The Office of Tax Simplification has proposed a change to the ‘seven-year rule’ as part of a body of recommendations to reform inheritance tax.
In its second and final report on the Inheritance Tax review, out today (July 5), the OTS recommended that the seven-year period in which gifts are taxed before death should be cut to five years in an effort to clear confusion and reduce the administrative burden.
It also said the taper relief should be axed, which sees gifts made three to seven years before death taxed on a sliding scale as long if they exceed the nil rate band of £325,000.
Additionally, gift exemptions should be consolidated into one gift allowance.
Inheritance Tax applies primarily on death, but also to gifts made to individuals within seven years of death and to lifetime gifts other than to individuals, charities and qualifying political parties.
Bill Dodwell, OTS tax director, said: "The taxation of lifetime gifts is widely misunderstood and administratively burdensome.
"We recommend replacing the multiplicity of lifetime gift exemptions with a single personal gift allowance, to be set at a sensible level, and incorporating an increased lower threshold for small gifts.
"The exemption for regular gifts should be reformed or replaced with a higher personal gift allowance.
"We recommend that the 7-year period be shortened to 5 years (significantly reducing the workload on executors), and abolishing the tapered rate of Inheritance Tax (which many find works in a counter-intuitive way)."
Mr Dodwell said the OTS had found the tax paid on gifts six or seven years before death was low.
Sean McCann, chartered financial adviser at NFU Mutual, said: "Most people are aware of the ‘seven-year rule’ – but few understand the ‘tapering rules’ mistakenly believing that you pay less IHT on all gifts if you survive more than three years rather than only on those gifts over the nil rate band of £325,000.
"Anything to reduce this complexity has to be a good thing when families are planning their financial futures."
The OTS also consulted on the capital gains uplift on death and feedback from the industry suggested this could be reconsidered.
The consultation used the example of investments in the Alternative Investment Market (AIM) to illustrate the impact of CGT on assets sold after death.
It used the example of a business owner’s £100,000 investment portfolio made up of AIM stocks – which benefit from business property relief after two years, invested directly via a financial adviser.
Upon her death, the shares are worth £250,000 and her children inherit the assets. When they come to sell them, they are worth £300,000.
Under IHT rules, the shares qualify for BPR and there is no inheritance tax to pay. However, the CGT uplift means that the £150,000 gain is wiped out upon death as the children have a capital gain of £50,000 – the increase in the value of the shares since death.
Kathryn Cearns, the OTS chairman said: "Although only a small number of people pay Inheritance Tax each year, a far greater number worry about it.
"The OTS’s packages of recommendations would go some way to achieving the goal of making the tax easier to understand and simpler to comply with."
Rachael Griffin, tax and financial planning expert at Quilter, said: "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."
The OTS is the independent adviser to government on simplifying the UK tax system. It makes recommendations for the government to consider but does not implement changes.
The OTS stated its consultation had generated an "unprecedented level of interest", which had made it clear "that many people had limited understanding about the way Inheritance Tax works".
There were nearly 3,000 responses to an online survey, a further 500 emails from individuals and more than 100 written responses from experts, it stated.
The first report, which dealt primarily with the administration of Inheritance Tax, was published in November 2018.
The review had been requested by chancellor Philip Hammond in January 2018.
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