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Chancellor requests simplification of IHT rules

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The Chancellor has asked the Office of Tax Simplification to look at ways of simplifying the inheritance tax (IHT) regime.

In a letter published on its website, Chancellor Philip Hammond stated: “The inheritance tax system and the system within which it operates is particularly complex, and I would like to request that the OTS carry out a review into the regime.”

The Chancellor said the review should include a focus on the technical and administrative issues with IHT, such as the process of submitting returns and paying any tax due as well as practical issues around routine estate planning and disclosure. He also said the OTS should look at the current rules on gifting.

The move was welcomed by tax practitioners. Anthony Nixon, partner and inheritance tax expert at Irwin Mitchell Private Wealth, said: “It is good to see the Chancellor of the Exchequer taking an interest in simplifying inheritance tax (IHT), which is well overdue.”

Nixon outlined three main areas where he would like to see reform:

  • Reform (perhaps complete abolition) of the complex new IHT allowance linked to the value of one’s home, known as the Residence Nil Rate Band (RNRB).  He said this discriminates against those who do not own their own home, those who do not have children, and those who are not married. The current £325,000 allowance, which has been fixed since 2010, could then be raised for everyone.
  • A fresh look at the IHT rules for trusts, where the opportunity for reform was missed by HM Revenue & Customs in a recent review.  It should be easier for those worried about their own improvidence to be able to create a trust for their own benefit, without tax penalties.
  • Simplification of the IHT reliefs for businesses and, particularly, farmers, whose families usually have to claim both agricultural and business reliefs, rather than making a single claim.

He added: “It is imperative that with change, the people who will be affected by these changes are considered at every turn. Simplification mustn’t come at the expense of fairness and justice to the families and beneficiaries who should receive inheritances.”

Sarah Coles, personal finance analyst at Hargreaves Lansdown, said: “Anyone who has ever wrestled with estate planning and inheritance tax can appreciate that the whole system can be a nightmare of complexity. The pension freedoms and the additional residence nil rate band may have reduced IHT for many, but they have made things much more complicated rather than less, so it’s about time someone took a big red pen to the myriad of rules and regulations.”

What might be in the spotlight?

Hargreaves Lansdown gives the runners and riders…

Deeds of variation

Deeds of variation allow beneficiaries of a will to amend how assets are distributed, often to save tax. A change would be unlikely, as they were reviewed back in 2015, when the government decided to leave well alone. Changes would be difficult, and given that they are relatively benign as a tax planning tool, it may not be worth it.

Potentially exempt transfers

The current rules state that after seven years, any gift is considered out of your estate for inheritance tax purposes. This rule is widely misunderstood, and in certain circumstances IHT can still apply to gifts made up to 14 years before death. It can also encourage people to make large gifts before it makes financial sense for them. There has been some speculation that this period could be reduced to two years.

IHT status of pensions and ISAs

Since pension freedoms, it’s now far more tax-efficient to pass your pension onto the next generation than it is to pass an ISA, because pensions are free of IHT (in the vast majority of cases) and ISAs are not. This has been very popular with pension savers, but has had a big impact on the way people view savings and investment in retirement. Death taxes have always had the potential to distort planning decisions, but since the pension freedoms, the IHT efficient solution has been to take a U-turn on how you spend your retirement savings.

Interaction with capital gains tax

Capital gains tax (CGT) washes out on death, so one way to avoid paying capital gains tax is never to sell anything. Of course on death there could be IHT to pay but CGT is a considerable barrier to investment decisions.

Trust taxation

Trust taxation in 2006 brought together a whole range of trust regimes into two, with monumentally complicated tax treatment. In some cases there are tax charges on entry, periodic tax charges and then exit charges. The regime was designed to make tax avoidance more difficult, but in the process added to what was already a complex regime. This is an area ripe for simplification.

Nil rate band and main residence nil rate band

The residence nil rate band is a relatively new addition, and is in the process of being phased in. It would be unusually early in the process to make a change, but would make life easier if it was merged with the nil rate band to form one simpler allowance.

Annual exemption

Each year, anyone can give away £3,000 of their assets in gifts free of inheritance tax. This figure has not changed for over 30 years, and if it had increased with inflation it would be around £9,500.

Investments which qualify for business property relief

Business property relief provides an IHT exemption once a qualifying investment is held for two years. Aimed at entrepreneurs and encouraging investment in small and often unquoted companies, this IHT break also applies to certain shares listed on the Alternative Investment Market (AIM). Since August 2013, AIM stock can be held in ISAs, attracting more people to invest while providing the potential for a complete lifetime and death tax free ISA account. Is the increased risk, volatility and potential liquidity issues worth a zero IHT trade off?

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