OTS proposes IHT rules shake-up

The Office of Tax Simplification (OTS) has proposed cutting the “seven-year rule”, a pivotal aspect of UK inheritance tax (IHT) planning that governs gifting, to five years to simplify its administration.

The recommendation, published in the OTS’ Inheritance Tax Review – second report: Simplifying the design of Inheritance Tax, a review ordered by Chancellor Philip Hammond in January 2018, is one of 11 proposals, concentrated on three primary areas of IHT, that will shake-up gifting rules.

However, the suggestion could prove controversial as it will allow people to ‘gift’ significant portions of their assets to substantially reduce their estate’s IHT. According to the latest data published by UK Finance, around 5 per cent of estates are liable for IHT, charged at 40 per cent above an individuals’ £325,000 threshold.

Assets that are given away during an individual’s lifetime are exempt from IHT, if the person lives for seven years after gifting the assets. However, in the event the person who gifted the assets passes away within three to seven years, the tax payable increases substantially.

In the report, the OTS concluded the seven-year rule made it difficult for executors to settle people’s financial affairs, as bank statements were only available up to six years prior.

Furthermore, making reference to data published by Her Majesty’s Revenue & Customs (HMRC), the report highlighted that the amendment would not reduce government revenue, as only £7m of the total £4.38bn IHT take in 2015/16 came from gifts that individuals made more than five years before death.

The report also advocated the abolition of the taper relief.

Commenting on the report, AJ Bell personal finance analyst Laura Suter said: “The inheritance tax system has become so complicated that many people simply do not understand the system, so any simplification to make it easier for families to navigate would be a positive development. Recent HMRC research found that just 45 per cent of people gifting money knew how inheritance tax rules worked, highlighting the need for both simplified rules and more education.

On cutting the seven-year rule down to five, Suter argued: “The OTS rightly acknowledges that the seven-year taper rule is hideously complex, and can cause people to be landed with an unexpected inheritance tax bill years after they were gifted money. However, the suggestion of reducing the seven years down to five and scrapping taper relief entirely looks like a bald tax grab and revenue-raising move. Instead the taper could be simplified into a two-step process for example, or if it’s scrapped entirely then the period should be shorter than five years.”

Suter also welcomed the office’s proposal to merge the annual gift exemption and the exemption for gifts in consideration of marriage of marriage or civil partnership into an overall personal gifts allowance. The AJ Bell senior analyst noted that the recommendation of reviewing the current allowance, adding that it has not increased “in decades so inflation has dramatically eroded its value”.

Despite the review being welcomed by many, Quilter tax and financial planning expert Rachael Griffin warned that “further tinkering” may be detrimental to the simplification of IHT, stating: “Before the government jump feet first into making these changes they need to step back and reflect on the purpose and vision of inheritance tax. If its purpose is to tax people based on how much wealth they have then the research is pointing to the necessity of reform. However, there needs to be proportionate reform.

“IHT makes up less than 1% of the total raised by the Exchequer and so would cover just one week’s worth of the cost of tax relief on pensions. It’s undeniably an issue, but government have bigger and more expensive fish to fry.

“Chancellor Philip Hammond was the one that ordered this review over a year ago. With the current Tory leadership battle, it is likely that we will have a new Chancellor in place soon and these recommendations may fall on deaf ears. However, one hopes that politicians will take a long-term view and see the necessity for reform.

“Changes to IHT could be a nice giveaway for the Conservatives if and when they have to head into a general election. Really though this should be a cross-party initiative as rules regarding inheritance tax are, by their very nature, long term and require advanced planning. A constantly shifting framework makes such planning impossible.”

To read the full report, click here.

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