Shake-up of Inheritance Tax

The “seven-year rule”, a bedrock of UK inheritance tax planning governing gift giving, should be cut to five years to simplify its administration, an independent review ordered by the chancellor has concluded.

The recommendation, published in a report on inheritance tax by the Office of Tax Simplification (OTS) on Friday, forms part of a proposed major shake-up of longstanding gifting rules. The proposal is likely to court controversy as it would enable those able to give away large chunks of their assets to substantially reduce their estate’s inheritance tax (IHT). About 5 per cent of estates are liable for IHT, charged at 40 per cent above an individual’s £325,000 threshold.

Assets given away during an individual’s lifetime are exempt from IHT if the person lives for at least seven years after making the gift. If the individual dies within three to seven years of making the gift, the tax payable tapers on a sliding scale. The OTS concluded the seven-year rule made settling people’s financial affairs difficult for executors as bank statements were only available going back six years.

Referencing data from HM Revenue & Customs, the report added the change would not reduce government revenue. Only £7m out of the total £4.38bn inheritance tax take in 2015/16, came from gifts that individuals made more than five years before death.

Bill Dodwell, OTS tax director, acknowledged the measure would be a “giveaway” for some. But, he added: “In the context of a tax that raised £5bn last year, we concluded it wouldn’t move the dial very far and it would help a lot of executors, as well as HMRC [with administration]”. The report also advocated scrapping the taper relief.

This “all or nothing” outcome could lead to more people taking out insurance to protect against the possibility they do not live past five years, said Lynne Rowland, tax partner at accountancy firm Kingston Smith. In another major overhaul to the rules, the OTS recommended the myriad existing IHT free gift allowances be replaced with one allowance per person. Currently, individuals can give away £3,000 a year without paying IHT and unlimited gifts of under £250 to other people. Parents can give £5,000 towards the cost of a child’s wedding and grandparents, £2,500, IHT free.

But, the OTS found the allowances, which have not changed since the 1980s, were confusing and poorly understood. While the body did not suggest a level for such an allowance, it pointed out the £3,000 annual limit would now be £11,900 if it had risen in line with inflation. The body also floated the idea of a higher personal gift allowance to replace a tax rule used by those with surplus income. The OTS said there were examples where the rule had been used to exempt gifts worth more than £1m.

“There would clearly be winners and losers from such a change,” the report acknowledged. “The very small number of people currently using the exemption in relation to large gifts could pay more Inheritance Tax.” Meanwhile, the OTS also questioned how business property relief, which is designed to reduce the IHT due when passing on family businesses, was being used to avoid paying IHT on investments in Aim-listed companies. “We think Aim is the only market in the world where investors can receive an inheritance tax benefit.” Mr Dodwell said. “Supporting a market in this way is a different policy objective from supporting passing a business down the generations.”

The report, the second and final stage of the OTS’s probe into IHT, follow’s November’s recommendation that the complex administration and excessive form-filling be tackled to reduce the burden on bereaved families. The Treasury said it would respond to the recommendations in due course.

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