Potential reforms to inheritance tax

29 January 2020

On 29 January 2020, the All-party Parliamentary Group (APPG) reviewing Inheritance and Intergenerational fairness published an informal report on Reform of inheritance tax (IHT). While many such reports are published by MPs, it follows two recent Office of Tax Simplification (OTS) reports on IHT and comes at a time when many are expecting a range of tax reforms to be announced in the Chancellor’s first Budget for the new Government. It may well influence future government policy.

The APPG report considers a range of reform options but its key recommendations would, if implemented en masse, make radical changes to both simplify IHT and lower the tax rate charged. However, that does not necessarily mean that the amount of IHT collected (currently £5.4bn a year) would fall under any new system and, in many cases, the tax collected from wealthy families would rise.

Lower rates but fewer reliefs

There is an increasingly widespread view that current reliefs and exemptions from IHT are in some cases outdated, and in others abused, as families seek to reduce the tax suffered when assets are passed down to the next generation. The report acknowledges that IHT is often described as a ‘voluntary’ tax, only paid by those who have not planned their tax affairs adequately.

The APPG report recommends that the most widely used reliefs (eg the 100% exemption for lifetime and death gifts to a spouse, and for gifts to charity) and the nil rate band (exemption for the first £325,000 of each estate) are maintained. But it suggests that reliefs for lifetime gifts made more than seven years before death, gifts out of income and the important business and agricultural property 100% exemptions are abolished: as, in their view, these reliefs frequently play a key part in the estate planning of wealthy individuals.

There are also a series of small reliefs for lifetime gifts that the APPG suggests are abolished and replaced with one simple annual exemption of £30,000. Where the annual allowance is exceeded, the proposal is that a lifetime tax at 10% is applied (half the current 20% rate for the limited range of gifts that are currently taxed as chargeable lifetime transfers). The report also recommends that all single gifts over £10,000 should be reported on tax returns and that the rules for trusts would also be simplified, but an annual tax charge would apply to them.

The current rate of IHT on death is 40% on chargeable amounts (ie after the nil rate band, any residential nil rate band and any other exemptions). The APPG proposes that this is reduced to 10% on taxable amounts up to £2m and 20% on the balance of the estate. However, it recommends that where tax arises on business assets, there is an option for the tax to be paid in instalments over 10 years. While the instalment option would make it less likely that beneficiaries will need to sell the business to pay the tax due, the abolition of the current reliefs would have significant implications for business owners.

Where IHT interacts with capital gains tax (CGT), the report suggests that, instead of beneficiaries inheriting assets at their probate value (ie value at the owner’s death), they should inherit the deceased’s original acquisition cost for tax purposes. This would often mean that CGT arises if a beneficiary sells the inherited asset, and creates practical complexities in identifying the original costs of the asset that may have been acquired decades earlier.

The report also suggests that the concept of domicile is removed from the new rules and that the tax applies to the worldwide assets of all individuals who have been resident in the UK for 10 out of 15 years, as well as taxing trusts that they have created where a UK resident can benefit from them.

Next steps

In theory, the Government could make substantial legislative changes from Budget day (11 March 2020). Assuming there is to be reform of IHT, it is more likely that the Government will want to consult on such a major shift on tax policy, with a view to changing the legislation from April 2021 or later. However, if a consultation goes ahead, it is also possible that some interim ‘reforms’ will be announced in Budget 2020 - perhaps described as ‘anti-forestalling’ measures to prevent tax avoidance. 

It is always important to review any estate plans that you have put in place as family circumstances and tax laws change. The UK’s IHT rules have not changed for many years but there is clearly potential for significant change in the next couple of years, so you should keep up to date with developments and seek expert advice on how potential changes could affect your family’s finances in the future.

Read the full APPG report.