Inheritance tax: Government advised to reduce seven-year gifting rule to five years

The Government’s independent tax advisor has undertaken an inheritance tax review requested by the Chancellor and offered recommendations on how to simplify it.

In their report, the OTS (Office of Tax Simplification) made 11 such recommendations, including:

• Reducing the seven-year gifting rule to five years
• Replacing the multiple forms of lifetime gifts with a single personal gift allowance & clarifying who is liable to pay tax on lifetime gifts
• Simplifying and clarifying the interaction between inheritance tax and capital gains tax (CGT)

Kathryn Cearns, OBE, OTS chairman 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.”

Industry reaction:

The recommendations from the OTS have received largely positive reactions from the accounting industry, but some of the potential changes will still be controversial.

Sue Moore, technical manager in ICAEW’s (The Institute of Chartered Accountants in England and Wales) tax faculty and James Ward, head of the private client team at law firm Kingsley Napley LLP looked at each key recommendation in detail.

Speaking of the report as a whole, Sue Moore said: “The inheritance tax system is a complex area for professional accountants to navigate, let alone grieving families, and the piecemeal additions to the original 1980s legislation make it more confusing.

“The OTS has come up with some sensible proposals to simplify the system, although some are controversial.”

James Ward said: “Overall, while some of the changes proposed by the OTS are welcome and sensible, some — like the proposal to remove excess income exemption and the uplift in base cost on death — will see tax mitigating tools removed for wealthy clients.

“However the reduction of the seven-year gifting rule trumps it all and will make gifting that little bit easier (either to survive or to insure against).

Recommendation: Reducing the seven-year gifting rule to five years

Sue Moore (ICAEW): “Reducing the seven-year survival period for gifts to five years is a very practical solution to the problem of obtaining bank statements that are more than six years old.”

“Taper relief is much misunderstood: the taper applies to the tax payable, but most people think it applies to the value of the gift.

“As most lifetime giving is below the nil rate band, the taper relief doesn’t kick-in very often so abolition of this relief – combined with a reduction in the survival period to five years – would probably mean more people would win than lose.”

James Ward (Kingsley Napley LLP): “Clearly the stand out proposal from the Office of Tax Simplification (OTS) must be the reduction of the seven-year gifting rule to five years. This is a welcome proposal.

“However, it does come with the removal of taper relief which means that substantial gifts will see no tax deduction after three years and will need to have a survival rate of the full five years to have any inheritance tax benefit.“

Recommendation: Replacing the multiple forms of lifetime gifts with a single personal gift allowance

Sue Moore (ICAEW): “The recommendation to combine the various gift allowances into one personal allowance is positive as many people are baffled by the various exemptions currently in place.

“More contentious is the suggestion that the normal expenditure out of income rules be abolished and included within a higher personal gift allowance.”

James Ward (Kingsley Napley LLP): “The OTS is also proposing to amend the general exemptions around gifting and bringing them all into one pot. This would see one large annual exemption of capital gifting which makes a lot of sense.

“The sting in the tail, however, is the proposal for the removal of gifting excess income after the deduction of normal expenditure.

“This is not widely used or even known about, yet for high earning individuals can be a way to pass substantial money down without running the risk of dying within seven years.

“High earners should be looking now to make such gifts as if this proposal is followed this exemption will be removed.”

Recommendation: Simplifying and clarifying the interaction between Inheritance Tax and Capital Gains Tax (CGT)

Sue Moore (ICAEW): “The recommendation to remove the capital gains tax (CGT) free uplift on death where an asset qualifies for relief from inheritance tax (IHT) could, if adopted, encourage earlier gifting of businesses which may be beneficial.

“Many business owners defer gifting their business to their children for fear of losing out on the CGT free uplift on death.

“However, to exclude the CGT uplift when the spouse exemption is claimed seems unjust as the taxman will get his slice of the IHT on the death of the surviving spouse.

“There are some areas that require further thinking: moving the liability for tax on lifetime gifts payable after death from the gift recipient to the estate could be challenging if the estate is left to a different beneficiary.”

James Ward (Kingsley Napley LLP): “This is the proposal to abolish the base cost uplift for capital gains tax on death when there is no inheritance tax payable on the asset.

“How this works is that if a husband was to die and leave a buy-to-let flat to his wife there is no inheritance tax due to the spouse exemption.

“However, there is capital gains tax uplift so that the wife could then sell the property if she wishes using the date of death value as the base cost.

“The proposed changes mean that the buy-to-let flat would not have an uplift to probate value and there would be a capital gains tax bill based on the husband’s acquisition costs not the value at the date of his death.

“This takes out a particular strong area of planning and would also potentially see HMRC picking up more capital gains and make it harder for people to sell property without a substantial capital gains tax bill.”

Additional thoughts:

Sue Moore (ICAEW): “The UK Government now collects over £5bn from IHT, up from about £0.5bn in 1980, so it is an increasingly important tax affecting more and more people. However only around 5% of deaths result in IHT being paid, so more people are worried about IHT than actually have to pay it.”

James Ward (Kingsley Napley LLP): “Of course, if we see a Corbyn led Labour government, this well thought out paper may find itself quickly looking like moving chairs around the Titanic.

“Inheritance tax as we know it would most likely totally change with the introduction of a punitive life time gift tax charge. This would stall inter-generational gifting which has become so vital for the younger generation.”

About OTS:

The OTS is the independent adviser to government on simplifying the UK tax system. The OTS makes recommendations for the government to consider. It does not implement changes – these are a matter for government and for parliament.