The Office for Tax Simplification released a report into inheritance tax earlier this month and it contained some good proposals and raised some interesting talking points for anyone working on avoidance inheritance tax (IHT).
The OTS has its job cut out with the complexities of the UK tax system as successive Chancellors have preferred headline-grabbing additions to the tax code rather than reform of the existing rules. This report is a good start on the complexities of a tax that is roundly hated by a wider section of the public than it effects and little understood. It contains a good summary of how the tax works and should be read by anyone that thinks they may be liable to IHT.
There are around 590,000 deaths in the UK each year but less than 25,000 result in IHT being paid or only 5% of estates. Despite this relatively small number this tax consultation did provoke a strong response and IHT is guaranteed to regularly generate Tabloid headlines.
The OTS review makes 11 recommendations and we will highlight the crucial ones.
- Replace the multiple gifting allowances with a single, higher allowance.
- Reduce the gifting period from 7 to 5 years and remove taper relief.
- Remove the need to take into account previous gifts made.
- Simplify who pays the tax on failed gifts.
- Review the CGT exemption on death.
- Review the qualification rules for Business Relief (BR).
- As above for limited liability partnerships.
- Review the approach to Agricultural Property Relief (APR).
- Review the need for valuations for BR and APR.
- Make life assurance IHT exempt without the need for a trust.
- Remove the Pre-Owned Assets rules.
The first three proposals concerning gifting are an excellent set of proposals. There are several gifting allowances; annual exemption £3,000, multiple gifts £250, gifts in consideration of marriage, gifts out of surplus income and this leads to confusion. Simplifying this to a single annual gift allowance would help people hugely to simply understand how much they are allowed to give without having to work out the interaction between these allowances. The annual limit of £3,000 giving per person would be the basis for the new allowance and if it had increased by inflation since it was introduced would now be £11,900 which seems like a reasonable amount to allow individuals to give each year.
It is also proposed that gifts of more than this amount would be exempt from IHT after just 5 years instead of the current 7 years. This would make it easier for individuals to plan their giving as they age and the removal of taper relief would not impact most people as it only benefits those that give more than their nil rate band of £325,000 and only applies to the excess above this amount. The third proposal would remove an irritating issue that currently plagues tax planners like us (when establishing a trust you have to take account of gifts made in the previous 7 years and therefore on death a period of up to 14 years can be taken into account).
The tenth proposal is a simple and effective one. Each year IHT on life assurance pay out because the benefits have not been placed into trust. This can happen because the individual didn’t get around to the trust admin, didn’t understand the rules or simply down to administrative error. It seems an obvious, fair and simple reform to make.
The most interesting section of the report is 6, 7, 8 and 9 and the rules surrounding Business Relief and Agricultural Property Relief but here the OTS seems to have pulled its punches. The recommendations in this section talk of the government reviewing some niche parts of these two reliefs. They do start to touch on more substantive areas by suggesting that BR shouldn’t apply to AIM shares but they stop short of recommending this. This hesitancy seems to relate to recently ex-Chancellor Hammond’s statement in response to the Patient Capital Review that the government were committed to Business Relief and the support it is giving for family businesses and the AIM market.
The report does add this caveat which might prompt further thought from an incoming Chancellor staring at a bare cupboard and the potential £1billion a year of tax lost to BR/APR:
However, in particular in relation to third party investors in AIM traded shares, BPR is not necessary to prevent the business from being broken up or sold in order to fund the payment of Inheritance Tax. This raises a question about whether it is within the policy intent of BPR to extend the relief to such shares, in particular where they are no longer held by the family or individuals originally owning the business.
This starts to raise an important area for debate. Business Relief in its first incarnation was introduced in the 1970s and like the introduction of APR intended to help family businesses to pass to the next generation without death tax causing the break up of the business.
Both BR and APR are used now by individuals with no family business or family farm to pass on. BR can be claimed on investments in AIM shares and since 2013 these shares have become eligible for ISA investment. In addition there are investment managers who market business relief investment funds that are even less risky than AIM stocks as they tend to invest in loans to residential property developers or physical infrastructure such as wind turbines or solar panels. There are also some high profile and wealthy entrepreneurs in the UK who have sunk huge amounts of cash into farmland to exempt their estates from IHT.
All of these examples seem to run counter to the intention of the law and look ripe for reform. The simple consequence of reform in this area would be huge levels of redemptions from the AIM market, BR investments and farmland. This would lead to huge falls in value and a drying up of liquidity as there would be fewer buyers than sellers.
As a firm we always help clients to plan with the tax allowances they are given by HMRC and for some tax breaks we always explain the balancing requirement to invest in higher risk smaller companies that Chancellors want to support. It is always about maintaining a healthy balance between the tax that needs to be raised (we have said before that IHT isn’t inherently evil) and exemptions to support parts of the economy. The risks in this area must be understood though both investment, liquidity and political. We have been quoted on this recently here.