Amongst a range of proposals from the Office of Tax Simplification is the reduction of the current 7 year period that it takes for gifts to fall out of an estate for inheritance tax to just 5 years. Good news for those who have undertaken significant gifting to date but there are proposals to restrict reliefs too so the devil, as always, is in the detail.  Here we consider the main proposals and the implications…

On 4th July the Office of Tax Simplification published its long awaited report on the design of inheritance tax with 11 specific recommendations being set out.

In our view, the report is an acknowledgement that the system has now become too complicated for individuals to get their heads around without specialist advice.  As a result, an unfair burden is placed on the tax payer to get things right and they are often required to keep onerous records for many years.  We naturally welcome any proposals that address those issues, provided the objective is simplification rather than revenue raising by the back door.

Highlights of the report are as follows:

Lifetime Gifts

Under the current rules there is a £3000 annual gift exemption and exemptions for gifts on marriage and small gifts (of up to £250 a time) and an exemption for regular gifts from surplus income.  The latter requires the taxpayer to keep detailed records of income and expenditure going back 7 years.  Under the new proposals these exemptions could potentially be replaced with an overall personal gifts allowance.

There is no recommendation as to the appropriate level of that allowance but we fear that it may be quite restrictive for those gifting significant sums on a regular basis, although the annual exemption has not been updated for decades so those gifting modest amounts may find any changes give them more scope.

7 Year Clock

Gifts in excess of any exemptions currently take 7 years to pass out of the estate completely, with any potential tax charge tapering down after three years. Tracking back so far is always problematical for executors unless records have been kept.

The report recommends reducing the 7 year period to 5 years and abolishing the current taper relief which applies in some circumstances to reduce any IHT on a gift within the 7 year period.

Hallelujah we say to this, although in some cases where gifts have exceeded the nil rate band of £325,000, the value of the taper relief can be substantial.

Payment of Inheritance Tax on Gifts

Confusion reigns on who pays the tax on a gift that ‘fails’ i.e. where the individual dies within 7 years.  Is it the estate or the recipient of the gift?  In cases where the nil rate band has already been used up, it is the recipient who faces the tax charge and this often comes as a nasty shock, especially if funds have been invested in property or used to pay down debt and there are no liquid funds to meet the bill!

Two options are set out:

  • have the tax fall on the estate and perhaps allocate the nil rate band proportionally across all gifts or
  • amend the rules so that executors can pay tax that HMRC have not been able to claim directly from the recipient

Further work is needed to explore these options.

Businesses and Farms

Thankfully, there is no suggestion of removing the exemption from inheritance tax for a privately held trading business or agricultural property. Indeed the suggestion is that the rules for IHT and capital gains tax in terms of determining what constitutes a trading business should be reviewed and ideally harmonised. The report does however question whether business relief should apply to third party investors in AIM traded shares but they do acknowledge the governments previous commitment to protecting the role business relief plays in supporting family owned businesses and growth in the AIM market.

Life Assurance

A great suggestion here is that death benefits from term insurance life policies be automatically deemed to be outside of the estate to avoid the need for them to be written in trust.  Again yes please to that!

Interaction Between Inheritance Tax and Capital Gains Tax

The suggestion is that the current capital gains tax uplift on death which applies to all capital assets including business property, farms, residential property and investments may be in question.  It is argued that it can distort decision making and result in individuals holding onto assets purely to ensure that any gains are tax free on death, regardless of the IHT consequences.

This topic merits further consideration and we will follow up with a more in depth note on this and other aspects of the report in due course.

Over the coming months we will monitor the government response to the report and as a matter of course we will be reviewing all clients overall estate planning as part of our ongoing planning.

And finally … what about a change of government? We also need to be aware of what the opposition might be contemplating too so read on to our next article for a sense of what Labour’s agenda might be…

Our key message remains GIVE AND LIVE!  If gifting is on your agenda talk to us and we can help you design an appropriate plan, using Trusts where necessary for asset protection or to simply get that 7 (or maybe 5) year clock ticking.  As always, if you have any queries or concerns, please don’t hesitate to contact us.

Useful Links:

OTS first report – published November 2018
OTS second report – published July 2019