Recommendations from the Office of Tax Simplification
Earlier this month the Office of Tax Simplification (OTS) published the second report on its Inheritance Tax Review. The first report was all about procedures, such as form filling and submission, but this second report has put forward recommendations for the actual tax. It’s long with 107 pages covering exemptions, gifts, business and agricultural reliefs, life insurance and anti-avoidance legislation. Far too much for me to precis in one go, so I will concentrate on a few points that have caught my eye.
The seven year rule – This well-known – though often misinterpreted – exemption says that if I give you, say, £100,000 (after I’ve already given away the Nil Rate Band (more on that later)) and I live for the next seven years, there would be no IHT to pay. But if I died before the seven years are up, you, as the recipient of my generosity, might not thank me, since you would have to pay up to £40,000 to HMRC. There is a taper that reduces the amount of tax payable in the last four years, but in reality the amount of tax collected from these last few years is negligible. So the OTS has recommended reducing the gifting period to five years and scrapping the taper.
This is a genuine simplification but it does introduce a ‘cliff edge’. In the above example, if I were to die after 4 years, 51 weeks and a few days, you would have to pay £40,000, but if I died a couple of days later there would be none to pay.
Gift Allowances – There are numerous gift allowances and these can be rather complicated. First of all there’s the annual gift allowance. This says you can give up to £3,000 a year free of IHT, and if you haven’t used the allowance in one year you can carry it over to the next, so up to £6,000 can be given away in one year. By the way, that’s £3,000 in total not £3,000 each to different people.
Then we have gifts in consideration of marriage and civil partnership (that’s too long-winded, I’m just going to call it the marriage allowance). Parents can give up to £5,000 (and that’s each parent, so £20,000 from all four Mums and Dads) and grandparents can give £2,500 each. Anyone else can make wedding gifts of up to £1,000.
As a brief aside, I’m reminded of the article I wrote in May that looked at the effects of inflation. The marriage allowance hasn’t changed since it was introduced in 1975. The average house in 1975 cost £10,388* , so one set of parents could have given their marrying child a new house as a wedding present. Today, the same marriage allowance would buy 4.6% of the average house…..the broom cupboard perhaps.
Finally, there is the small gifts allowance. You can give up to £250 each to any number of individuals. It’s there to avoid the need to report every single Christmas and Birthday present. If I was feeling generous I could give £250 each to 10 friends. I could also give £3,000 to an eleventh friend using the annual allowance, but I could not give him £3,250. If I did, £250 would be subject to the 7 year rule, unless he was getting married in which case I could give him, £4,000, but not £4,250.
See, I told you it was complicated, especially the interaction between each of the gift allowances and the other IHT allowances (the 14-year rule anyone?). So the OTS has suggested replacing the annual and marriage allowances with a single ‘personal gifts allowance’ and has suggested reviewing the level of the small gifts allowance.
Other IHT-efficient gifts include to charities; for the nation; for family maintenance; of land to housing associations; and to political parties (no comment), but I’ll leave those to one side for now.
Nil Rate Band – This is another well-known exemption the application of which is often misinterpreted. It’s commonly known that the first £325,000 of an estate is exempt from IHT. It has been frozen since 2009 and would be around £423,000 today if standard inflationary increases had been applied over the last 10 years. But it is the interaction with the seven-year rule that is often misunderstood.
Where a gift over the annual allowances has been made, this gift is set against the Nil Rate Band first, and ‘uses up’ the NRB for the whole seven year period. This can have rather unpleasant and unintended consequences. The example given by the OTS illustrates this very well:
The OTS has put forward a recommendation that the NRB should no longer be allocated to lifetime gifts in chronological order but allocated proportionately, and that any Inheritance Tax due in relation to lifetime gifts to individuals should be payable by the estate. That would mean both James and Claire keeping their full gift and the rest of Sarah’s estate paying the IHT, unless there wasn’t enough in the estate in which case James and Claire would each pay a fair amount.
Of course, all of the above is simply part of a review which puts forward recommendations to the Government. How many of those recommendations will be adopted and in what form we cannot know, nor indeed when. There are some genuinely reforming recommendations in the report that, were they all to be taken up, would bring significant change. But, for now, it’s a game of wait and see. In the meantime, if you’re thinking of making gifts for IHT purposes, may I urge you to seek advice first. As the OTS has shown there are many pitfalls for the unwary.
*Nationwide UK House Prices Survey
Philip Chandler FPFS, CFPTM, Chartered MCSI
Chair of Aspinalls Technical and Investment Committee