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Lisa Spearman provides an update on IHT and Office of Tax Simplification second report

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With everything that is going on at present it is very difficult to be precise about what tax changes we might expect and when. The second report of the Office of Tax Simplification (OTS) looking at the future of Inheritance Tax has just been published, suggesting that those changes may not be too far distant.

We will need to see where the new administration’s priorities lie and it may not be until after Brexit is resolved – one way or another – before the matter becomes entirely clear but nonetheless the report makes quite interesting reading.  The link to the whole document is here.

Let me attempt to summarise it for you

It seems generally agreed that the current system of IHT is not efficient or effective as it includes a lot of bolted on pieces of law and the joins are clunky at best. The OTS has looked at the design of the tax to see which areas can be improved or removed altogether and their suggestions are not all bad news for taxpayers and they look at three areas:

Life time gifting

There are a great number of small and arguably outdated reliefs many of which are virtually worthless in today’s money. These, combined with “taper relief” where the tax may be reduced once a donor survives a gift by more than 4 years, and the well-publicised failure of many people to understand what is and is not an exempt gift to e.g. a charity or a political party, make apparently simple lifetime giving difficult for both the living and the executors of the deceased to track.  The OTS suggests that there should be a single overall gifts limits, taper relief should be abolished but the required survivorship period for total exemption reduced from seven to five year.

As well as being difficult to calculate there can also be questions as to who is liable to pay the tax on a lifetime gift in the event of the donor’s premature death and the OTS suggests this should be formalised to be the residue of the estate. The only downside I can see to this is that examiners for professional bodies will have to find a replacement for the traditional “double grossing“question.

Capital Gains Tax

The interaction between CGT and IHT can be challenging in the sense that when planning one is trying to divine the least worst option.  A lifetime gift is a good idea for IHT but often leads to an immediate CGT charge. If the donor dies within seven years there is at least an element of double taxation. As two capital taxes the theory is that only one should apply at a time. This does not always work. Sometimes there is double taxation and sometimes there is double relief. The OTS solution is to remove the CGT charge on a gift where an IHT exemption applies so that asset is acquired by the recipient at the donor’s cost rather than as now at its market value. The taxable gain is then deferred unless and until the asset is sold. This also stops so-called dry tax charges which arise where there is tax to pay but not proceeds with which to fund it.

Businesses and Farms

Whether or not a business or a farm qualifies for relief from IHT depends on different tests than for CGT but the fundamental principle is the same: policy should be to preserve businesses and not require a sale or break up to fund a tax bill the timing of which is out of everyone’s control. The OTS suggests that treatment should be aligned and in particular gives the example of furnished holiday lettings -These are recognised as a trade for CGT and income tax but are an investment asset for IHT – and suggests that the anomaly is removed and they are accepted as a trading asset for all purposes.

The OTS recognises that it should not be necessary to require a Court to determine if a property is a farmhouse and recommends that HMRC produce clearer and more consistent definitions.

In other areas of review it is suggested that the Pre Owned Assets Tax (POAT) rules should be abolished. Hands up if you remember POAT? In essence, HMRC lost a tax case and introduced the rules to prevent people being able to make gifts while retaining some future benefit or use of the asset given away. It was all highly controversial when introduced in 2005 with the biggest objection being the levy of an income tax to correct Inheritance tax poorly drafted legislation.  Their abolition is a long overdue and much welcomed improvement.

Sadly it seems that one outbreak of common sense is enough for one report so the equally clumsy and impenetrable residence nil rate band is likely to survive the cull.

The report does not directly address Trusts issues other than to observe that they are complicated and HMRC may want to consider the matter as part of its general overview. I am not entirely persuaded that the Trust rules are unduly complicated and certainly not unfair and I very much hope they leave well alone but I may be in a minority in this view: we will see. What the report does say, which is very sensible, is that there is no justification for requiring life insurance policies etc to be written in trust and suggests that such policies should simply be outside of the scope of IHT. This makes tax sense and also eases the particularly onerous registration requirements which currently apply to such trusts.

How are you affected?

Not too bad then and overall I would suggest the report gets a 7/10 from me. There are some missed opportunities but any improvement in the design of the tax is better than none as IHT applies increasingly widely.  The report is only suggestions at the moment and quite a long way from law but let’s hope that the changes can be brought into effect – at least the good ones.

There is no one size fits all answer to this uncertainty but it makes it more important than ever that your affairs are reviewed to establish if there is any action you should take to make sure your financial arrangements are appropriate for changing times. Please contact your Mercer & Hole partner or me to discuss matters further.

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