Inheritance Tax Relief: Simplification could increase tax liability

Earlier last year the Chancellor of the Exchequer asked the Office for Tax Simplification (OTS) to carry out a review on aspects of Inheritance Tax (IHT) in order to identify simplification opportunities. The OTS published the first part of its report in November 2018, which dealt with various administrative recommendations. The OTS has now published the second part of its report, which deals with simplifying the design of IHT. The OTS focused on the following three key areas of IHT.

Businesses and farms

Of particular interest to farmers and landowners will be recommendations within the OTS’ report focused on businesses and farms. As the law currently stands, trading businesses and farming assets may qualify for relief from IHT because of business property relief (BPR) and agricultural property relief (APR).

An important condition for BPR is that the business must not consist wholly or mainly of holding investments, with “wholly or mainly” thought to be greater than 50%. This differs from the CGT position where holdover relief and entrepreneurs’ relief may apply, where there is substantial trading activity on an 80:20 split of trading vs investment. The OTS has recommended that the reliefs are brought in sync with each other, with BPR matching the current CGT position. If this recommendation is legislated, it will make it more difficult to shelter investment assets within trading businesses and could reduce the availability of BPR.

In order to qualify for APR, the farmhouse or any farm cottage must be occupied for agricultural purposes. Where a farmer moves out of the farmhouse to receive medical treatment or goes into care, HMRC will consider the availability of APR on a case by case basis. Whilst the OTS has not specifically suggested an alternative, it has recommended that HMRC should adopt a clearer and more transparent approach. We would welcome any such clarifications.

Interaction with Capital Gains Tax

Under current legislation, there is no CGT on death and the person inheriting an asset is treated as acquiring it at its market value on the date of death. This is known as the CGT uplift. The uplift means that assets can be sold shortly after death, without CGT being due, so that where assets pass to an individual exempt from IHT (such as assets qualifying for BPR or APR and assets passing to a spouse) neither IHT nor CGT will be payable.

The OTS considers that the benefit provided by the CGT uplift, where there is an IHT exemption is resulting in people putting off passing on assets to the next generation during their lifetime and it should therefore be removed. It recommends that where there is an IHT exemption, instead the recipient should be treated as having received the asset at the historic base cost. Any reforms in this area may influence changes to estate planning for farmers and landowners. 

Lifetime gifts

The OTS has recommended a significant overhaul of current lifetime gifting provisions.

Currently where an individual makes gifts in the seven years prior to their death, these will be brought into consideration when calculating IHT due on their estate. The OTS believes that this period is too long and has recommended that the period be shortened to five years. The OTS has also recommended abolishing taper relief on lifetime gifts which exceed an individual’s nil rate band. This would adversely affect individuals who make large lifetime gifts who would otherwise have benefitted from a reduced liability to IHT after three years’ survivorship.

Under current legislation, the normal expenditure out of income exemption (NEOI) allows an individual to make gifts out of their surplus income without such gifts giving rise to an IHT liability. The OTS has also recommended abolishing this and instead raising an individual’s annual allowance (set at £3,000 since 1981) in line with inflation.

Summary

Whilst the OTS has made recommendations in the past that have not been taken up by the UK Government, it is important to be aware of the potential changes which may arise from the report. If the changes recommended by the report are implemented then it may be necessary to revisit existing estate planning to ensure tax efficiency going forwards.