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HMRC to overhaul of inheritance tax and lifetime gifting?

The Office of Tax Simplification (OTS) has undertaken an extensive consultation exercise revealing many areas where they feel IHT is either poorly understood, counter-intuitive, requiring substantial record keeping, creates distortions, or where the law is simply unclear.  It has recommended sweeping reforms in a bid to reduce the complexity.

This is partly because, as house prices soar in some parts of the country, an ever-increasing number of individuals are being caught within the IHT net.

IHT applies primarily on death, and on some lifetime gifts.

Basically, there is a tax-free IHT threshold of £325,000, or £650,000 for married couples and civil partners, but this figure has not been increased for many years.  Married couples and civil partners also have the added benefit of the residence nil-rate band which gives them up to an additional £150,000 each of tax-free property-based inheritance as of 6 April 2019. This allowance is set to rise to £175,000 from 6 April 2020.  However, this is only available if the residence is left to children or grandchildren, so it is not available to childless couples.

The OTS report contains 11 recommendations to deliver a ‘more coherent and understandable structure to the tax’, as they feel it is widely misunderstood by individuals.

The main areas the OTS has suggested for reform are:

  • Lifetime gifts, or Pets, the seven-year period is shortened to five years;
  • Removing taper relief on lifetime gifts;
  • Replace gifts out of income with a higher personal gift allowance;
  • Create an overall personal gifts allowance to cover small gifts;
  • Setting the percentage of non-trading activities for Business property relief to fall in line with entrepreneur’s relief;
  • Align the treatment of furnished holiday lettings with that of the income tax and capital gains tax treatment.

The reduction from five to seven years on lifetime gifts will be a welcome reform for many, but removing the taper relief from lifetime gifts means that individuals will now have to survive the full five years, rather than see a reduction in IHT after only three years.

Gifts out of income are used by many individuals to reduce their IHT liability, and quite large amounts are passed to descendants using this allowance.  If this is replaced with a more restrictive allowance, then this could result in many people paying more IHT.

The OTS report also highlighted complexity in the interaction between IHT and CGT, as well as in relation to the reliefs available for businesses and farms.

However, it did not propose simplification of the residence nil rate band, which is complex and difficult to administer. This was because the residence nil rate band is still relatively new, and they feel more time is needed to evaluate its effectiveness before recommendations can be made on how best to simplify it, even though it can cause great confusion among people planning their estates.

In addition, it is an unfair allowance, as married couples or civil partners, together with single individuals, do not benefit from this allowance, even though they may have beloved nieces and nephews who could inherit.

Response to this consultation was overwhelmingly high with nearly 3,000 responses to an online survey, a further 500 emails from individuals and over 100 written responses from experts. I think this shows what an unpopular and complex tax IHT is, and perhaps the best way to deal with this would be to simply abolish it all together and replace it with a general gift tax, as many other countries have done.