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Inheritance Tax Simplification

Inheritance Tax – a brief history

Dating back to the 17th century, a tax on death has long been unpopular.

The tax has existed in many forms since then, for example:

  • The legacy tax of 1780
  • The 1796 tax on estates (introduced to fund the war against Napoleon)
  • The 1894 estate duty (an effort to raise revenue to eliminate a £4m fiscal deficit)

Inheritance tax as we know it now was introduced in 1986 and replaced capital transfer tax.

But the tax has not stopped evolving, and it will be interesting to see whether this particularly complex tax can be simplified now that the Office of Tax Simplification (OTS) has been tasked with ensuring that Inheritance Tax is ‘fit for purpose’.

OTS review

The focus of the review will be on technical and administrative issues, including:

  • The process of submitting inheritance tax returns and paying any tax that is due.
  • Practical issues relating to routine estate planning and disclosure.
  • The rules on gifts and whether the present framework distorts decisions in relation to transfers, investments and other relevant transactions.

Gifts, where the annual exemption for marriage gifts and small gifts has been set at £3,000 for more than 30 years, are an obvious target for simplifying and updating exemptions.

While fewer than 5% of estates incur inheritance tax, the number of estates has been growing, mirrored by the total tax take.

In 2016-17, HMRC receipts from inheritance tax stood at £4.84bn, up from £2.396bn in 2009-10 – an increase of 102% in seven years, mostly as a result of a 60% surge in house values in London and the South-East.

It is likely that the review will cover some of the more complex areas in the current inheritance tax legislation, including the taxation of:

  • Trusts
  • Exemptions
  • Reliefs including business property and agricultural property reliefs
  • The new residence nil rate band allowance.

The findings and proposals of the OTS report may have a significant impact on the effectiveness of existing inheritance tax planning arrangements.

Residence nil rate band

In July 2015, George Osborne announced that those owning a property worth up to £1m would be able to leave it eventually to their children or grandchildren free of inheritance tax from 2020-21.

This residence nil rate band allowance raises the inheritance tax threshold introduced in stages from April 2017 for those who satisfy complicated criteria. This provides an additional inheritance tax allowance of £125,000 in the current tax year, increasing by £25,000 in the next two tax years with the result that, by 2020-21, the residence nil rate band will stand at £175,000.

Apart from the residence nil rate band, there is still in the 2018-19 tax year a nil rate band of £325,000 – unchanged since 2010-11 with no plans for it to rise until at least 2019. Meanwhile, the standard inheritance tax rate is also unchanged – 40% for anything above the £325,000 threshold.

For those who qualify, therefore, there will be inheritance tax allowances totalling £500,000, double that for married couples, resulting in the headline-grabbing £1m of allowances by 2020.

From 2021-22, the residence nil rate band allowance will increase in line with the consumer prices index.

Not all tax experts agree that the residence nil rate band is an appropriate simplification, in fact the legislation is incredibly complex.

Business Property Relief

One area that could be looked at in the review is the use of business property relief (BPR) assets in inheritance tax planning, which enables people to remove assets from the tax net after the qualifying period. Specific questions around this are included in the OTS survey, as it was originally drafted to enable business owners to pass on their businesses on death without destroying its value through a requirement to pay inheritance tax.

Pension planning

Since new pension freedoms legislation in 2015, pensions are once more very tax-efficient, passing outside the dutiable estate on death. The review may see pensions becoming a target to remove the discrepancy between the treatment of pensions and ISAs, whereby most pensions are free of inheritance tax, yet ISAs are not.

Trusts

Unintended consequences may also affect those who want to use trusts for non-tax planning reasons to provide for profligate beneficiaries or to protect the estate after a second marriage.

Simplification?

We do not yet know whether the review will lead to ‘simple’ inheritance tax simplification, or a replacement of inheritance tax in its current form. Talk of property taxes or wealth taxes is unpopular, although should Labour win the next general election, drastic changes to inheritance tax will be more likely. At last year’s election, Labour announced plans to scrap the double relief inheritance tax threshold on property for spouses with some reports suggesting it would even cut the overall threshold to around £300,000.

Probate fees

In 2017 the government was considering increasing fees on the probate application so that larger estates could end up with a fee running in to thousands of pounds instead of the current fixed fee of a couple of hundred. Whilst those plans have currently been put on hold to implement them will just be another death tax by a different name.

Gifts tax

The Resolution Foundation, a think tank, has recently suggested that Inheritance Tax should be abolished altogether and replaced with a lifetime receipts tax which would be much fairer than the current system. Let’s see whether the OTS agree.

Much of this is conjecture; the OTS has a track record of making recommendations that are later ignored by the government of the day – so watch this space until the Autumn!