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Chancellor asks for review of inheritance tax

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Deepbridge Capital


Chancellor Philip Hammond has written to the Office of Tax Simplification asking for a review of inheritance tax (IHT).

His aims, Hargreaves Lansdown told IFA Magazine, are as follows:

  • a simpler, fairer and better system;
  • a focus on technical and administrative issues such as submitting returns and paying tax due;
  • a look at how the current gift rules interact with the wider IHT regime;
  • whether the current framework distorts decision making – the big recent change here being pensions, now far more tax efficient on death than ISA.

The letter is here.

Sarah Coles, personal finance analyst, Hargreaves Lansdown, said: “Hammond suggests the Office of Tax Simplification looks at whether the current inheritance tax framework distorts decision-making, well we can save them the time, because of course it does. The tax framework distorts people’s behaviour and financial decisions, and inheritance tax is no exception.”

“Anyone who has ever wrestled with estate planning and inheritance tax can appreciate that the whole system can be a nightmare of complexity. The pension freedoms and the additional residence nil rate band may have reduced IHT for many, but they have made things much more complicated rather than less, so it’s about time someone took a big red pen to the myriad of rules and regulations.”

What might be in the spotlight – runners and riders 

1. Deeds of variation

Deeds of variation allow beneficiaries of a will to amend how assets are distributed, often to save tax. A change would be unlikely, because they were reviewed back in 2015, when the government decided to leave well alone. Changes would be difficult, and given that they are relatively benign as a tax planning tool, it may not be worth it.

2. Potentially exempt transfers

The current rules state that after seven years, any gift is considered out of your estate for inheritance tax purposes. This rule is widely misunderstood, and in certain circumstances IHT can still apply to gifts made up to 14 years before death. It can also encourage people to make large gifts before it makes financial sense for them. There has been some speculation that this period could be reduced to two years.

3. IHT status of pension and ISA

Since pension freedoms, it’s now far more tax-efficient to pass your pension onto the next generation than it is to pass an ISA, because pensions are free of IHT (in the vast majority of cases) and ISAs are not. This has been very popular with pension savers, but has had a big impact on the way people view savings and investment in retirement. Death taxes have always had the potential to distort planning decisions, but since the pension freedoms, the IHT efficient solution has been to take a U-turn on how you spend your retirement savings.

4. Interaction with capital gains tax

Capital gains tax (CGT) washes out on death, so one way to avoid paying capital gains tax is never to sell anything. Of course on death there could be IHT to pay but CGT is a considerable barrier to investment decisions.

5. Trust taxation

Trust taxation in 2006 brought together a whole range of trust regimes into two, with monumentally complicated tax treatment. In some cases there are tax charges on entry, periodic tax charges and then exit charges. The regime was designed to make tax avoidance more difficult, but in the process added to what was already a complex regime. This is an area ripe for simplification.

6. Nil rate band and main residence nil rate band

The residence nil rate band is a relatively new addition, and is in the process of being phased in. It would be unusually early in the process to make a change, but would make life easier if it was merged with the nil rate band to form one simpler allowance.

7. Annual exemption

Each year, anyone can give away £3,000 of their assets in gifts free of inheritance tax. This figure has not changed for over 30 years, and if it had increased with inflation it would be around £9,500.

8. Investments which qualify for business property relief

Business property relief provides an IHT exemption once a qualifying investment is held for two years. Aimed at entrepreneurs and encouraging investment in small and often unquoted companies, this IHT break also applies to certain shares listed on the Alternative Investment Market (AIM). Since August 2013, AIM stock can be held in ISA, attracting more people to invest in these shares, which provides the potential for a completely lifetime and death tax free ISA account. Is the increased risk, volatility and potential liquidity issues worth a zero IHT trade off?

IHT facts

In the tax year 2016/17, HMRC received £4.84 billion in inheritance tax.

£16 million of that wasn’t paid in cash, but in transfers of assets ranging from artworks to property.

In 2014/15, 216,507 people passed on their estates with no inheritance tax due, and 23,250 paid tax.

Danny Cox, Chartered Financial Planner at Hargreaves Lansdown, added: “At the moment, planning within the system is decidedly lumpy and uncomfortable, and potentially pushes people into financial decisions they wouldn’t otherwise make. Reducing the tax you pay is simple in concept but often complex in execution, leaving administrative headaches for your executors and beneficiaries.”

“People are drawn to making large gifts to reduce tax, but the danger is that they under estimate their life expectancy and leave themselves short, particularly with the rising potential for long term nursing care.”

“However, any changes aren’t likely to be overnight sensations. If you are to avoid paying needless inheritance tax, you will have to get to grips with the system as it stands, to take advantage of any tax breaks you can.”

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