25 Jul 2019
Proposed Changes to Inheritance Tax by the Office of Tax Simplifications (OTS)
Treatment of Lifetime Gifts
Inheritance Tax (IHT) is a complex area and lifetime gifts is only a small part of the whole legislation. The proposed changes to the treatment of lifetime gifts include: -
- Shortening the 7-year rule to 5 years,
- Changing the current IHT annual exemptions (AE) amount and/or
- Doing away with the taper relief which could reduce the IHT due, when a gift is brought into the IHT charge if the donor fails to survive the required period to make the gift exempt.
Most individuals who make lifetime gifts understand that they need to survive 7 years for the gift to be exempt from IHT. They also know that they can give away £3,000 per annum tax free.
The proposed changes appear to concentrate on gifts to individuals which do not have any IHT consequences at the date of the gift. These Changes do not tackle the complex legislation for: -
- Chargeable lifetime transfers
- Gifts with reservation of benefits or,
- Previously owned assets rules
When someone dies, the IHT nil rate band (NRB), currently £325,000, is offset against any gifts made by the deceased in the last seven years, after taking into account any AEs. If the total of failed gifts exceeds the NRB then IHT at 40% will be charged but tapered if the gifts were made more than 3 years prior to the death of the deceased. Any tax due is payable by the donee.
The proposed changes are likely to create a two-tier system and will make the rules even more complicated rather than simplify them. The following consequences of the changes do not appear to have been considered: -
- From what date would the changes apply?
- To which gifts? Would this apply only to gifts made after the change or
- Would this apply to all gifts made by an individual who dies after the date of the change, regardless of when the gifts were made?
The OTS is not addressing the issue which is at the heart of the matter. It is not necessarily how complex the rules are but the fact that most people do not keep a record of the gifts they have made. This causes significant difficulties for the Executors of an Estate.
The 7-year rule could be reduced to 4 years to align it with the current requirements to keep tax records.
The annual exemption thresholds should be increased, as they have remained the same since 6 April 1981 for the £3,000 annual exemption and 6 April 1980 for the £250 small gifts exemption.
Last by not least, record keeping is essential: -
- Advisers, including solicitors, should encourage clients to give them information recording gifts each year, or advise them to keep a list with their will and codicils, financial records etc.
- A leaflet could accompany the council tax bill or notice of coding to recommend taxpayers to keep records. A campaign could be run in the national newspapers.
- How about introducing tax education in school/colleges to prepare students for the future?
Inheritance Tax (IHT) & Capital Gains Tax (CGT) interaction
The value of a person’s estate is calculated based on the market value of their chargeable assets at the date of death. This can be reduced by various reliefs such as the spouse exemption, IHT reliefs such as Business Property Relief (BPR) and Agricultural Property Relief (APR), so no or very little IHT is payable in respect of these assets.
Currently, there is a tax-free uplift in value as at the date of death for CGT purposes, which means there is no CGT to pay at that date. Any assets in the estate are passed to the beneficiaries at their market value at the date of death and if these are sold relatively quickly very little or no CGT is paid.
The proposed changes would apply to any assets which are covered by the spouse exemption, or IHT reliefs (BPR and/or APR). The changes state that these assets would no longer be transferred to the beneficiaries at the value at the date of death BUT at the value the asset was originally acquired by the deceased. The resulting CGT payable by the beneficiaries could be significantly more.
The proposed changes raise other significant questions: -
- What if the asset value at the date of death is less than when it was acquired by the deceased?
- When was the asset acquired and at what cost? Written records may not be available.
- What if the deceased inherited the asset themselves? What value will be used?
- If the asset was acquired before March 1982, further costs will be incurred to obtain a valuation at that date.
- What is the interaction with Principal Private Residence relief (PPR)? Will the beneficiary be entitled to claim a deduction for the deceased qualifying PPR period?
- If the asset has been improved during the period of ownership will this expenditure be added to the base cost?
- If the asset is a business asset which is sold less than two years after the death of the deceased, will the beneficiary benefit from the deceased’s accumulated period which would enable them to claim entrepreneur’s relief and pay a lower rate of CGT on the gain?
- If the assets consist of unquoted shares, and only part of their value qualify for BPR, will the base cost on transfer to the beneficiary reflect this?
- If these assets have benefitted from the spouse exemption, and the surviving spouse/ civil partner (CP) subsequently dies, the value of these assets will be uplifted to the market value at the date of their death to calculate the IHT chargeable. Do the changes mean that unless the assets no longer qualify for IHT reliefs (BPR/APR), the value transferred to the beneficiaries will still be restricted to the base cost of the asset when acquired by the first spouse/CP to die?
These proposed changes complicate the IHT position rather than simplify it. They will impose a greater burden on the executors dealing with the deceased’s estate They will not make the tax system fairer. They may cause many beneficiaries to make mistakes when reporting disposals of assets, they have inherited as the base cost might be impossible to determine with any certainty.
To receive further advice on this matter, please contact Michele Shapland.