Simplifying the design of inheritance tax - OTS publishes second report
This second report makes recommendations to make substantive aspects of the design of Inheritance Tax simpler, more intuitive and easier to operate.
The OTS is the independent adviser to government on simplifying the UK tax system, to make it easier for the taxpayer. The OTS makes recommendations for the government to consider. It does not implement changes - these are a matter for government and for parliament.
Following a consultation process which generated an unprecedented level of interest - and made it clear that many people had limited understanding about the way Inheritance Tax works - this report explores the design complexities of the tax.
Inheritance Tax applies primarily on death, but also to gifts made to individuals within 7 years of death and to lifetime gifts other than to individuals, charities and qualifying political parties.
The report contains 11 recommendations to deliver a more coherent and understandable structure of the tax. These are concentrated on three key areas of Inheritance Tax:
1 Lifetime gifts, including liability for paying any tax due on such gifts
2 Interaction with Capital Gains Tax
3 Businesses and Farms
Many of the problems identified are connected, so solving one in isolation would simply create knock-on issues in other areas. That is why some of the 7 recommendations consist of packages of changes that would need to be implemented together.
Four main areas are grouped as packages, where some elements have an Exchequer cost and others raise money. They are: the taxation of lifetime gifts; looking at who pays tax where lifetime gifts are taxable; simpler exemptions for lifetime gifts; and a review of business exemptions to ensure they are focused on the policy goals and are consistent across different taxes.
The report recommends:
- 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 out of surplus income should be reformed or replaced with a higher personal gift allowance.
- the 7-year period be shortened to 5 years (significantly reducing the workload on executors), taper relief should be abolished (as many find it works in a counter-intuitive way) and the ’14 year rule’ should end. Data made public for the first time shows the tax paid on gifts 6 or 7 years before death is low.
- where there is Inheritance Tax to pay on lifetime gifts, the government should explore 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.
- where a relief or exemption from Inheritance Tax applies, the government should consider removing the capital gains uplift and instead provide that the recipient is treated as acquiring the assets at the historic base cost of the person who has died.
- consider whether it continues to be appropriate for the level of trading activity for BPR to be set at a lower level than that for gift holdover relief or entrepreneurs’ relief.
- review the treatment of indirect non-controlling holdings in trading companies.
- consider whether to align the Inheritance Tax treatment of furnished holiday lets with that of Income Tax and Capital Gains Tax, where they are treated as trading providing that certain conditions are met.
- the government should consider ensuring that death benefit payments from term life insurance are Inheritance Tax free on the death of the life assured without the need for them to be written in trust.
- the government should review the POAT rules and their interaction with other Inheritance Tax anti-avoidance legislation to consider whether they function as intended and whether they are still necessary.
- 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. Chapter 10 of the report sets out respondents’ suggestions for simplification, which the OTS invites the government to consider when reviewing this area of policy.
- the OTS has received comments suggesting that the Inheritance Tax regime for trusts is too complicated. These are set out in Chapter 11 of the report for the government to consider in the context of that broader consultation.
- since 2012, where a person leaves 10% or more of their net estate to a charity, the rate of Inheritance Tax payable on their estate is reduced to 36%. As this relief will take time to fully embed itself, no recommendations have been made on changes to the 36% rate.
Interestingly, on the subject of IHT and ill-health pension transfers, the OTS said the below:
'The OTS has heard that the operation of the two-year rule regarding gratuitous benefits is causing a high degree of uncertainty for financial advisers because at the time of undertaking such transfers, there can be no certainty as to whether a transfer will be considered to be creating a gratuitous benefit.
The OTS understands that in practice, it is very unusual for HMRC to argue that there has been a transfer of value. HMRC will only argue that a transfer of value has arisen where there is evidence of an intention to confer a gratuitous benefit.'
Kathryn Cearns, OBE, OTS Chairman said 'Although only a small number of people pay Inheritance Tax each year, a far greater number worry about it. The OTS’s packages of recommendations would go some way to achieving the goal of making the tax easier to understand and simpler to comply with.'
The full report can be accessed below.