Ireland 
USA The future of Inheritance Tax
A comparison of the key recommendations in the Office of Tax Simplification (OTS) and the All Party Parliamentary Group (APPG) reports
Inheritance Tax (IHT) is one of the more controversial taxes in the UK. It has received increasing attention over recent years, particularly in relation to the complexity of the rules and their perceived impact on social equality. A number of reports on IHT have been issued, two in particular shed some light on how IHT in the UK could develop and put forward possible changes to the regime.
HMRC commissioned a report on the influence of IHT reliefs and exemptions on estate planning and inheritances in 2017. The report did not make any specific recommendations but noted agents’ views that IHT planning was primarily driven by a desire to keep businesses and farms intact on the death of the owner. A reduction in IHT liabilities was found to be a secondary concern. The understanding of IHT among the participants was found to be very low - a consequence of the complexity of the rules.
The Office of Tax Simplification (OTS) then carried out two reviews of the IHT regime. The first report, published in November 2018, focused on simplifying the administrative aspects of IHT. The second report, released in July 2019, set out recommended changes to the IHT rules.
The All Party Parliamentary Group (APPG) produced a report on reforming IHT in January 2020. These recommendations go further than the OTS reports, proposing more significant reforms to the current IHT code, as well as CGT changes to lifetime gifts and on death.
Below is a comparison of the key recommendations in the OTS and APPG reports. Whilst these reports have been produced by influential organisations, they were not produced by statutory bodies; the Government may be informed by them but is not bound by any of the recommendations.
The two sets of recommendations share little in common, making it even more difficult to predict which, if any, of the recommendations will be favoured by the Government. If nothing else, the continued focus on IHT indicates that we are likely to see some change, at some point.
It may be an opportune time for families to consider how they may be affected by any potential changes, and to start discussing this with their advisers. Clearly, it is impossible to forecast which tax policies will be in place in the next couple of months, or beyond, so any action taken in anticipation of changes involves significant risk. However, collating your financial information and considering plans for the future could put you in a better position. This is regardless of whether or not you are taking action now, in certainty of current rules, or gaining a better understanding of the implications of potential IHT changes for you and your family. A review of your financial affairs may therefore be very timely, given the background set out above.
IHT rate
Current regime
40% unless a relief or exemption applies. No tax on most lifetime gifts.
APPG proposals
A lower flat rate, such as 10%, unless a relief or exemption applies. If the estate exceeds £2 million, a 20% rate is suggested.
OTS proposals
No changes proposed.
Nil rate band of £325,000
Current regime
£325,000 exemption for individuals, to be offset first against lifetime gifts in the last seven years (set against earliest gifts first). Any remainder is then offset against the death estate. May be transferred between spouses/civil partners.
APPG proposals
Replace with a death allowance of approximately £325,000. Not available for offset against lifetime gifts. Transferable between spouses and civil partners.
OTS proposals
The nil rate band should be allocated proportionately across the total value of lifetime gifts, with the remainder available to the death estate.
Residence nil rate band (RNRB)
Current regime
The RNRB is £175,000 from April 2020 and is transferable between spouses/civil partners.
APPG proposals
Abolish the RNRB. An estate would therefore be exempt only up to £650,000 on last death of a spouse/civil partner.
OTS proposals
As the RNRB is relatively new, the OTS argues that more time is needed before simplifications can be recommended.
PET and chargeable transfer regime
Current regime
Lifetime gifts into trust are taxed at 20%. Gifts to individuals are tax free if the donor survives seven years and retains no benefit in the gifted property. Taper relief is available after three years of survival.
APPG proposals
Abolish both PETs and chargeable lifetime transfers. Lifetime gifts taxed at 10% at the time of the gift and the donor will bear the tax liability. Applies to all lifetime gifts that exceed an annual allowance of £30,000.
No grossing up will be required because the ‘loss to the estate’ principle will be removed.
OTS proposals
- Reduce the 7 year period to 5 years, so that gifts to individuals made more than 5 years before death are exempt from IHT;
- Abolish taper relief; and
- Either IHT on lifetime gifts to individuals should always be payable by the estate; or
- Executors should pay IHT on lifetime gifts out of assets due to be distributed to gift recipient where HMRC cannot collect the IHT from the donee.
Cumulation principle and grossing up
Current regime
These rules aggregate certain lifetime gifts going back 14 years to the death estate and gross up chargeable gifts in the will when remaining estate is exempt.
APPG proposals
Abolish these rules to prevent certain types of manipulation.
OTS proposals
Remove the need to take account of gifts made outside of the 7 year period when calculating the IHT due.
Relief for lifetime gifts
Current regime
- Individuals receive an annual IHT exemption of £3,000;
- Small gifts of up to £250 are exempt from IHT;
- Gifts for maintenance of family are exempt from IHT;
- Gifts in consideration of marriage are exempt from IHT; and
- Normal expenditure out of income is exempt from IHT.
- APPG proposals
APPG proposals
Abolish these reliefs and introduce an annual gifts allowance of £30,000 that cannot be carried forward. A 10% tax would apply on all gifts in excess of this threshold.
OTS proposals
- Replace annual gift and gifts in consideration of marriage exemptions with an overall personal gifts allowance;
- Consider the level of this allowance and reconsider the level of the small gifts exemption; and
- Reform the exemption for normal expenditure out of income or replace it with a higher personal gift allowance.
Spouse exemption
Current regime
Transfers between spouses are exempt from IHT.
APPG proposals
No changes proposed.
OTS proposals
No changes proposed.
Charity exemption
Current regime
Gifts to charity are exempt from IHT and, if 10% or more of an estate is given to charity, the remaining estate is taxed at a lower rate of 36%.
APPG proposals
Retain the exemption for gifts to charity but abolish the reduced rate on the remaining estate where 10% is given to charity.
OTS proposals
No changes proposed. More time is needed to evaluate the effectiveness of the reduced rate.
Agricultural Property Relief (APR)
Current regime
100% APR is available on farms after two years if it is farmed ‘in hand’ and on let land after seven years. This means many farms are not taxed on death.
APPG proposals
Abolish APR. Introduce an option to pay the IHT arising on death or lifetime transfers over ten years.In the case of farms, these could be interest-free instalments.
OTS proposals
HMRC should review its current approach to the eligibility of farmhouses for APR in sensitive cases, such as where a farmer needs to leave the farmhouse for medical treatment or to go into care.
Business Property Relief (BPR)
Current regime
100% BPR can be available on transfer of a business, or shares in an unquoted company where the business is more than 50% trading. This means many businesses are not taxed on death.
APPG proposals
Abolish BPR. Introduce an option to pay the IHT arising on death or lifetime transfers over ten years if the asset transferred is illiquid. In the case of businesses, these could be interest-free instalments.
OTS proposals
- Review the required level of trading activity to consider if it should be aligned with the rules for gift holdover relief or entrepreneurs’ relief;
- Review the treatment of indirect non-controlling holdings in trading companies. Such holdings are likely to be treated as investments, whereas if held directly by the individual they may be eligible for BPR;
- Align the IHT treatment of furnished holiday lets with that of income tax and CGT where they are treated as trading; and
- Review the treatment of limited liability partnerships to ensure that they are treated appropriately for the purposes of the BPR trading requirement.
Alternative Investment Market (AIM) investments
Current regime
AIM investments can be eligible for BPR and therefore not subject to IHT if they are held for at least two years before transfer or death.
APPG proposals
The proposed abolition of BPR would result in AIM investments being subject to IHT. The lifetime tax on gifts of AIM investments would be immediately payable; no instalment option will be available.
OTS proposals
No changes proposed, although the OTS questioned whether or not the application of BPR to AIM investments was in line with the policy intent of BPR.
Trusts
Current regime
Lifetime gifts to trusts are usually subject to 20% IHT if the gift exceeds £325,000, and then taxed at 6% every ten years.
APPG proposals
- Align the treatment of gifts to trusts with the tax treatment of gifts to individuals;
- No nil rate band should be given to trusts;
- Recommends closure of loopholes that move property between beneficiaries in a trust;
- Impose an annual fixed rate of tax on trusts with discretionary beneficiaries and tax when property is distributed out of the trust; and
- Gifts to interest in possession trusts taxed as a gifts to the individual beneficiaries.
OTS proposals
- Consider exempting death benefit payments from term life insurance from IHT without the need for them to be written in trust; and
- Consider replacing the nil rate band for trusts with a de minimis threshold specifically for trusts.
- The OTS considers that the IHT treatment of trusts should be addressed in the round as part of the HMRC trust consultation.
CGT position on lifetime gifts and on death
Current regime
CGT is often payable on lifetime gifts by the donor as the disposal is usually deemed to take place at market value. On death, there is a tax-free uplift of assets to market value so the recipient inherits the assets at their market value, with no CGT immediately arising.
APPG proposals
Align the CGT treatment on lifetime gifts and on death by abolishing the tax-free uplift on death. The donee will instead inherit the base cost of the donor. For both lifetime gifts and on death the gain is held over until the donee sells the asset.
OTS proposals
Where another relief applies, such as BPR, APR or the spouse exemption, remove the CGT uplift. Instead, provide that the recipient is treated as acquiring the assets at the historic base cost of the person who has died.
Pension funds within the death estate
Current regime
The rules governing pensions and IHT are complex. Broadly, pension savings may be free of IHT if the pension provider has discretion over the transfer of the funds. Discretionary trusts may be used to ensure pension savings do not incur IHT.
APPG proposals
Pension funds held at death would be taxed at 10%, or 20% to the extent that the death estate exceeds £2 million. No IHT would apply if the funds were transferred to a spouse or civil partner.
OTS proposals
No changes proposed, but the OTS commented that wider changes to the taxation of pension transfers are needed in the future.
Non-UK domiciled individuals
Current regime
Currently, non-UK domiciled individuals only pay IHT if they die leaving UK-situated assets or they have been UK resident for more than 15 out of the last 20 years. In the latter case, an IHT exemption is retained on trusts set up by them before the 15-year limit. Those born with a UK domicile of origin may still have to pay IHT, even if not resident in the UK for many years.
APPG proposals
Domicile to be abolished as a connecting factor. It is recommended that those resident for 10 out of the last 15 years are subject to worldwide IHT. Trusts set up by non-UK domiciled individuals should be subject to the annual tax if they have been UK resident for more than 10 out of 15 tax years if any UK resident can benefit.
OTS proposals
No changes proposed.
Gifts with reservation of benefit (GWROB) and pre-owned assets income tax (POAT) rules.
Current regime
These are complex anti-avoidance rules to prevent the donor giving away property during his or her lifetime in order to avoid IHT on death, but still benefiting from the property after the date of the gift.
APPG proposals
The introduction of a tax on lifetime gifts would remove the need for GWROB and POAT rules. An individual who gives away his or her home may then continue to live in the property without any IHT consequences (though this may impact the availability of CGT reliefs on sale).
OTS proposals
Review the POAT rules and their interaction with other IHT anti-avoidance legislation to consider whether they function as intended and whether they are still necessary.
Ref: NTAJ14022027
Disclaimer
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.
