The Office of Tax Simplification (OTS) released its second report on the reform of Inheritance Tax on 5th July 2019.
Their first report, issued in November last year, addressed various administrative matters. This second report focuses on the technical aspects of Inheritance Tax and, in particular, makes recommendations relating to lifetime gifts, the interaction with Capital Gains Tax and reliefs for businesses and farms. The purpose of the various recommendations is to make the Inheritance Tax regime simpler, more intuitive and easier to operate.
In relation to lifetime giving, the OTS recommends a package of reforms which would include:
- Replacing the annual exemption (£3,000) and the marriage exemption (£1,000, £2,500 or £5,000) with a single “personal gifts” exemption and reconsidering the levels at which these exemptions and the small gifts exemption (£250) are set – because they have not been increased since the 1980’s.
- Reforming the rules for the “normal gifts out of income” exemption or replacing it with a higher personal gift allowance.
- Reducing the period after which lifetime gifts become exempt from Inheritance Tax from 7 years to only 5 years. A corresponding part of this proposal is that taper relief, which is seen to be poorly understood and confusing for taxpayers, would also be abolished.
Of particular interest to farmers and other business owners will be the OTS proposals for Business Property Relief (BPR) and Agricultural Property Relief (APR).
For Business Property Relief, the report recommends that:
- The government should review the rules for so-called “mixed businesses” – i.e. businesses which include some trading and some investment activities – and consider whether or not these should be aligned with the Capital Gains Tax rules which apply to those businesses. Currently, a business can qualify for BPR if more than 50% of its overall activities are trading in nature (rather than investments). In contrast, under Capital Gains Tax for Entrepreneurs’ Relief and Business Asset Holdover Relief, at least 80% of the overall business has to relate to trading activities before those reliefs are available. If the government were to choose to align the BPR rules with the Capital Gains Tax rules (i.e. increase the trading requirement to 80%), a great number of businesses that qualify for BPR under the existing regime would no longer qualify under a revised regime. Such businesses will need to review the composition of their business activities and take corrective action to preserve BPR on at least some of their business assets.
- The Inheritance Tax rules for Furnished Holiday Lettings should be brought into line with those for Income Tax and Capital Gains Tax. Under these rules, if a Furnished Holiday Let meets certain conditions as to the period it is available for letting and the periods during which it is actually let, it is deemed to be a trading activity for Income Tax and Capital Gains Tax purposes. This has the advantage of allowing access to reliefs such as Entrepreneurs’ Relief and Holdover Relief which are otherwise usually reserved for trading activities. An alignment of the Inheritance Tax rules with the Income Tax/Capital Gains Tax rules would be welcome. It would allow more taxpayers to qualify for BPR and, in addition, it would make the availability of the relief in any particular situation much clearer. Under current case law, most Furnished Holiday Letting businesses will fail to qualify for BPR.
- The government should consider abolishing the Capital Gains Tax-free uplift to market value on death for assets which already qualify for an Inheritance Tax exemption (which would include BPR and APR). Instead, the OTS suggests that the recipient of the asset should take over the deceased’s tax base cost – which would mean more Capital Gains Tax to pay if and when a beneficiary sells the inherited asset.
In relation to APR, the OTS has suggested that the government should review its approach to the eligibility of APR for farmhouses in “sensitive” cases, such as where the farmer has to leave the farmhouse for medical treatment or to go into care.
We will have to wait and see whether the government will take up any of these recommendations for reform and, if so, which ones it will choose to implement. Simplification of the rules on gifting and the number of allowances would be beneficial but inevitably there will be some losers. Any changes will inevitably prompt taxpayers to review their business arrangements and succession plans and, perhaps, to make changes to their Wills. Recognising this, the OTS has recommended that any changes the government decides to implement should be legislated well in advance of the date that they will come into effect to give taxpayers enough time to understand the new regime, consider the impact it will have on them and to make any necessary changes to their Wills and their business or other financial arrangements.
The Treasury has indicated that it will respond to the recommendations made in the report in due course.
If you have questions regarding the recommendations, please get in touch with a member of our tax team.