Summer Budget (1) The Main Residence Nil Rate Band
As promised, this is the first in a series of short articles explaining the summer budget changes announced in July 2015. Today we will explain (and it needs a bit of explanation) the Main Residence Nil Rate Band.
First, a bit of history. Those with long memories, or interested in politics, will remember that, while in opposition, the Tory party announced at their 2007 conference they intended to increase the tax free amount on death for Inheritance Tax (“IHT”) purposes to £1,000,000 (it was at that time only £300,000 and not transferable). This proved very popular, especially with voters in the South-East of England, many of whom lived in houses worth more than £300,000 but less than £1,000,000. The then-chancellor, Gordon Brown, responded by dusting off a policy which had, apparently, been under consideration for a while: making the tax free amount or “Nil Rate Band” transferable so that, if a married couple did not use the tax-free amount on first death (because the estate passed from one to the other at that point, in a transfer which was exempt for IHT purposes) an additional allowance could be claimed on the second death. This raised all sort of potential complications: what if a person died having been married more than once before? What about couples who were not married? What about where some of the tax-free allowance had been used but not all of it? Were we talking about a cash amount or a percentage of the allowance, which is likely to be a greater amount at the time of the second death than the allowance that applied on first death? None of this deterred Gordon Brown, who seemed to relish bit of complexity in his legislation, and the changes were brought into force the following year. The “Transferable” allowance was to be equal to the percentage (not the cash amount) of the allowance previously unused, carried forward to the current allowance; the couple had to have been married or in a civil partnership at the time of the first death (so the allowance was of no use to unmarried or divorced couples); and any number of previous spouses could “count” for the purpose of calculating the allowance, so long as the total allowance claimed did not exceed 100% of one current allowance. The drafting, as you can imagine, was quite complicated.
Perhaps surprisingly, however, it worked pretty well. Everyone understood the concept. Many families benefitted from a reduced or eliminated IHT charge on the second death and the amount raised by IHT dipped, particularly with the drop in house prices caused by the “crash”. Some votes were won back. Just not enough.
When a new government was elected, however, it was short of cash. Very short. And the Tories had some new partners, in the shape of the Liberal Democrats, who set a low priority on reducing IHT for the middle class and a higher priority on more generous income tax allowances. The “£1,000,000 pledge” was, therefore, one of the first things to go, and the policy was explicitly abandoned in the coalition agreement. The nil rate band (by then £325,000) was frozen for the next few years. House prices slowly began to recover, and the amount raised by IHT began to recover with this (see the chart in the “What We Do” section of this site). Middle class voters in the South East began to squeal, again. As a second election loomed, there was pressure on the Tory party to revive the “£1,000,000 pledge” which, if it were to be transferable, would now, of course, give a couple a tax-free capacity of £2,000,000. The government’s finances were still not in sufficiently good shape to accept this sort of reduction in IHT revenue, though, so what was to be done?
The answer was to announce a new policy, at the expense of yet more complexity, trying the dress up a much less generous pledge as if it was worth the same as the original £1,000,000 pledge. Discussions about the proposal were leaked and reported in The Guardian during the election campaign – http://www.theguardian.com/money/2015/mar/16/tories-1m-inheritance-tax-giveaway-sensitive-papers-wealthier-households – and it was then duly announced by the Prime Minister as “You’ll be able to pass on up to £1m per couple completely tax-free”. The actual proposal was an additional nil rate amount of up to £175,000 per person, restricted to that person’s interest in their residential property but transferable (£325,000+£175,000 doubled is ££1,000,000 – see?). Perhaps this policy, too, was expected to be ditched in the coalition talks that were expected to follow the election. Except that, in fact, the Tories won an outright majority and so the proposals needed to be enacted. An announcement was made in the Chancellor’s Summer Budget statement and some, but not all, of the policy as announced has now been included in the second 2015 Finance Bill (bit of a rush, was it?). So what have we now got?
Well, the first thing to say is nothing, yet. The new policy will only apply to deaths after April 6th 2017. If Granny dies before then – bad luck. It is then phased in over four years, so the full amount of the allowance will not be available until the end of tax year 2020-2021 (hope Granny is feeling fit and well?). The extra allowance can be claimed if a person, at the time of their death, passes their interest in a residence on to their Direct Descendants only (children, step-children and grandchildren but not, for instance, nephews and nieces) on their death. What if they owned (and used as a residence) more than one property? The Executors of their estate can nominate which one of multiple properties can be used – so if, say, Granny lived in a terraced house worth £150,000 and also used a holiday cottage worth £130,000, the Executors could nominate the house and be entitled to £150,000 of the additional allowance. What if Granny had been moved to a care home at the time of her death? The new allowance applies only to a property used as a residence “immediately before a person’s death” which would, on the face of it, mean the allowance could not be used if the house had been sold or let, or would be limited to a smaller amount if the deceased had “downsized” before their death: the Chancellor has announced, however, that amendments will be made in the 2016 Finance Bill to cover this possibility, so long as the sale or downsizing happened after the Summer Budget announcement (8th July 2015). This all sounds horribly complicated so it is not surprising that the government needs another year to draft it.
The new allowance will be “transferable” and you will be able to “look back” to deaths of spouses or civil partners which happened before April 2017 for this purpose. The amount that can be carried forward from these earlier deaths is, however, limited to only £100,000. You will also have to claim any allowance carried forward within a 2 year time limit or you lose it (solicitors will be nervously checking their diary systems and professional negligence policies). What if the pre-deceasing spouse had themselves downsized or made a lifetime gift of their property at the time they died? The legislation and announcements are silent on that at the moment: it may just be in the “too difficult” box. We’ll see when the 2016 Finance Bill is published next year but, at least, there is no indication in the legislation that the main allowance being claimed on a second death and the transferable allowance brought forward from an earlier death have to be in relation to the same property.
And how is this going to be paid for? Well, the £325,000 tax free amount, which had already been frozen in 2010 out to 2014, and then again to 2017-2018, is now to be frozen yet again, to the 2020-2021 tax year. That’s a significant tax tightening. There is also a formula whereby, for estates worth over £2,000,000 (which might be quite a lot of them, by the time all this is fully effective, given the rate of increases in house prices, particularly in London and the fact that all other assets also have to be included for this purpose) the new allowance is progressively lost. Depending on how house prices move, this measure could, quite quickly, be worth a lot less than it seems to the 2015 voter, particularly when compared to the original proposal for a simple increase in the threshold in 2007. Wouldn’t it make life a lot simpler just to go back to that?