Nisha Patel looks to the future of probably the most unpopular of all taxes.
Calculating and planning for an inheritance tax (IHT) liability can be confusing. There are reliefs and exemptions on gifts to consider and the interaction with other taxes. This article takes a look at some of the complications IHT can cause.
Background
IHT is a tax on an individual's estate upon their death and on certain gifts made by the individual during their lifetime. The first £325,000 (for 2019/20) of this is covered by the nil rate band. After that, the rate of tax is 40% on death, or 20% on chargeable lifetime transfers.
Following a request by the government, the Office of Tax Simplification (OTS) has undertaken a review of this tax. In its second report, published July 2019, the OTS made eleven recommendations to simplify IHT.
The report can be found here: www.gov.uk/government/publications/ots-inheritance-tax-review-simplifying-the-design-of-the-tax
Lifetime gifts
There are three types of gifts or transfers that an individual makes during a lifetime. They are exempt transfers, potentially exempt transfers (PET), and chargeable lifetime transfers (CLT).
Examples of the more common exempt gifts include an annual allowance of £3,000, small gifts not exceeding £250 a year per donee, and various limits for gifts on marriage. Other exemptions include family maintenance, regular gifts out of income and gifts to charities and qualifying political parties. When calculating the IHT due, the nil rate band is first applied to these lifetime transfers. The balance is then used to reduce the value of the total estate.
The OTS report found that many people are not aware of the different exemptions and allowances available to them in order to create an effective gifting strategy. In response, the report recommends replacing the various lifetime gifts exemption with just one higher personal gift allowance.
PETs become exempt if the donor lives for seven years after gifting. If the donor dies within seven years, taper relief applies. This is time-consuming when taking into account the amount actually saved. The OTS recommends reducing the seven-year period to five years and abolishing taper relief altogether.
Another recommendation in this area is to clarify and simplify the rules upon whom the IHT liability falls; and allocating the nil rate band.
Interaction with capital gains tax
Gifts that are made in a person’s lifetime usually have capital gains tax (CGT) and IHT consequences. In some instances, it may give rise to both CGT and IHT if the donor dies within seven years of gifting. In other cases, there may be a choice between gifting during an individual’s lifetime or holding onto an asset until death.
One example of this is where, on the death of an individual, an asset gets transferred to a beneficiary at market value. The beneficiary then sells the asset. CGT is calculated using the market value at death.
If the asset had been transferred before death (ignoring any reliefs), CGT would have been calculated using the original cost, giving a higher CGT exposure. This difference is known as the capital gains uplift. The OTS believes this should be removed and a fairer tax should be levied when the asset is sold.
Business and agricultural property relief
As indicated above, there are different reliefs available for CGT and IHT purposes.
For example, for CGT purposes, the definition of trading activity for holdover relief is considered to be 80% of all activities. Meanwhile, the trading activity requirements in business property relief is at least 50%. The OTS advocates aligning these anomalies.
