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Office of Tax Simplification - Proposed changes to IHT

The Office of Tax Simplification has published the second of its reports on the proposed reform of Inheritance Tax (IHT).

It includes some sensible suggestions, says Karen Sadler.

The headline reforms include:

  • Reducing the number of years a gift remains on the IHT clock from seven to five, which aligns with banks retention of records;
  • Simplifying some of the gift exemptions to a single personal gift allowance, to be set at a higher rate than the current £3,000;
  • Allocating the nil rate band on gifts across all gifts brought into the IHT account and placing the tax charge on the estate rather than the gift recipient;
  • Allowing all term life insurance payments to be IHT free without needing to be written into trust;
  • Aligning the tests for businesses and furnished holiday lets across IHT, income tax and capital gains tax;
  • A review of the pre-owned asset tax, which has always caused confusion and increased complexity.

But perhaps the recommendation with the widest ramifications is one slotted into the middle of the report under the title of 'Interaction with Capital Gains Tax'.

Currently, any asset held on death benefits from an uplift in its value to market value, meaning that if it is sold after this date by the estate or the beneficiaries, they are able to use the market value at the date of death as the base cost. This can significantly reduce or eliminate any Capital Gains Tax liability.

This favourable capital gains tax treatment feels logical where the asset is subject to IHT at 40%, where it is not covered by the nil rate band, but not where the asset has benefited from an IHT free uplift in value.

The report recommends a new approach to assets where the value is uplifted at death, but also benefits from an IHT exemption or relief.

Take the example: a business or Alternative Investment Market (AIM) shareholding is passed to beneficiary with Business Property Relief.

In these cases, the OTS recommends the asset pass at its historic base cost to the beneficiary. Therefore, while the IHT treatment remains the same, the asset will not benefit from an uplift to market value within the estate for capital gains tax. Should the investment or business be sold, the beneficiary would generate the same gain as if the asset has been sold by the deceased. This is designed to remove the incentive to hold assets to death simply to benefit from the value uplift.

More work needed

Disappointingly, there was no recommendation to remove the highly complex residential nil rate band, a seemingly easy target for simplification.

The OTS stated that as it ‘is still relatively new’ and that ‘more time is needed to evaluate its effectiveness before recommendations can be made on how best to simplify it’.

The OTS does however provide the suggestions submitted by the review for the government to consider. It also sets out the comments received relating to the inheritance tax of trusts for the government to consider in a separate consultation on the taxation of trusts.

We now wait to see if the government proposes any changes on the back of the OTS recommendations. Given the current pollical climate, it seems unlikely that we will see much, if any action on these matters before the end of the year at the earliest.

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