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 and will have significant impact for business owners and farms, 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.
What do businesses and farms need to know?
The OTS proposals will have ramifications for business owners and farmers and the following should be taken into consideration:
- Consider whether it is appropriate for the level of trading activity for Business Property Relief to continue to be lower than for gift hold over relief or Entrepreneur’s relief.
- Consider the treatment of indirect non-control holdings in trading companies and aligning the treatment of furnished holiday lets with that of income tax and capital gains tax.
- Review the treatment of limited liability partnerships to ensure they are treated appropriately for the purposes of the BPR trading requirement.
- Consider the eligibility of farmhouses for agricultural property relief where the farmer has gone into care.
- HMRC should be clear when a valuation of a business or farm is required and if so, whether it is a formal valuation or an estimate.