Q4 2019

www.wealthandfinance-news.com 4 Wealth & Finance International - Q4 2019 IHT: Change is on the way – but will it go far enough? The Government is being urged to proceed with plans to simplify inheritance tax (IHT), following publication of the Office of Tax Simplification’s (OTS) Part 2 review of the system, which included a number of recommendations. Whilst changes are needed, the review’s focus on ‘simplification’ may not be enough, with further measures required to create a fair and practical system. Many believe that the review of IHT was long overdue and significant change is urgently needed. Often described as overly complex, the current rules can create additional difficulty for families at what is an already emotionally turbulent time. The Chancellor’s call for an IHT rethink was also prompted by socio-economic factors, and the need to level the playing field between higher and lower-income families. Rising property prices and long frozen IHT allowances mean that more are caught by the tax than ever before, with last year’s take exceeding £5bn for the first time. While only the wealthiest of those impacted have access to planning advice, this means that proportionally, IHT is having the greatest impact on those who can least afford it. Importantly, the OTS’s review has focused on simplification from a “technical and administrative” perspective, stopping short of recommending a more extensive overhaul. However, if enacted, these changes will certainly be a step in the right di- rection – helping to create a system that is fair, transparent and easier to navigate. One of the key proposals relates to the shortening of the so-called ‘seven-year rule’ for potentially exempt transfers (PETs). PETs are gifts of assets made during an individual’s life that incur no IHT liability if the gift is made seven years before death. If the giver dies within seven years, IHT can still be charged. However, the tax rate is reduced for gifts made at least three years before death via a tapering relief. Whilst the rules around PETs require detailed record-keeping – creating a significant administrative burden – the taper rules mean little extra IHT is paid after five years. However, the OTS’s recommendation to reduce the seven-year period to five, and do away with the tapering system, could introduce new problems. The current rules are fair in that any tax liability is graduated according to when the gift was made, whereas the new proposals would create a cliff-edge for those using PETs. Someone dying after 4 years and 11 months would be liable to IHT in full on the value of the gift, even though this liability would have disappeared after five years. Another recommendation made by the OTS is the introduction of a single gift allowance. Currently, individuals can make an IHT-free gift under a wide range of IHT allowances. The OTS has recommended that this is reduced to a single gift allowance per person. It has reported that the current rules are too complex and poorly under- stood and switching to a single gift allowance would provide much-needed clarity. It is noteworthy that the review stops short of suggesting what the new allowance should be. The suggestion is that the level should take into account inflation, which for the annual gift allowance - frozen since the 1980s - could see an increase to £11,900. It is likely that more consultation would be needed to agree a fair level. Other notable recommendations include changes to the rules around normal expendi- ture out of income gifts, and the proposed removal of the capital gains tax (CGT) uplift on death. Commonly used as a planning tool by wealthy individuals to minimise IHT, the rules for gifting income have attracted controversy. As long as gifts are made regularly and do not reduce the giver’s standard of living, they can currently be made IHT-free. There is no clear definition of exactly what constitutes ‘normal expenditure out of in- come’, which may be leaving the system open to abuse. Whilst the OTS identified that these guidelines need reform, it recognised the difficulty in replacing such a subjective exemption and further detail will be required to ensure a clearer and fairer system. Similarly, the suggested removal of the CGT uplift, which applies when a person inher- its assets, will require further thought. CGT is currently not chargeable on such assets, but is on lifetime gifts. The existing rules mean that IHT applies instead on all parts of an estate above the ‘nil rate band’ of £325,000. Dissecting this rule further, the OTS has identified a number of issues relating to its application. For example, where the asset qualifies for IHT relief, an individual may not pay any charge at all. In other cases, if a donor of a lifetime gift dies within seven years, the beneficiary could end up paying a double charge. Such discrepancies are hard to justify and, it may seem reasonable for the OTS to recommend removing the CGT uplift where IHT relief applies. However, this will adversely impact estates that have planned for the existence of the IHT reliefs, which were designed to ensure the continuance of an asset or business. Furthermore, it does not resolve concerns over the double charge. Without doubt, the existing IHT system is crying out for simplification, and the above proposals could go a long way towards creating a fairer system, which can be more easily navigated by beneficiaries at a difficult time. However, the devil in these propos- als will very much lie in the detail. For example, the level of any single gift allowance will be critical to its success – whether it is viewed as a fair simplification and overdue correction for inflation, or simply as a tax grab. The risk is that in seeking to cover every eventuality, the rules will only add complexity, leaving IHT as inaccessible as ever. For individuals who are concerned about how any rule changes might affect them, it’s worth bearing in mind that the review’s recommendations are unlikely to be translated into legislation quickly. While it’s important to consider these recommendations when formulating long-term plans, no immediate action is required at this stage. Despite concerns that the review has been too focused on simplification, the recom- mendations made are a positive indication of the Government’s intention to introduce change. While we may not yet have all the details of what’s in store for IHT, what’s clear is that the system is about to change and probably for the better. David Truman is a private client partner at accountancy firm, Menzies LLP