What Next For IHT?
The Office of Tax Simplification (“OTS”) after publishing their first paper, which focussed mainly on the process by which Inheritance Tax (“IHT”) is administered has now published its second paper, reviewing the tax itself and making recommendations to the Treasury for how it could be updated.
In this article I summarise the recommendations, and comment on them.
Lifetime Gifts: the OTS recommends that the current system, with the £3,000 annual allowance and specific exemptions for small gifts and gifts on the occasion of a marriage, is too complicated and should be replaced by a single personal gifts exemption. It also recommends that the “Normal Expenditure Out of Income Exemption” (very useful for tax planning purposes), should be phased out as “too confusing”. Comment: The cash limited exemptions are badly out of date and do need reforming. However, doing away with the normal expenditure exemption would affect a lot of arrangements already in place, where the donor may have lost capacity to change standing orders and allowance payments.
The “7 year rule” and Taper Relief: The recommendation is that the 7 year period after which Potentially Exempt Transfers (“PETs”) become inheritance tax free be reduced to 5 years. There are certain circumstances (particularly relating to gifts to trusts) which potentially extend the 7 year period to as much as 14 years, which the OTS think is too long and the rules, which depend on the order in which gifts were made, are too confusing. It also recommends that Taper Relief should be abolished. Comment: Taper relief is confusing, and really only applies to a few wealthy individuals, as does the 14 year period, so it is right to abolish both of these. It is unclear, however, that an arbitrary period of 5 years is any better than an arbitrary period of 7 years for PETs.
Capital Gains Tax: the recommendation is that the “uplift on death” (the fact that inherited assets are acquired at probate value, so any inherent gains are wiped out by the death) distorts decision making and should be replaced by some sort of historic cost basis. Comment: Terrible idea. How am I supposed to know what old Uncle George paid for the assets he left me on his death? Almost impossible to implement, practically.
Businesses and Farms: The OTS has been relatively restrained, here. They limit their recommendations to inconsistencies in the exemptions for CGT and IHT purposes and a couple of difficult areas – holiday lets and farmhouses occupied by retired farmers. Comment: There is a case for abolishing Agricultural Property Relief altogether and there are a number of other difficult areas – equestrian land, for example and what is the appropriation valuation “discount” for farmhouses. The OTS recommendations here are not thorough or radical enough.
Life Assurance: Life Assurance policy proceeds are part of the deceased’s estate, if they are the policyholder and subject to IHT. It is for this reason that policies are often “written in trust” (i.e. the policyholder is the body of trustees, not the deceased who was the life assured). The OTS recommends that the need to do this be removed by making Life Assurance policy proceeds exempt. Comment: Good idea, but this could be quite an expensive one for the treasury. Also, why shouldn’t other forms of long term saving, like an ISA, be similarly exempt?
Pre-Owned Asset Tax: The OTS recommends the government review this complicated and little understood any-avoidance measure. Comment: Indeed, it is ridiculously complicated and barely enforced because so few people understand it properly. Get rid of it.
Residence Nil Rate Band: This is the new allowance, introduced only in 2016 and not fully implemented yet, giving an additional tax-free allowance for a main residence left to “direct descendants”. The OTS thinks it is too soon to recommend reform of the allowance, which has proved fiendishly complicated and unfair in practice but recommends the government look at the various representations made to the OTDS about simplifying the system, in due course. Comment: Better to abolish it altogether.
Charities: The OTS notes that the special rate (36% rather than 40%) for estates where more than 10% of the net estate is left to charity is not well understood or well used but it is “too early” to make recommendations about it. Comment : You do not need to wait longer to find this is an overcomplicated bit of headline- and vote- grabbing by a previous Chancellor. Bin it.
Given that the current Chancellor, Philip Hammond, is unlikely to survive the accession to power of a new Prime Minister (Jeremy Hunt or, more likely, Boris Johnson) these suggestions are unlikely to be implemented soon. With the chances of a general election increasing, however, and tax pledges having been made by the candidates already, the OTS report may get referred to quite often until there is, actually, a long overdue of IHT which is currently overcomplicated and unpopular.