One of the last Inheritance Tax planning opportunities in the UK is headed for the bin, under the slender disguise of simplification.
The Office of Tax Simplification; an independent adviser to government, issued in July this year it’s second report on simplifying the Inheritance Tax system. In Chapter 4 it recommends the removal, in part, of a capital gains tax relief. Hmmm!!!
How does simplification of Inheritance Tax justify the removal in part of a Capital Gains Tax exemption?
In 2015/16 there were 590,000 deaths in the UK, of which only 270,000 estates were required to file an IHT tax form. This means that most estates are too small to warrant completing an IHT form.
Of the 270,000 estates which did file an IHT form, only 14% paid any tax. This is less than 5% of all deaths in any one year.
The reduction from potential tax payers to 14%; 86%, is due to the broad scope of the exemptions. 64% rely on the nil rate band of £325,000, 2% rely on Business Property Relief (BPR), 1% rely on Agricultural Property Relief (APR), 14% on spouse relief and the remaining 8% on other hotchpot reliefs.
But, of the 14% of estates which do pay tax the annual tax take is £4.38 billion.
In the beginning of the Report the Office of Tax Simplification is at pains to say that it does not address matters of ‘policy’ such as whether, Inheritance Tax should be replaced by Capital Gains Tax. Hmmm!
Could it be that inheritance tax affects only 24,500 people and raises £4.38 billion, whereas if it were replaced by capital gains tax 55,000 people would be brought into charge to tax with an estimated £1.3 billion in tax, a shortfall of £3 billion.
This strategy straight-jacket does not however restrict it from exploring ways in which more tax could be raised through the interaction of IHT and CGT.
Bequests on death benefit from an ‘uplift whereas gifts during life benefit from only a ‘hold over’.
If for example, Tom acquired shares at £102,000 and waits until his death to bequeath them to his son Rory, when they are worth £202,000 – Rory will receive them at a base cost of £202,000. He can sell them the next day, for £202,000 and pay not a penny of capital gains tax. The gain in Tom’s shares of £100,000 has been ‘uplifted’.
However, if before Tom dies, he gives his shares, to his son Rory, when the shares are worth £202,000, Rory receives the shares at Tom’s base cost of £102,000. The gain has been ‘held over’. This means that Tom does not pay Capital Gains Tax when he receives them or on Tom’s death. Tom’s gain has been held over until Rory sells them. At this point Rory will pay Capital Gains Tax as if he had acquired them at Tom’s base cost of £102,000 and will pay Capital Gains Tax on the gain made while Tom owned them of £100,000.
Furthermore, if Tom’s shares were in his family business it is likely that they will qualify for BPR; 100% exemption from Inheritance Tax. If Tom hangs onto the family business until death, neither Capital Gains Tax nor Inheritance Tax is payable – an attractive proposition.
The OTS claims that the difference between lifetime ‘hold over’ and the death ‘uplift’ distorts the decision making of wealth owners. True.
The report goes on ‘A similar issue arises where the spouse exemption from Inheritance Tax applies. The capital gains uplift can apply when assets are transferred on death and are covered by the spouse exemption so that capital gains are wiped out and no Inheritance Tax is paid. However, lifetime transfers between spouses do not benefit from the uplift. This can also distort the decisions couples make about the timing of asset sales.’
The report having highlighted the ‘distortion’ then goes on to make a recommendation ‘Where a relief or exemption from Inheritance Tax applies, the government should consider removing the capital gains uplift and instead provide that the recipient is treated as acquiring the assets at the historic base cost of the person who has died’.
The report points out that the reason why the Inheritance Tax exemptions are available for spouses, farms and businesses is because the payment of tax could affect the lifestyle of a surviving spouse, or the viability of a farm or ongoing business if tax had to be paid at that time. A hold-over of gain would delay the payment of tax until such time as the asset is liquidated but would not eliminate it.
All of this makes sense.
But what puzzles me is how the Office of Tax Simplification tasked with looking into Inheritance Tax and restricted in strategic scope, can recommend the removal of a Capital Gains Tax exemption?
If you would like to find out more or explore how you can plan now, before this recommendation becomes law contact email@example.com com or phone 020 3740 7422