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Inheritance tax – The complex landscape of gifts

Rebecca Durrant, partner & national head of private clients, Crowe, 15/12/2022

Rebecca Durrant, Crowe

[IHT} is, broadly speaking; a voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue’, Roy Jenkins (British Politician)

The quote above implies that those with wealth are for the most part able to structure their affairs sufficiently well to ensure that the tax on their death estate is as small as possible. 

This is often true (and frankly keeps tax advisers like me in a job!) so when we consider that only four percent of deaths (24,500) in the UK actually result in an IHT liability, we can see why it is also said that IHT is a tax that very few people pay, but many more are worried about.

The latest statistics reported by HMRC showed that IHT accounts for £6.1 billion of tax in 2021/22, an increase of 14 percent from 2020/21. While this is not an insignificant amount, compared to income tax, national insurance and VAT it is relatively small. 

However, the nil rate band of £325,000 has been frozen at the same level since 2009 and is not now likely to increase until beyond 2027/28, which will be almost 20 years. In real terms, this means that this fiscal drag will bring more estates into the realms of IHT than ever before, particularly as for most people the highest value asset they have is their home. 

Property values are on the wane at the moment but we should not discount the exponential growth the market has seen over the last couple of years which will have a significant impact.

In real terms, had the nil rate band increased with inflation it would now be worth over £500,000. While this would more than cover the average house price in more modest parts of the UK at £294,599 (UK house price index September 2022), it does not reach the heights of London where the average property price from the same index was £544,133. This means that many more people will need to give some thought to the tax exposure on their estates.

There are many criticisms of the current IHT system, not least its complexity, but mainly that the system itself has not changed since the 1980s when it was first introduced. This is noticeable, particularly when considering lifetime gifts.  

Gifts as part of estate planning are still relevant and can typically achieve a good result, however, they can present challenges as the current system is complicated and outdated.

As an example, every person can make a gift of £3,000 annually without a charge to tax or reporting requirements. Indeed, if a gift in one year is not made then that exempt allowance can be carried forward for one year allowing a gift of £6,000 to be made the following year. 

Not in itself an insignificant sum for many people but if we put this into context and allow for 40 years of inflation, we could be considering gifts of £14,298 annually meaning almost £30,000 could be given away every two years without tax or reporting. A much more practical sum in today’s market.

This is just one of the oddities around the IHT system; gifting, in general is complex as more significant gifts whether settled into Trust or gifted to an individual, can fall back into a person’s estate if they do not survive for seven years from the date of the gift and can therefore be taxed. 

This can then result in unintended consequences for the recipient who could find themselves with a tax liability of up to 40 percent of the value they have received. This would be hard enough if it were cash but imagine if this were a treasured asset that may then have to be sold?

The soon to be disbanded Office of Tax Simplification (OTS) produced a report in 2019 outlining this along with other complexities and anomalies within the IHT system. One of the more significant issues they considered was the position regarding business asset relief and the interaction between IHT and capital gains tax (CGT). 

This will be covered in more detail in part three of this series, but the main premise of the discussion was around the different criteria that businesses need to meet to qualify for business asset disposal relief for CGT and business relief for IHT which is more generous. 

Also, the IHT rules create an uplift in market value to assets received by a beneficiary, which can in many cases mean that a business can be sold with little if any tax paid. Clearly, something about which HMRC is not keen. It can also distort behaviour as families can be more reticent about succession planning for businesses with this in mind.

It is clear that the IHT system does need an overhaul but it needs to be done sensitively with an eye on simplicity and practicality. Politically it is and has always been a hot potato, and we might expect to see more fundamental changes to the system if a Labour government were in office. That said, the prospect of moving to a lifetime gifts limit as Labour have suggested was part of the OTS recommendations. 

This government has said that it does not intend to make any changes until the next parliament, but only time will tell if those changes will be its to make. In the meantime, we are still stuck in the 1980s!

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