Inheritance tax reform – change on the horizon?
As Benjamin Franklin famously said, 'there are only two certainties in life - death and taxes'. Inheritance tax (IHT), often colloquially known as 'death tax' controversially combines both of those certainties. Now, the Office of Tax Simplification (OTS) has announced plans to review IHT in an attempt to simplify this notoriously complex area of the law.
Inheritance tax has always been an especially complex and controversial area of taxation. Its unpopularity means that it has been vulnerable to ill-thought through additions and revisions by politicians looking to curry favour with the electorate. As a consequence, the laws have grown up piecemeal and are confusing to navigate. Even the Chancellor Phillip Hammond acknowledges that IHT is 'particularly complex'. Recent changes to the law on domicile for IHT purposes have made matters worse, significantly increasing the scope of the IHT legislation's applicability.
Inheritance tax – a potted history
The earliest tax on estates was introduced in 1794 as a way to fund the Napoleonic wars. Modern inheritance tax can be traced back to 1894, when the government introduced a tax on death on the capital value of land. When death duties were introduced, they were intended to apply only to the very wealthiest members of society. The idea was to re-distribute wealth, taking funds from the very richest and spreading it among the rest of society. All very noble intentions.
Fast forward several centuries and the argument that IHT applies only to the very wealthy is more difficult to make stick. With house prices at an all-time high and IHT reliefs failing to keep pace, many people who would not consider themselves especially affluent now find themselves liable to inheritance tax on their death.
By way of example, when IHT was first introduced in 1986, the average London house price was £55,000 and the available tax-free allowance (the Nil Rate Band – NRB) was £71,000. Now the NRB is £325,000 but the average London house price has shot up to £481,556. When you consider that IHT is charged at 40% on the value of the estate above the NRB, or 36% if 10% or more of the estate is left to charity, (incidentally the second highest rate in the world), the numbers start to look quite considerable.
Residence Nil Rate Band – an example of the need for reform
In an attempt to combat this mismatch, the government introduced the residence nil rate band (RNRB) in April last year. The RNRB is an additional tax free allowance which applies to the family home, and is an excellent example of how to overcomplicate a tax rule.
In theory, by 2020 spouses will be able to pass on up to £1 million tax free (as long as their total estate does not exceed £2 million). However, for fear of accusations of introducing tax breaks for the wealthy, the RNRB comes with a whole host of complex conditions and exclusions. Notably, RNRB is only available on a property that you own at death, or at least have owned since the rules were announced in July 2015, and that you have lived in at some point. To get the full allowance, the property's value must not be lower than the RNRB at death (there are downsizing provisions, but they're complex enough to occupy a full article by themselves!). Most controversially, the residence must be inherited by a direct descendant to qualify for the relief – so no tax breaks for those without children, however fond they might be of their chosen beneficiaries. In summary, a complete headache.
Hope for the future – the OTS review
The OTS has recognised that IHT rules are over-complex. A survey has been launched to garner opinions and they have promised to review the existing rules in an attempt to simplify them where possible.
Any review of this area must be seen as a positive step. Fingers crossed that it results in a clearer and more straightforward regime, but I won't be holding my breath just yet.
If you would like to contribute an opinion to the OTS survey click here.