Ripe for reform?

By St James’ Wealth Management    26 October 2018

Inheritance Tax rules could be carved up in the upcoming Budget.

While more forecasts will be provided by the Office for Budget Responsibility on Monday, the government appears to have made some progress towards its goal of bringing down the deficit, through spending restraint and rising tax revenues. Yet the improving picture may not deter the chancellor from hunting down further savings, as he seeks to raise money to meet spending commitments made by the prime minister at the Tory party conference.

Inheritance Tax (IHT) is one area that could see reform. Though the tax is only paid by 4% of estates, the amount it collects is rising sharply, hitting £5.3 billion in 2017/181, and the rules governing it are fiendishly complicated. Indeed, the IHT regime is strewn with an assortment of misunderstood rules, resulting in taxpayers exposing their estates to a larger IHT bill than necessary.

Even the chancellor admits IHT is “particularly complex”. Earlier this year, he commissioned the Office of Tax Simplification (OTS), which gives independent advice to the government, to review IHT and report back with any proposals “to ensure that the system is fit for purpose and makes the experience of those who interact with it as smooth as possible”.

The chancellor’s letter also singled out the current gifting rules and how they relate to the wider IHT system. The rules on IHT exemptions for smaller amounts have not changed for more than 30 years; you can still only pass on £3,000 a year free of IHT, or £6,000 if you carry over last year’s unused exemption as well. You can also make regular gifts out of your income, and these are also exempt from IHT, so long as you can demonstrate they do not affect your standard of living.

It has been suggested an annual single gifting allowance of £10,000 would be both simpler and fairer. However, the chancellor needs to raise money, and hiking the gifting allowance will not help him do that.

Fall guy

The Institute for Fiscal Studies (IFS) has suggested that the way pensions are taxed on death is one area the government could seek to reform. Pension pots are currently outside the scope of IHT, and whoever inherits one is only liable for Income Tax when they withdraw the money. However, if the pension saver dies before age 75, an exception is made and there is no tax liability on the money withdrawn.

“Removing the IHT and Income Tax exemptions for inherited pension wealth would stop unfairly favouring those who inherit pension wealth rather than other forms of wealth”, says the IFS.

However, it is highly unlikely that the Chancellor will touch this. Not only is the current system very popular with pension savers, but it is also having a positive impact on the way people view saving for retirement. Moreover, the chancellor would almost certainly receive significant opposition from his party if he reversed the rules on inherited pensions.

So where else could he look? Perhaps he could be persuaded to change the rules on Capital Gains Tax (CGT) in relation to inheritances. Currently, when someone passes away, the CGT liability on any increase in the value of assets prior to death effectively dies with them. According to the IFS, this encourages people to hold on to assets that have risen in value, even if they would prefer to sell them and use the proceeds in some other way. It has therefore proposed that this relief is scrapped.

In December 2012, the government estimated that the relief cost it £490 million, though it has declined to publish an estimate since then on the grounds that the cost “cannot be reliably estimated” from existing data.2

Trick or treat?

While it’s impossible to know in advance what the Budget will bring, the OTS consultation has been concluded and a report is expected to be published shortly. Whether its recommendations form part of Hammond’s Budget considerations remains to be seen.  However, it will be interesting to see what the OTS proposes, and whether the chancellor takes any action as a result.

As always, Westminster is rife with rumours and speculation.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are dependent on individual circumstances.

Leave a Reply

Your email address will not be published. Required fields are marked *