A recent report by the Resolution Foundation has suggested a complete overhaul of the Inheritance Tax system, describing the current system as “beyond repair”.
The report states that Inheritance Tax is considered by the public to be the most unfair of the major taxes, and that it is also “failing to keep pace with the growing importance of wealth transfers”.
Why does the report conclude that Inheritance Tax is unfair?
Three reasons were provided:
- it is viewed as a tax on the dead, with the perception that this amounts to double taxation i.e. taxing those whose assets have already been subject to taxes such as income, capital gains and stamp duty land tax;
- the rate of taxation (40%) is perceived as being too high; and
- it is considered to be easy to avoid for some, to the extent that the tax is perceived as being ‘voluntary’ for the rich.
In fact, on that final point, lifetime gifting is a popular and, can be an effective means of gifting assets in a tax efficient manner by reducing the value of the estate subject to tax at death. For a gift to become completely exempt from Inheritance Tax, the person making the gift, known as the “donor”, must survive for seven years. In addition to the total exemption, the rate of tax payable on the gift can be subject to “taper relief” where the donor dies between three and seven years. That is why such gift, which may become liable to Inheritance Tax, are referred to as potentially exempt transfers, or PETs for short.
Further, and in any event, each person has an “annual allowance” of £3,000 which they can pass tax free and which can usually be rolled over to another year if not used.
There are various other exemptions, such as small gift exemptions and exemptions for wedding gifts.
What about trusts?
Trusts are also perceived as a way to avoid tax. Whilst trusts can certainly help to mitigate tax in certain circumstances, since 2006 “relevant property trusts” have been subject to an “entry charge”, a 10 yearly charge and an “exit charge” . In addition to Inheritance Tax, these trust can also be subject to income tax and capital gains tax.
The Residence Nil-Rate Band
The report also discusses the Residence Nil-Rate Band , which was introduced in April 2017. The Residence Nil-Rate Band is a tax free allowance of, currently, £125,000 (increased from £100,000 per individual on 6 April 2018) which is available to every individual (subject to particular requirements being met) in addition to each individual’s nil-rate band of £325,000 as at the date of publication. However, the Residence Nil Rate-Band has not been popular with everyone as it only applies to those who own a property and who leave that property to their descendants.
The Residence Nil Rate sum is also phased out if the estate is worth over £2 million.
In order to combat the perceived ease of avoidance and unpopularity of the current system, the report suggests a complete overhaul of the system; to start afresh and impose the payment of a “Lifetime Tax” on the recipient of the gift and not the estate of the deceased or the individual gifting an asset.
This is similar to the system adopted in much of continental Europe where the tax is a true “Inheritance Tax” in that it is the beneficiary or recipient of the gift who is subjected to the tax, rather than the estate.
The new proposed system would be a Lifetime Receipts Tax. It is proposed that each individual would have a lifetime tax allowance of £125,000. Once inheritance of a gift of more than £125,000 is received an increasing rate of ‘lifetime tax’ would apply. Under these proposals, any sums over £125,000 would be subject to 20% lifetime tax, whilst any sums over £500,000 would be subject to lifetime tax at 30%.
The recipient would not only be taxed for receiving inheritance after a loved one had passed away but the ‘lifetime’ tax would also apply to all monetary gifts received during their lifetime, excluding those within one’s annual allowance.
The proposed changes, however, do not stop there. The report also suggests that the existing reliefs, such as Business Property Relief, Agricultural Property Relief and the capital gains tax uplift on death will be subject to scrutiny and the rules could be tightened to reduce the scope of tax avoidance. It is recommended that the claimable value of both Agricultural Property Relief and Business Property Relief is to be capped at £5 million and the recommendation goes further by suggesting that the minimum ownership requirement is increased. For example, to claim Agricultural Property Relief under the current system, you (as the farmer) must have owned and farmed the land for a minimum of two years, but it is suggested that the new minimum period of ownership would be five.
For those who are married or in a civil partnership, the report has not suggested any changes to the current position which enable transfers to be made tax free, irrespective of the amount.
Will the suggestions come into force?
The Resolution Foundation is a think tank, and thus does not have any legislative standing. As such, there is no guarantee that anything within the report will, in fact, be implemented.
That being said, the report raises some interesting and noteworthy points and, if its finding do, in fact, mirror public opinion and perceptions then it is not entirely unlikely that successive the government will look to implement a number of the suggestions.