Despite reducing complexity, the series of recommendations made by the Office of Tax Simplification (OTS) for updating and simplifying Inheritance Tax (IHT) legislation has been met with a cool response from financial advisers, according to new research from TIME Investments.
Just over a third (35%) of advisers surveyed felt that the recommendations would not encourage the earlier transfer of wealth between generations, with only one fifth of advisers (19%) believing the changes would have a positive impact. Just under a half (45%) of those questioned didn’t know if it would have an impact. To help advisers understand the implications of the OTS report, TIME is running a series of nationwide workshops.*
The research also showed that over half (58%) of advisers’ clients have not yet asked for IHT advice – with the primary reason cited as complexity due to the poor understanding of IHT rules.
Sam Jermy, Senior Business Development Manager, TIME Investments, comments:
“The response to the OTS recommendations is interesting because they are specifically designed to simplify IHT rules which haven’t been reviewed for decades. We believe that the suggested reforms will encourage earlier transfer of wealth between generations, providing much needed support for younger generations who are battling to get on the housing ladder and cope with the present day cost of living.”
The OTS report primarily focuses on three areas of IHT: lifetime gifts; interaction with Capital Gains Tax; and businesses and farms. Below, Jermy provides an overview of what the recommendations could mean for investors.
A commonly held view is that the transfer of wealth between generations should take effect on death, rather than before. However, some tax efficient gifting can be done in advance using the existing gift allowances. There’s a lot of confusion and misconceptions though, about how and when gifts can be made before attracting tax. These misconceptions have inevitably restricted and delayed the transfer of wealth between generations.
The current gifting allowances have remained static since 1981, so an increase in allowances to make them more meaningful and relevant would be welcome. However, the OTS has not recommended a specific figure, as this would be a policy decision. The small gift allowance was originally introduced to help avoid every small gift having to be disclosed, so it is sensible to increase this amount to a more meaningful level or build this into an overall annual personal gifts allowance. This simplification would encourage more gifting of wealth before death.
It is interesting that the OTS found that little IHT is paid on gifts made more than five years before death. One reason for this could be the difficulty in locating financial records beyond five years. The proposed reduction of the gifting time limit from seven to five years makes sense considering their findings and could encourage greater transfer of wealth between generations at an earlier stage. The OTS has also recommended the removal of taper relief and this, coupled with a reduction to five years could create a cliff edge scenario where gifts are 100% within IHT calculations one day and then fall out the following day.
A further recommendation of the report was to remove the need to consider gifts outside of the seven-year period (known as the 14-year rule). This comes into play where a chargeable transfer has been made in the seven years prior to a Potentially Exempt Transfer (PET) and then death occurs within seven years of the PET. Generally, this is a poorly understood area of the IHT rules and the removal of this would no doubt be viewed positively by many. The result would be that any gift made more than five years before death would effectively be ignored when calculating IHT on death – this would be a big step forward in simplifying a complicated area of tax planning.
Businesses Relief (BR) and Agricultural Property Relief (APR)
The OTS report highlights the important role BR and APR play in ensuring that farms and businesses can continue from generation to generation, and in supporting the provision of investor finance to some small and medium sized businesses. The report also touches on the complexity of the qualifying rules for BR and APR. This demonstrates the importance of working with a specialist BR provider to ensure underlying trading businesses remain qualifying throughout the lifetime of an investment.
In terms of potentially simplifying the currently complex IHT landscape, these changes would probably be broadly welcomed. Helpfully, the OTS are suggesting that there should be enough lead time ahead of the implementation any changes for people to have time to take account of the new regime and consider any impact on their personal situation.
Interaction with Capital Gains Tax (CGT)
The OTS has concluded that the interaction between IHT and CGT is complex and can distort decision-making. The report has suggested that where a relief or exemption from IHT applies, the Government should consider removing the CGT uplift and instead treat the beneficiary as having acquired the assets at the historic base cost of the person that has died.
This recommended change is primarily focused on trying to create a level playing field for decision-making around whether to gift away assets during a lifetime or wait until death. This change could also lead to earlier transfer of assets and a greater flow of wealth across generations, providing beneficiaries with access to an inheritance at a more useful stage of their life.