No tax is popular; however, public opposition to Inheritance Tax (IHT) is particularly widespread despite the fact that only a minority of estates have to pay it. In fact, IHT accounts for less than 1% of UK taxes while affecting less than 5% of estates.
To address criticisms that IHT is unnecessarily complex and unfair, various bodies have been established in recent years to make recommendations and offer practical solutions for reform.
Ultimately, the Government is responsible for considering and implementing any changes suggested by these groups. Of course, the Government could review the recommendations and decide to retain the current regime. But, should it opt for reform, what could be in store for the future of IHT?
Option 1: Implement the OTS Recommendations (July 2019)
What does ‘OTS’ stand for and what do they do?
The Office of Tax Simplification (OTS) is an independent adviser to the government which offers recommendations to make the design of UK Tax easier to navigate.
In July 2019, the OTS published its second Inheritance Tax review.
Although it is not yet known whether any of the recommendations within the review will lead to legislative changes, it is worth bearing the proposals of the OTS in mind particularly when considering if and when to make a lifetime gift.
The OTS Proposals
The 7-year period
Arguably the most eye-catching recommendation from the report is the proposal to shorten the existing 7 year rule for gifts with a 5 year rule. Currently, when someone makes a lifetime gift, the transfer is not immediately chargeable to inheritance tax. If the transferor survives 7 years from making the gift, they avoid any tax liability.
Justification? The OTS has justified this proposal as data shows the tax paid on gifts 6-7 years prior to death is low. It also suggests it is a way to reduce the significant workload borne by executors.
Effect? As a result of this recommendation, individuals would only need to survive 5 years following a gift in order for it to become exempt for inheritance tax purposes.
However, with this welcome proposal come more controversial recommendations.
The OTS has suggested that taper relief should be abolished.
Taper relief applies in instances where potentially exempt transfers become chargeable, and tax is payable as a result of that transfer i.e. where a transferor dies within 7 years of making a gift. Essentially, for gifts made within 3 to 7 years of death the tax payable is ‘tapered’, or reduced, on a sliding scale.
The current rates are stated below.
|Years between gift and death||Tax payable|
|Up to 3 years||40%|
|More than 3 years||32%|
|More than 4 years||24%|
|More than 5 years||16%|
|More than 6 years||8%|
|7 or more years||0%|
Justification? Taper relief is complex and very little inheritance tax is raised for gifts between five and seven years old.
Effect? The effect of the removal of taper relief would be that gifts would see no tax reduction unless the transferor survived the full 7 (or, under the proposals, 5) year period when the gifts would qualify as inheritance tax-exempt.
A single personal allowance exemption
The OTS has proposed that the various exemptions for lifetime gifts (covering small gifts, gifts for weddings and the annual exemption) be pooled into one large annual exemption of capital gifting, set at a sensible level. In making this suggestion, the OTS also proposed the removal of the exemption where an individual gifts regular amounts from their surplus income.
Justification? Replacing the multiplicity of exemptions with a single personal allowance makes a lot of sense with regard to the aim of the OTS: to simplify the design of inheritance tax. Moreover, the OTS suggests that the personal allowance would incorporate an increased threshold for small gifts.
The exemption of normal expenditure out of income is not widely used and would be ‘replaced’ with a higher personal gift allowance.
Effect? High-earning individuals would no longer benefit from an exemption where making regular gifts from their surplus income. Instead, whether the gift is exempt for inheritance tax purposes would depend on whether they survive the 7 (or, under the proposals, 5) year rule.
Among its recommendations, the OTS has proposed that the government explore the rules surrounding who is liable to pay inheritance tax on lifetime gifts. Their proposed reform would be for the tax is payable by the estate. Under this reform, the burden would pass from the recipient of the gift to the person who makes the gift.
In addition, the OTS suggests reform of the current operation of the nil rate band should be considered. Under the proposed reform, the nil rate band would no longer apply to lifetime gifts in chronological order but rather be allocated across the total value of lifetime gifts.
Option 2: Adopt the APPG’s proposal to replace IHT (January 2020)
What does ‘APPG’ stand for and what do they do?
Similarly to the OTS, in their recent report the All-Party Parliamentary Group (APPG) for Inheritance and Intergenerational Fairness examines concerns surrounding IHT. In particular, it reviews various objections to IHT for validity and suggests possible methods for reform.
Whereas the OTS focussed on piecemeal reform of IHT design, the APPG has suggested a radical overhaul of the current IHT regime.
The APPG Proposals
Recommendation 1: The CGT tax-free death uplift and current IHT regime
The APPG’s main recommendation is to replace the current IHT regime with a low flat-rate tax payable on both lifetime gifts and transfers on death, and to reduce IHT reliefs.
The reform would affect the way IHT operates in a number of ways:
Low flat-rate tax
A suggested flat-tax rate of 10% would replace the current regime. At present, estates are taxed at 40% with reliefs and exemptions applying to anything in excess of £325,000.
In addition, the APPG suggest that all reliefs except the spouse and charity exemptions should be abolished.
Justification? The tax will be set at a low enough rate that it can apply on a broad basis and it dispenses with the need for multiple complex reliefs.
Effect? Reliefs would effectively be scrapped, including Business Property Relief and Agricultural Property Relief which can be valuable tools in estate planning.
‘Potentially-exempt’ transfers would be abolished, except those between spouses and civil partners, meaning all lifetime transfers would be immediately chargeable to tax.
Annual lifetime allowance
The current annual allowance of £3,000 would be replaced by an ‘annual lifetime allowance’ of £30,000.
In addition, the nil-rate band would no longer be available for lifetime transfers. Instead, it will available only on death as a ‘Death Allowance’ of £325,000.
Justification? This is based upon evidence that the average smaller household makes lifetime gifts of under £5,000 per annum and thus would fall well into the bracket.
Effect? This proposal effectively abolishes the ability to make a potentially exempt transfer of unlimited value. Instead, any gifts which exceed the £30,000 annual allowance would be immediately liable to tax of 10%.
It would however also mean that lifetime gifts would not affect the tax payable on death. This would avoid the current need for executors to identify all gifts made over £3,000 within 7 years of the death and thus make their role easier to perform.
CGT tax-free death uplift
In addition, the principle that no CGT is payable upon death (known as the ‘tax-fee CGT uplift on death’) would be abolished.
Effect? The recipient of any gift or inheritance would inherit the donor’s base cost, not the value at date of death. Therefore, if they were to sell the asset, they would pay tax on their gain and the deceased’s gain.
Recommendation 2: Greater power given to HMRC and HM Treasury
The APPG have also suggested the introduction of compulsory reporting of lifetime gifts in excess of £3,000.
Justification? At present, HMRC has limited information of untaxed lifetime gifts as most do not need to be declared, for instance because the donor has survived 7 years.
Effect? This means that that any gift over the current £3,000 threshold (or a new threshold set by the Government) would need to be reported to HMRC, even if the gift is not immediately taxed.
Overall, the OTS and APPG have produced comprehensive reviews particularly in light of the wide range of opinion on the current tax regime.
On the face of it, the recommendations proposed by the report would simplify the design of inheritance tax albeit with consequences which could prove to disadvantage taxpayers if the proposals were agreed and be impractical in practice.
It should be remembered that there is no guarantee that the government will necessarily adopt any of the recommendations made by the OTS or APPG. However, following Britain’s formal exit from the EU and the 10-month transition period ahead, the question arises of when the recommendations will reach parliamentary debate… if at all?
Consistent with our policy when giving comment and advice on a non-specific basis, we cannot assume legal responsibility for the accuracy of any particular statement. In the case of specific problems we recommend that professional advice be sought.