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Press comment: Gov need to relfect on inheritance tax's purpose before tinkering

05/07/2019

If you’re covering the Office for Tax Simplification’s report on inheritance please see the following comment from Rachael Griffin, tax and financial planning expert at Quilter.

Rachael GriffinRachael says:

Simplification was the name of the game for this report and that is a welcome goal. However, further tinkering to the system may do just the opposite. Before the government jump feet first into making these changes they need to step back and reflect on the purpose and vision of inheritance tax. If its purpose is to tax people based on how much wealth they have then the research is pointing to the necessity of reform. However, there needs to be proportionate reform. IHT makes up less than 1% of the total raised by the Exchequer and so would cover just one week’s worth of the cost of tax relief on pensions. It’s undeniably an issue, but government have bigger and more expensive fish to fry.

Chancellor Philip Hammond was the one that ordered this review over a year ago. With the current Tory leadership battle, it is likely that we will have a new Chancellor in place soon and these recommendations may fall on deaf ears. However, one hopes that politicians will take a long term view and see the necessity for reform. Changes to IHT could be a nice giveaway for the Conservatives if and when they have to head into a general election. Really though this should be a cross-party initiative as rules regarding inheritance tax are, by their very nature, long term and require advanced planning. A constantly shifting framework makes such planning impossible.

Gifting allowance

There is no way to avoid inflation in day to day life – it eats away at our savings, it increases the cost of daily expenses and much more. And yet the government have avoided the eroding nature of inflation as the gifting allowance has remained frozen at the same rate since the early 1980s. Bringing it in line with the modern day is a no-brainer. It is not only fair, it will increase the flow of money through generations. Today’s personal annual gifting limit of £3,000 doesn’t go far, while the buying power of nearly £12,000, which is what it would be had it risen in line with inflation, could make the difference when it comes to paying school fees or buying a house.

However, it should be noted that while the OTS has observed the gifting allowance is outdated and acknowledged a need to increase they’ve ducked pinpointing the figure. They’ve merely highlighted what it would be if it was in line with inflation. An ideal approach would be to align it with the ISA allowance and index it to avoid the problem in the future.

Lifetime gifting - Potentially exempt transfers

Lifetime gifting is a clear area of complexity.  The interplay of surviving seven years or your loved ones having to navigate how taper relief may or may not apply depending on whether the nil rate band had been utilised was ripe for an appearance in the OTS report. Reforming the rules around lifetime gifting are sensible, but instead it recommends shifting the timespan from seven to five years. On the face of it this appears beneficial.  The OTS identified that gifts made beyond five years pay little IHT due to the effect of taper relief, but are adversely impacted because the gifts reduce the nil rate band available and so in general increase the IHT paid by estates.

One of the most complicated areas of the gifting policy is: what happens when someone who has been given a gift, that was a potentially exempt, now has IHT to pay?

The OTS has acknowledged there are significant challenges with the current system. It currently means the recipient of the gift will have some of it clawed back.  This is both complex, in terms of administration and many people gifting or receiving the gift may not be aware of the rules. The OTS has recommended, sensibly that this should instead be paid from the estate.

They’ve also suggested changes the way the nil rate band is applied to such gifts. At the moment when an estate is added up it works chronologically, starting from seven years prior to death. That means gifts made in the seven years prior to death use up the nil rate band of £325,000 before the rest of the estate.

If you have already used your nil rate band of £325,000 – through gifts or otherwise – and you continue to gift above this allowance, then die within seven years, how much tax has to be paid depends on a tiered structure linked to when you die.

This is as clear as mud to most people and so a simplification is welcome and sensible.

However, the OTS also recommended removing the taper relief which, while complicated and confusing, did have its place as it reduced the amount of tax people paid depending on how long they lived. The real problem with the taper rule was how it interacted with the nil rate band. Removing the taper seems like an extreme response to the problem which introduces a cliff edge and increases tax. Simplification should not equal an increase in tax.

Lifetime gifting - Normal expenditure out of income

On the face of it scrapping of ‘normal expenditure out of income’ and replacing it with a higher personal allowance seems like a double win – a larger and simpler allowance. However, in reality it’s a kick in the teeth. Normal expenditure out of income wasn’t well understood, but it was hugely beneficial. It allowed people to gift as much as they wanted as long as it was out of their regular income – a threshold would obviously cap this exemption. This does not encourage the flow of wealth through the generations. It does the exact opposite by limiting it.

Getting rid of the Capital Gains Tax uplift

The OTS suggests the government get rid of the capital gains tax uplift on death. In other words if they sell the asset they will be subject to CGT on the gains made. This will drastically increase the number of people who inherit things they can’t afford and means that someone who was responsible enough to buy a property and hold on to it will not be able to let their loved ones benefit fully from the growth of that property.    

Again the rationale here seems sound, that the CGT uplift encourages people to hold onto assets until they die and restricts the flow of assets through generations. However, changing the rules on CGT isn’t the way to tackle this issue. If anything it exacerbates intergenerational inequality.

Residence nil rate band

The main residence nil rate band was a prime area for simplification. The OTS report highlighted that even some solicitors choose not to advise clients on it due to its complexity.

The OTS took into consideration recommendations to scrap this complex allowance and increase the nil rate band. The report details calculations that show the cost savings of scrapping the RNRB would lead to a £51,000 increase to the nil rate band to £376,000. They calculate this would mean that 5,370 more estates would have paid IHT by 2023-2024 than if the residence nil rate band is left as is.

Increasing the nil rate band to £500,000 would have a dramatic effect and, if implemented today, would mean 34,400 fewer estates paying IHT by 2024. However the Exchequer would have to stomach around £7.5 billion in costs. Still the government should consider whether it can find some middle ground where it would cost them slightly more and impact the same number of people so the public doesn’t risk paying more tax than necessary to the complexity of the rules. 

The report notes that the RNRB was most common topic of correspondence that the OTS received.  They found that the rules place certain groups at a disadvantage including those who don’t have children, elderly siblings who live and own a home together and those that don’t own a home. The OTS to some extent wipes its hands of all this saying it is not an issue of simplification, but one of policy. But these issues can’t be ignored and provide further rationale for reform.  

Spousal exemptions

The OTS has rightly understands that changing the definition of spouse to include a cohabiting partner or a sibling would be dramatic and not just impact inheritance tax but the whole tax landscape. While this may not be in scope for the OTS, it should be high on the Government’s agenda and they should not shy away from tackling this societal issue sooner rather than later.

Figures from the ONS show that marriage rates remain at historical lows – in 1941 there were 471,000 marriages in the year compared to 243,000 in 2016 - a drop of nearly 50%. Tax rules no longer reflect the behaviors of the nation which mean that unmarried couples and their children are often treated unfairly and not afforded the same rights.

Pensions

Pensions are given a cursory nod in the OTS paper and they rightly call for pension rules to be amended so all pension policies are not subject to inheritance tax. At the moment there are older style pension plans which are written in a way that means they are subject to inheritance tax.

While the report is not explicit on the frankly bizarre rules about pension transfers during ill health. It would be both simpler and just to remove the rule that anyone who transfers their pension in ill health and dies within two years could see the remainder of their pot taxed at 40%.  

Terms life insurance policies

The OTS has noted that there are many advantages for writing a life insurance policy in trust and many people don’t do this. So to simplify it they are recommending that all death benefits are inheritance tax free regardless of being placed in trust.

This is welcome and of course ideal in the spirit of simplification. However, there remains the problem of probate. A trust means loved ones can benefit without waiting for the delays that probate brings and paying probate fees which, with the proposed steep fee rises, is going to be an increasing issue.

In general when it comes to trusts the OTS took a light touch approach and noted the HMRC trust consultation will have a wider remit. 

Anti-avoidance rules

Naturally we need a system of taxation that makes sure people pay what they owe and is also robust enough to penalise people who knowingly avoid tax. However, the current set of rules have so many layers that you need very specialised knowledge to even come close to understanding them. The consequence is that people shy away from making important inheritance tax plans as they simply don’t want to fall foul of the overcomplicated rules. The inheritance tax system should motivate the right behaviours such as encouraging inheritance tax planning, which in turn stimulates the flow of intergenerational wealth, not the opposite. Therefore, examining whether the anti-avoidance rules are still fit for purpose is a welcome recommendation.

 

For more information contact

Kathleen Gallagher023 8072 629307990 004932kathleen.gallagher@quilter.com
Alex Berry023 8072 626007741 151931alex.berry@quilter.com

Notes to editors:

About Quilter plc:

Quilter plc is a leading wealth management business in the UK and internationally, helping to create prosperity for the generations of today and tomorrow.

Quilter plc oversees £114.9 billion in investments (as at 31 March 2019).

It has an adviser and customer offering spanning: financial advice; investment platforms; multi-asset investment solutions; and discretionary fund management.

The business is comprised of two segments: Advice and Wealth Management and Wealth Platforms.

Advice and Wealth Management encompasses the financial advice business, Quilter Financial Planning; the discretionary fund management business, Quilter Cheviot; and Quilter Investors, the Multi-asset investment solutions business.

Wealth Platforms includes Old Mutual Wealth UK platform; Old Mutual International, including AAM Advisory in Singapore; and the Old Mutual Wealth Heritage life assurance business.

The Quilter plc businesses are being re-branded as follows: 

  • Quilter Financial Planning (previously Intrinsic)
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  • Quilter Financial Adviser School
  • Quilter Cheviot
  • Quilter Investors
  • Old Mutual Wealth (becoming Quilter Wealth Solutions in 2020)
  • Old Mutual International (becoming Quilter International in 2020)

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