Call for radical overhaul of inheritance tax and lifetime gifting
The Office of Tax Simplification (OTS) has recommended sweeping reforms of inheritance tax in a bid to reduce complexity as more people are caught by the tax as house prices soar, but has no proposals to deal with the overly complex residential nil rate band, reports Sara White
5 Jul 2019
Inheritance tax (IHT) applies primarily on death, but also to gifts made to individuals within seven years of death and to lifetime gifts other than to individuals, charities and qualifying political parties.
The coalition government made some attempts to increase the threshold after 2015, with the introduction of the married couple’s allowance lifting the threshold to £650,000, but this leaves thousands exposed to the single person rate of £325,000, which has not been increased in at least 10 years. This was last increased in April 2008 when the indexation of IHT rates was also removed.
Married couples and civil partners also have the added benefit of the residence nil-rate band which gives them an additional £150,000 each of tax-free property-based inheritance as of 6 April 2019. This allowance is set to rise to £175,000 from 6 April 2020.
At the same time, the annual allowance for lifetime gifts has not risen since the 1980s and is outdated based on the original principle of gifting outside of tax.
The OTS report contains 11 recommendations to deliver a ‘more coherent and understandable structure to the tax’, which is widely misunderstood by taxpayers, although it notes that only an estimated 25,000 estates are liable for inheritance tax each year, representing less than 5% of deaths.
The main area for reform is the taxation of lifetime gifts, including where individual liability lies, simplifying the exemptions and a review of business exemptions to ensure they are focused on the policy goals of raising tax.
The OTS would also like to see the seven-year period shortened to five years. Currently If people give gifts away they have to pay IHT if the total given exceeds £325,000 and they die within seven years.
James Ward, head of the private client team at law firm Kingsley Napley LLP, said: ‘Clearly the stand-out proposal must be the reduction of the seven-year gifting rule to five years. This is a welcome proposal. However, it does come with the removal of taper relief which means that substantial gifts will see no tax deduction after three years and will need to have a survival rate of the full five years to have any inheritance tax benefit.’
The OTS’s extensive consultation exercise revealed many areas where IHT is either poorly understood, counter-intuitive, requires substantial record keeping, creates distortions, or where the application of the law is simply unclear.
Bill Dodwell, OTS tax director, said: ‘The taxation of lifetime gifts is widely misunderstood and administratively burdensome.
‘We recommend replacing the multiplicity of lifetime gift exemptions with a single personal gift allowance, to be set at a sensible level, and incorporating an increased lower threshold for small gifts. The exemption for regular gifts should be reformed or replaced with a higher personal gift allowance.
‘We recommend that the seven-year period be shortened to five years (significantly reducing the workload on executors), and abolishing the tapered rate of inheritance tax (which many find works in a counter-intuitive way). Data made public for the first time shows the tax paid on gifts six or seven years before death is low.’
Only 12% of people made gifts in 2017-18 with the obvious split between those who were older and more affluent giving the most - those aged 60 or over gave a median total of £4,000, compared to £3,500 for those under 60, according to the Lifetime Giving report by the IFS and NatCen.
‘Where there is inheritance tax to pay on lifetime gifts, the OTS recommends the government explores options for simplifying and clarifying the rules on who is liable to pay this tax, and how the £325,000 threshold is allocated between different recipients,’ Dodwell said.
The OTS report also highlighted complexity in the interaction between IHT and CGT, as well as in relation to the reliefs available for businesses and farms.
However, it did not propose simplification of the residence nil rate band, which is complex and difficult to administer. This was a measure introduced in 2017 to remove £150,000 of value of a main residence from the scope of IHT. Respondents to the consultation were highly critical of the tax break. OTS accepted that ‘the most complicated aspects of the residence nil rate band are the downsizing provisions. The residence nil rate band is one of the most complex areas of inheritance tax and generated a large proportion of the correspondence received’.
‘Since the residence nil rate band is still relatively new, more time is needed to evaluate its effectiveness before recommendations can be made on how best to simplify it,’ the OTS report stated.
Rupert Wilkinson, Partner at Wilsons, a private client law firm, said: ‘It’s disappointing to see the OTS choose to leave the residence nil rate band untouched, as it causes great confusion among people planning their estates.
‘It would be much simpler to ditch the relief entirely. The government should instead consider raising the IHT threshold from £325,000 – which has not moved in more than a decade – to £475,000 to match the total current nil rate band, removing the complex rules linked to property ownership.’
IHT receipts totalled £5.2bn in 2017-18, an increase of 8% (£388m) compared to 2016-17 with wealthier estates contributing nearly half of total IHT revenue. Over that particular tax year, only 4.2% of all UK deaths were subject to IHT.
Response to this consultation was overwhelmingly high with nearly 3,000 responses to an online survey, a further 500 emails from individuals and over 100 written responses from experts. A typical tax consultation usually generates around 30 to 40 responses at the most.
Report by Sara White
OTS Inheritance Tax review: Simplifying the design of the tax issued 5 July 2019