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Proposed changes to IHT rules

The Office of Tax Simplification (OTS), an influential independent adviser to the government has proposed changes to Inheritance Tax (IHT) rules, which if implemented may mean that the existing wealth succession plans of many will cease to be tax-efficient.

It may be some time before any changes come into force but it’s worth being aware of the proposals and consider their potential impact as part of your wealth management plan.

We look at the main proposals and their implications.

‘7-year rule’ to be reduced to 5

It’s widely understood that one of the simplest ways of reducing your IHT bill is to give money away whilst you are still alive. This is a ‘potentially exempt transfer’ and currently, regardless of the size of the gift, there’s no IHT to pay if the donor survives for 7 years after it is made. Also, provided the donor survives at least 3 years, a taper relief reduces the IHT charge on death.

The OTS recommend reducing the 7 years to 5 and scrapping the taper relief. Whilst this may simplify matters, any non-exempt gifts made within the last five years of life, would attract IHT at 40% on death. Therefore if you are thinking of gifting non business assets in the short to medium term we would recommend that you consider doing this sooner rather than later.

Single gift allowance

Individuals are currently eligible for a number of IHT reliefs when making a gift during their lifetime, such as the annual exemption of £3,000 and £5,000 tax free sum which a parent can give to a child who is marrying.

Most gift allowances have not increased since the 1980s.

The OTS has suggested simplifying the rules by replacing the IHT-free gift allowances with a single, but higher, personal gifts allowance.

Whilst this would simplify record-keeping, for many individuals, making regular lifetime gifts is a straightforward way to pass funds to the next generation tax-free and will be part of their family’s wealth plan.

The OTS proposed single gift allowance proposal could restrict amounts of ‘exempt’ gifts an individual can make.

Gifts from existing income

Individuals can currently give away unlimited sums from their income IHT-free if the gift is made on a regular basis and doesn’t affect the donor’s standard of living, and the 7-year rule doesn’t apply here.

This exemption is one of the most underused but valuable reliefs, albeit meticulous record keeping is required to avoid HMRC challenge. The proposed change would see this relief disappear with the OTS proposing that it is either replaced with a fixed percentage of income which people are permitted to gift, or scrapping the rule altogether and replacing it with a higher single gift allowance.

This would mean the small number of people who currently use this exemption in relation to large gifts would pay more IHT.

Business Property Relief (BPR)

BPR is a valuable relief that can give 100% IHT relief for trading assets. BPR is available for shares in companies that are ‘mainly’ trading.

The OTS proposes that the definition of ‘trading company’ be brought into line with the test for Entrepreneurs’ Relief – generally, this will mean that the company’s trading activities must constitute at least 80% of its whole activities whereas currently for IHT purposes this is widely accepted to be a 51% test.

Increasing the threshold to 80% will mean that many companies would no longer be eligible for BPR. Individuals holding shares through a holding company will have to ensure that at least 80% of the activities of the group will qualify which will impact significantly on mixed trading / investment groups. Businesses which are structured this way may lose this relief under the proposed new rule.

Removal of Capital gains tax (CGT) uplift

The OTS has proposed removing the capital gains uplift which applies when someone inherits assets.

Currently, IHT is charged on the market value of assets in the individual’s estate. To avoid paying tax twice, individuals inheriting assets from the estate are treated as acquiring them at market value. There is a corresponding uplift to the original CGT base cost of the assets which is available even if no IHT is actually paid on the asset.

The OTS recommends removing the CGT uplift where no IHT has been paid on the asset because reliefs or exemptions are available such as the spousal exemption, BPR or Agricultural Property Relief. This will be a significant change and will mean that individuals will need to consider gifting much earlier to avoid a ‘dry’ tax charge on death.

This will make things more complicated, as asset histories will have to be traced on death and it will require the original acquisition records to be passed on to the beneficiary.

In Summary

It is acknowledged that the IHT rules are outdated and complex, and in need of reform. However, the recommendations by the OTS seem to ‘take away’ more than they ‘give’. We advise clients that prior planning to avoid IHT is always beneficial – however with more individuals required to keep income generating assets later in life to fund living costs (including care costs), gifting is not always practical.

The OTS only make recommendations but the Treasury do listen – therefore whilst it might be a while before any of the recommendations migrate to the statute books, it is clear that changes are under consideration. We would always recommend cashflow planning and an IHT review if you have significant wealth to understand better when is best to start gifting to avoid large IHT liabilities.

Disclaimer

The information was correct at time of publishing but may now be out of date.

Tax
Posted by Lisa Wilson
11th September, 2019
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