In Focus: TaxMar 24 2021

Tax day: What does the future hold for IHT?

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Tax day: What does the future hold for IHT?
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As part of a March 23 unveiling of more than 30 different publications relating to tidying up the UK's tax system, the Treasury said it had recognised the need to simplify and smooth out the administration of IHT.

In the update, Jesse Norman, financial secretary to the Treasury, said it was "cutting IHT red tape for more than 200,000 estates every year, dramatically reducing the amount of paperwork many families fill out."

This means that more than 90 per cent of non-taxpaying estates each year will no longer have to complete IHT forms when probate or confirmation is required from 1 January 2022.

Reporting regulations will also be updated for estates where the deceased was never domiciled in the UK but owned indirect interests in UK residential property.

And that was pretty much it. No reforms of the current allowances, no updates, no bringing reliefs into the 21st century.

This was a great disappointment to tax professionals, especially after a series of reports over the past few years, many of which called for a more radical rethink of IHT in the UK, especially as some of the reliefs and thresholds were set in the 1980s.

An opportunity has been missed to introduce more meaningful reforms.Cutts

Rachael Griffin, tax and financial planning specialist for Quilter, says: "This is a step forward towards greater simplicity, but leaves the system largely unchanged.

"We are still a long way from seeing any fundamental changes to the IHT system as recommended by the Office for Tax Simplification and the APPG on Inheritance & Intergenerational Fairness.”

In reports published in November 2018 and July 2019, the OTS set out its proposals for reforming IHT.

The first report concentrated on reducing the paperwork and heavy administration burden associated with IHT. The second report focused on updating certain reliefs and exemptions.

The report by the all-party parliamentary group, issued in January 2020, favoured radical reform and abolition of many of the current IHT reliefs.

While tax day has not ushered in significant reforms and recommendations - rather a 'tidying up' of the IHT legislation and administration - commentators have expressed hope that a proper overhaul of IHT may yet be on the cards. 

Change is overdue

Changes to the IHT nil-rate band were effectively ruled out earlier this month when it was frozen at £325,000 per person until 2026. But there was still the possibility of other proposals, commentators claim.

Edward Grant, director responsible for professional development at St James's Place, said IHT is "desperately" in need of an update. 

He points out that had the lifetime limit on gifting of £3,000 per tax year been updated in line with inflation since its creation back in 1981, the limit would now be £11,900. 

Unsurprisingly, he is not alone in wanting IHT thresholds to be raised.

Jenny Cutts, head of the private client team and Partner at Wedlake Bell, comments: “Despite the hype, and the deficit, the government's tax day failed to address areas previously flagged for reform.

"For IHT, reform is long overdue with a draconian tax rate of 40 per cent, and a complex and outdated system of reliefs and exemptions."

She points to the APPG recommendation to simplify IHT with a reduction or reliefs and exemptions combined with a lower, flat "life-time" rate of 10 per cent as a 'missed opportunity'.

She adds: "The most tax day offered was a cut in paperwork for non- taxable estates with a value of up to £1m. Although this step is welcome, an opportunity has been missed to introduce more meaningful reforms."

According to George Bull, senior tax adviser for RSM UK, the chancellor really ought to "bring forward proposals adopting some of the recommendations of the OTS:

These might include: 

  • Abolishing the exemption for normal gifts out of income, the scope of which is often disputed, and which requires extensive record-keeping; and
  • Replacing some of the smaller exemptions and allowances with a higher overall personal gift allowance.

"Both of these proposals would be relatively simple to introduce in the short-term and could well encourage people to make more lifetime gifts", Bull says.

Changes to limits on lifetime giving and trust tax

One of the documents released by the government this week is a summary of responses to the 2018 consultation ‘The Taxation of Trusts: A Review’.

The responses did not indicate a desire for a comprehensive reform of trust tax at this stage, but the Treasury has said the "government will keep the issues raised under review".

In the 22-page responses document, the government outlined how many of the 100 responses to the 2018 consultation had stressed the positive role trusts play in society, and explained that trusts are often the most appropriate legal mechanism for passing on, or managing and protecting, wealth and assets.

The document stated: "They commented on how the current tax rules can be perceived as creating barriers to using a trust.

"The main areas where respondents sought reform concerned income tax and IHT.

"When considering income tax, respondents were mostly concerned about complexities in how the tax is administered, whereas regarding IHT, respondents were generally concerned about unfairness and complexity."

But while these were acknowledged, there appears to be no change to the rules around trusts or gifts - at least for now. 

Or rather, just one: the current rule allowing those dealing with a trust or estate to provide an IHT return without requiring physical signatures from all those involved will be made permanent.

Bull comments: "We may see some limits to lifetime gifting which many countries have and removal of capital rebasing on death. We have had a review of IHT and recommendations made by the Office for Tax Simplification, but these have seem to have been largely put to one side.

However, according to Andrew Dixon, head of wealth planning for Kleinwort Hambros, IHT planning is always about "striking a balance between ensuring you have enough for your lifetime while passing on surplus wealth as efficiently as possible.

"The rules may change, but the aim will remain the same."

Pensions and IHT

Existing ways to mitigate IHT liabilities include considering the pension pot, as Dixon explains: “Pensions have a unique place in the UK savings and investment landscape and tend to be loved and loathed in equal measure.

"From a planner’s perspective, they provide a dream solution: a fund which can be used for your lifetime but transferred, on death, without IHT.

“The removal of a death benefits charge on pensions has meant many individuals can manage the drawings on their pensions to exploit the unique treatment of pensions, which do now form a key part of a client’s IHT planning. 

"Should pension death benefits become unattractive, clients would need to revisit the previous plans they have made to ensure they remain appropriate."

He calls the changes made to the death benefit charge a "deliberate attempt by [former chancellor] George Osborne to appeal to the middle classes".

But while the government did not make any of the anticipated announcements this week, the odds of major changes to pensionst taxation in future remain finely balanced. 

Dixon says: "We can conclude the cost of pensions tax relief is seen as a burden within the Treasury and benefits skewed towards the wealthy.

"However, changing the system would undoubtedly result in confusion and cost for employers/employees alike, not least members of final salary schemes such as NHS doctors. Interestingly, no one ever talks about the pensions tax relief as a net figure.

"While you receive tax relief going in tax is usually paid on the way out in future years."

What pensions changes were there?

Tax Day documents did outline some pensions tax technical updates. For example, the government has said it has identified several aspects of the pension tax framework that "do not work as intended in all situations and need updating to deal properly" with age discrimination cases.

For example, the current framework does not straightforwardly permit individuals to ask their pension scheme to settle annual allowance charges from previous tax years by reducing their future pension benefits ('scheme pays').

The government will therefore make technical updates to pension tax rules to remove such anomalies.

It is also going to review reviewing the appropriate taxation framework for superfunds, that is to say consolidation vehicles for defined benefit pension schemes. 

But given the absence of tinkering to pensions tax relief, the pension, as with gifts and trusts, remains a valuable tool for IHT planning purposes.

“Otherwise", as Steven Cameron, pensions policy director for Aegon says, "tax day gives us no new insights into what the chancellor may have planned for reforms of pensions tax relief, CGT or IHT.

"The chancellor has talked of his ‘sacred duty’ to repair the nation’s finances, and in advance of taking forward policies, it’s always worth checking these won’t be sunk by the ‘devil in the detail’.”

simoney.kyriakou@ft.com