Possible changes for Inheritance Tax rules

The detailed report from the Office of Tax Simplification (OTS) – Simplifying the design of Inheritance Tax (IHT) – is a lengthy read at 107 pages! If you don’t fancy a bit of bedtime reading then don’t worry, we’ve pulled out some of the highlights relating to IHT.

Lifetime gifts

We spend a lot of time talking to clients about the available gift allowances, with cashflow planning helping to highlight what someone can or cannot afford to give away. It’s apparent however that the various gift allowances are confusing. There are lots of types of ‘gifts’ – annual, small, wedding, gifts out of income – and there is a suggestion to do away with these and have a single annual allowance.

The seven-year rule

It is relatively well known that large gifts can be made, as what is known as a potentially exempt transfer (PET), the donor must survive for at least seven years. Of course the rules are much more complicated than that, but the general understanding is that such gifts will have an impact on IHT if you die within seven years of giving them.

The report proposes that this sevenyear term is reduced to five years. A common issue with estate planning is people leaving it late in life to start IHT planning, by which point seven years is a potentially long time to survive, and therefore carrying the risk that larger gifts will ‘fail’. As such, reducing the time by two years would be a welcome move.

Tied to the above is the idea to remove the taper relief. We often speak to people who get confused by the taper, not understanding that it is a taper on the tax due rather than of the amount gifted. Taper is only available when the gift (or cumulative gifts in the previous seven years) is over the nil rate band, currently £325,000. There is also what is known as the ’14-year rule’ which is even more confusing! The idea is to scrap this, which would certainly make tracking gifts and establishing any tax due a much simpler task.

Capital Gains Tax

There are a number of interactions between Capital Gains Tax (CGT) and IHT, which make planning essential but which can cause surprises to those unaware. The worst-case scenario for many would be gifting assets in their lifetime – thus triggering a CGT liability – and then passing away within seven years of that gift, and paying (additional) IHT as a result of the failed PET.

It is relatively well known that there is a capital gains ‘uplift’ on death, even in the common scenario whereby assets are simply passed to a surviving

spouse. This can lead to situations where individuals hold onto assets in later life knowing that will be more tax favourable than gifting during their lifetime, which could then lead to a significant CGT liability. Once the asset is passed through the estate, the value at death becomes the new ‘base cost’ and gifting or selling the asset may then be more tax favourable. This is particularly relevant where assets are passed to a surviving spouse (which is exempt from IHT), or where assets qualify for Business Property Relief (BPR) or Agricultural Property Relief. This can often lead to no tax – either CGT or IHT – being due, and is something that is proposed to change. The idea is complex and would involve something similar to holdover relief (a relief against CGT in certain scenarios), but this would need some careful drafting if it were to come into legislation.

Term assurance plans

At present, if a life assurance plan is not held in trust it becomes part of a taxable estate. In a very sensible proposal, the idea would be that term assurance plans would automatically be exempt from IHT without the need for trusts, which individuals (and some insurance companies!) struggle to understand.

The Alternative Investment Market (AIM) shares

AIM shares have become increasingly popular with investors, given that they attract BPR after two years of ownership. The report questions this, given BPR was originally designed to prevent smaller businesses being split up upon death (to pay death duties) – a valuable relief for families

“A common issue with estate

planning is people leaving it late in life to start IHT planning.”

to allow businesses to pass down the generations. However, with AIMlisted companies, the relief is slightly at odds with the original intention given investors are ‘removed’ from the business and act as a third-party owner.

AIM ISAs (Individual Savings Accounts) have been available since 2013, and as such this area of investing has grown in popularity. This move would adversely affect a number of those who have sought the tax reliefs available from this style of investing. There would also be a knock on effect to the value of those AIM companies, so this would need to be carefully considered before any move could be put in place.

Stuart Coombe