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Government advisers recommend major IHT reforms

Emma Lunn
Written By:
Emma Lunn

The Office of Tax Simplification has set out a number of proposals that would make inheritance tax (IHT) easier to understand.

Families will be able to pass more wealth to future generations if new IHT proposals are adopted into law.

The Office of Tax Simplification (OTS), which advisers the government on tax issues, said IHT was overly complex and recommends overhauling outdated gifting rules.

The body’s report was commissioned by Chancellor Philip Hammond in 2018 in an attempt to address intergenerational unfairness issues.

IHT applies primarily on death, but also to gifts made to individuals within seven years of death and to lifetime gifts other than to individuals, charities and qualifying political parties.

Lifetime gifts

There are several exemptions from IHT relating to lifetime gifts, which haven’t changed since the 1980s. These are exemptions for the first £3,000 given away each year, for individual gifts of up to £250, gifts to someone getting married or entering a civil partnership, and regular gifts out of a person’s disposable income.

Bill Dodwell, OTS tax director, said: “The taxation of lifetime gifts is widely misunderstood and administratively burdensome. We recommend replacing the multiplicity of lifetime gift exemptions with a single personal gift allowance, to be set at a sensible level, and incorporating an increased lower threshold for small gifts. The exemption for regular gifts should be reformed or replaced with a higher personal gift allowance.”

The OTS also recommended that the seven-year period be shortened to five-years and abolishing the tapered rate of IHT. Data made public for the first time shows the tax paid on gifts six or seven years before death is low.

Where there is IHT to pay on lifetime gifts, the OTS recommends the government simplifies and clarifies the rules on who is liable to pay this tax, and how the £325,000 threshold is allocated between different recipients.

Capital gains tax

The OTS consultation also highlighted the complexity in the interaction between IHT and capital gains tax (CGT), as well as in relation to the reliefs available for businesses and farms.

The OTS said aspects of the regime distort the decisions families face when passing assets to the next generation, where there are different tests applying to what is broadly the same activity.

The report makes recommendations to address these distortions and reduce complexity and asks the government to consider whether the reliefs are targeted most effectively at the policy objectives.

Kathryn Cearns OBE, OTS chair, said: “Although only a small number of people pay inheritance tax each year, a far greater number worry about it. The OTS’s packages of recommendations would go some way to achieving the goal of making the tax easier to understand and simpler to comply with.”

Missed opportunities

Sean McCann, chartered financial adviser at NFU Mutual, said: “Broadly, we strongly support many of the recommendations in today’s report. Inheritance tax is one of the least understood and most feared taxes so any efforts to encourage more families to discuss what can often be a very sensitive subject are to be welcomed.”

However, McCann said the report missed opportunities concerning the residence nil rate band.

In addition to the IHT standard nil rate band (currently £325,000) a residence nil rate band (RNRB) was introduced from 6 April 2017. This is available when residential property is left to direct descendants. It pushes the nil rate band to £475,000 for the tax year 2019-20 and to £500,000 for the tax year 2020-21.

McCann said the current rules are both unfair and complex and those who don’t have children miss out. He added that the rules when downsizing or selling to move into care are unnecessary complex.

A study in April identified a lack of awareness around inheritance tax rules (IHT) among Brits, including the gifting limit and the nil-rate-band.