explores two alternatives for either reforming or amending the rules on liability for payment of IHT on lifetime gifts to individuals and the allocation of the nil rate band. The first option (reform) would involve:
The second option (amendment) would make executors liable to pay IHT on lifetime gifts only out of assets they handle and which are due to be distributed to the gift recipient, in cases where HMRC has not been able to collect the money directly from the recipient.
Commenting on these options, John Bunker said: ‘Particular attention will be needed to the proposals to change the rules on where liability for tax falls as between recipients of lifetime gifts and those who inherit on death. This is very much a matter of fairness between different people rather than raising more or less money for the exchequer. People’s wills have been drawn up on one basis but risk being taxed under another and some of the proposals on allocation of liability have much wider implications.’
Interaction with CGT
Recommendation 5 would remove the uplift for CGT base cost on death where a relief or exemption from IHT applies.
The CGT uplift means assets can be sold shortly after death without either IHT or CGT consequences, which the OTS believes can distort decision making by causing people to delay passing on assets to the next generation during their lifetime. The OTS has concluded that this distortion is best addressed by amending CGT rules rather than changes to IHT.
James Ward believes abolishing the CGT uplift would have a negative effect for taxpayers. This would remove ‘a particularly strong area of planning and would also potentially see HMRC picking up more capital gains and make it harder for people to sell property without a substantial CGT bill’, he said.
John Bunker described removal of the CGT uplift on death as ‘perhaps the most eye-catching proposal in the report’, while acknowledging that ‘there would be significant losers from it’. Despite this, Bunker said ‘it can be seen as removing an anomaly and levelling the playing field between lifetime giving and death transfers and deserves careful consideration from government’.
Businesses and farms
The next five recommendations concern business property relief (BPR) and agricultural property relief (APR).
Recommendation 6 calls for a package of changes to:
It is common in modern joint ventures for non-controlling holdings to be held indirectly, such as through a holding company. These holdings in trading companies are likely to be treated as investments and not eligible for BPR.
HMRC’s current guidance indicates that furnished holiday lets will in general not qualify for BPR, even though they are deemed to be trading for income tax and CGT purposes.
Recommendation 7 suggests reviewing the treatment of limited liability partnerships to ensure they are treated appropriately for the purposes of the BPR trading requirement.
Although LLPs are generally regarded as transparent for tax purposes, current IHT legislation suggests trading groups with an LLP as their holding vehicle may not be treated as trading for BPR purposes.
Recommendation 8 concerns HMRC’s approach to the eligibility of farmhouses for APR in sensitive cases, such as where a farmer needs to leave the farmhouse for medical treatment or to go into care. While HMRC’s current guidance considers such circumstances on a case-by-case basis, the OTS believes the tests should be clarified.
Recommendation 9 concerns valuations for APR and BPR, calling on HMRC to clarify in its guidance as to when a valuation of a business or farm is required and whether it needs to be a formal valuation or an estimate.
The OTS notes that valuation will become particularly important if the government decides to increase the level of trading activity needed to qualify for BPR (recommendation 6 above) because more businesses would become subject to IHT.
The final two recommendations look at other areas, including life assurance products, pensions, and pre-owned assets tax (POAT).
Recommendation 10 calls for death benefit payments from term life insurance to be free of IHT on death without the need for them to be written in trust.
Recommendation 11 calls on the government to review the POAT rules and their interaction with other IHT anti-avoidance legislation to consider whether they function as intended and whether they are still necessary.
The report also invites the government to take account of respondents’ comments in relation to the residence nil-rate band (chapter 10), trusts (chapter 11), and reduced rate where 10% of an estate is left to charity (chapter 12).
The full report is available at bit.ly/2xGMetv.
The second report of the Office of Tax Simplification (OTS) on its review of IHT, entitled Simplifying the design of inheritance tax, looks in detail at the more complex issues raised in its call for evidence between April and June 2018. The first report, published in November 2018, made recommendations covering administrative aspects of IHT. The OTS highlighted in that report that while around half of all estates each year are required to submit an IHT account, less than 5% of all deaths result in IHT becoming payable.
This second report explores complexities and technical issues around gift exemptions, lifetime gifts, and distortions in the way business property relief and agricultural property relief operate. It makes eleven main recommendations, grouped into three key areas:
Lifetime gifts and exemptions
The first four recommendations are concerned with lifetime gifts and exemptions.
Recommendation 1 is presented as a package of interrelated changes to:
The OTS does not make any recommendation as to the level of the proposed personal gift allowance, although it does suggest taking account of inflation since the original limits were set. The normal expenditure out of income exemption is described as ‘anomalous’, ‘confusing’ and ‘difficult to document’. Two options are suggested:
James Ward, head of private client at Kingsley Napley LLP, described the proposal to remove the normal expenditure out of income exemption as the ‘sting in the tail’ of this package. Although the exemption is not widely used or even known about, Ward said, ‘for high earning individuals it can be a way to pass substantial money down without running the risk of dying within seven years. High earners should be looking now to make such gifts as if this proposal is followed this exemption will be removed’.
Recommendation 2, also a package of changes, suggests:
Responses to the call for evidence indicated that it can be difficult for executors to obtain records going back as far as seven years, which requires considerable record keeping, but raises little tax.
The call for evidence also found that taper relief for gifts made more than three years before death is ‘poorly understood’, particularly the fact that the tapered rate only applies to very large gifts or those made late which take the total of gifts over the nil rate band. A suggested alternative approach could be to taper the value of the relevant gift rather than the rate of tax. This would mean applying taper to all such gifts and not just those exceeding the nil rate band.
James Ward commented: ’Clearly the stand out proposal from the OTS must be the reduction of the seven-year gifting rule to five years. This is a welcome proposal. However, it does come with the removal of taper relief which means that substantial gifts will see no tax deduction after three years and will need to have a survival rate of the full five years to have any inheritance tax benefit’.
John Bunker, chair of the CIOT’s succession taxes sub-committee, commented: ‘Reducing the seven-year period for lifetime gifts to five years, while scrapping taper relief, would be a significant simplification, reducing the bureaucracy involved in complying with IHT rules for many affected’.
Recommendation 3 would remove the ‘14-year rule’ which requires a small number of individuals who have made gifts into trust to take account of gifts made outside of the seven-year period.
It may be necessary to look back up to 14 years before death when a lifetime gift into trust is followed by a lifetime gift to an individual, after which the person who has made the gift dies within 7 years.
Recommendation 4 explores two alternatives for either reforming or amending the rules on liability for payment of IHT on lifetime gifts to individuals and the allocation of the nil rate band. The first option (reform) would involve:
The second option (amendment) would make executors liable to pay IHT on lifetime gifts only out of assets they handle and which are due to be distributed to the gift recipient, in cases where HMRC has not been able to collect the money directly from the recipient.
Commenting on these options, John Bunker said: ‘Particular attention will be needed to the proposals to change the rules on where liability for tax falls as between recipients of lifetime gifts and those who inherit on death. This is very much a matter of fairness between different people rather than raising more or less money for the exchequer. People’s wills have been drawn up on one basis but risk being taxed under another and some of the proposals on allocation of liability have much wider implications.’
Interaction with CGT
Recommendation 5 would remove the uplift for CGT base cost on death where a relief or exemption from IHT applies.
The CGT uplift means assets can be sold shortly after death without either IHT or CGT consequences, which the OTS believes can distort decision making by causing people to delay passing on assets to the next generation during their lifetime. The OTS has concluded that this distortion is best addressed by amending CGT rules rather than changes to IHT.
James Ward believes abolishing the CGT uplift would have a negative effect for taxpayers. This would remove ‘a particularly strong area of planning and would also potentially see HMRC picking up more capital gains and make it harder for people to sell property without a substantial CGT bill’, he said.
John Bunker described removal of the CGT uplift on death as ‘perhaps the most eye-catching proposal in the report’, while acknowledging that ‘there would be significant losers from it’. Despite this, Bunker said ‘it can be seen as removing an anomaly and levelling the playing field between lifetime giving and death transfers and deserves careful consideration from government’.
Businesses and farms
The next five recommendations concern business property relief (BPR) and agricultural property relief (APR).
Recommendation 6 calls for a package of changes to:
It is common in modern joint ventures for non-controlling holdings to be held indirectly, such as through a holding company. These holdings in trading companies are likely to be treated as investments and not eligible for BPR.
HMRC’s current guidance indicates that furnished holiday lets will in general not qualify for BPR, even though they are deemed to be trading for income tax and CGT purposes.
Recommendation 7 suggests reviewing the treatment of limited liability partnerships to ensure they are treated appropriately for the purposes of the BPR trading requirement.
Although LLPs are generally regarded as transparent for tax purposes, current IHT legislation suggests trading groups with an LLP as their holding vehicle may not be treated as trading for BPR purposes.
Recommendation 8 concerns HMRC’s approach to the eligibility of farmhouses for APR in sensitive cases, such as where a farmer needs to leave the farmhouse for medical treatment or to go into care. While HMRC’s current guidance considers such circumstances on a case-by-case basis, the OTS believes the tests should be clarified.
Recommendation 9 concerns valuations for APR and BPR, calling on HMRC to clarify in its guidance as to when a valuation of a business or farm is required and whether it needs to be a formal valuation or an estimate.
The OTS notes that valuation will become particularly important if the government decides to increase the level of trading activity needed to qualify for BPR (recommendation 6 above) because more businesses would become subject to IHT.
The final two recommendations look at other areas, including life assurance products, pensions, and pre-owned assets tax (POAT).
Recommendation 10 calls for death benefit payments from term life insurance to be free of IHT on death without the need for them to be written in trust.
Recommendation 11 calls on the government to review the POAT rules and their interaction with other IHT anti-avoidance legislation to consider whether they function as intended and whether they are still necessary.
The report also invites the government to take account of respondents’ comments in relation to the residence nil-rate band (chapter 10), trusts (chapter 11), and reduced rate where 10% of an estate is left to charity (chapter 12).
The full report is available at bit.ly/2xGMetv.
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