Inheritance tax is often misunderstood1 and causes fear in many more than the 5% of estates which currently pay it.
What might change? The Office of Tax Simplification and an All Party Parliamentary Group have made suggestions. Here are some possible changes, based on those and my own thoughts:
The rate: A reduction from 40% to 20% (if your IHT plan is to spend your money, that is the most fun way to do so – and you’ll probably suffer 20% VAT on most items. So a similar 20% tax on not spending has some logic.)
Exemptions and zero rates With a lowered rate, widening the base of those who pay may make sense, if the overall rate can be made acceptable. Removal of the capital gains tax free uplift on death where no IHT is payable – but deferral of the tax on those death gains until the asset is sold by the recipient.
Reliefs A cap on relief for business and farming assets, to perhaps £1m per person (currently unlimited) and the spreading of the tax payable over 10 or 20 years, to prevent the need to sell the business or farm just to pay the tax. Removal of relief for AIM shares.
Gifts Reducing and simplifying the seven year gift period, removing minor multiple exemptions to one simple amount and reduced record keeping. A lower rate of tax (10%) on gifts.
Trusts Recognition that these can be part of a sensible plan to encourage gifts while protecting the gifted assets from being used unwisely by young beneficiaries. Simplification of the taxes on trusts.
What planning should take place now?
- Consider making gifts now
- Review assets qualifying for relief and consider trusts
- Review and update your will
- Consider life insurance level (often the easiest way to plan for IHT)
1 see https://blackshawtax.com/2019/11/12/inheritance-tax-houses-common-errors/
General election time tends to cause a spike in views being expressed on IHT and houses. By a combination of lack of awareness, the complex tax system, and sometimes political intent, common errors arise.
Some examples from the December 2019 election campaign are:
- Not realising that only around 5% of death estates suffer IHT each year – see https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/832126/IHT_Commentary.pdf
- Not being aware that the residence nil rate band can increase the normal £325k nil rate band by £150k* – see https://www.gov.uk/guidance/inheritance-tax-residence-nil-rate-band
- Thinking IHT is double tax, rather than often being partly or mainly the result of otherwise tax free growth (or not much worse “double tax” than VAT)
- Hoping that giving away all or part of the house saves IHT – in many cases it makes things worse, due to reservation of benefit, pre-owned asset tax and loss of capital gains tax free uplift
- Forgetting the instalment option – see https://www.gov.uk/paying-inheritance-tax/yearly-instalments
- Worrying, when young and healthy enough that life cover can cheaply cover the IHT risk
- Forgetting the transferable nil rate band – see https://www.gov.uk/guidance/inheritance-tax-transfer-of-threshold
- Focusing on “40%”, rather than what actual blended tax rate might apply – eg the estate of a married couple (or widow/widower) with £1.2m house might suffer 8.3% IHT on that asset
- Not realising that a reduction in the IHT rate, or its abolishment, might be balanced by the removal of the tax free uplift on death or private residence relief
- In hoping for IHT to be replaced with something else, that an annual wealth tax might cause more hardship than IHT on an elderly low income and valuable house owning taxpayer
- Worrying about IHT but not taking advice
If any others are spotted, I am happy to add to the above list.
- Even if IHT is payable on the house, there may be other resources to draw upon, such as the deceased’s pension fund
- In some circumstances, where more than one generation live in the family home, it is possible to gift and share part of the property with the younger generation without it being a reservation of benefit – see https://www.gov.uk/hmrc-internal-manuals/inheritance-tax-manual/ihtm14360
*it is this residence nil rate band that Labour’s 2019 manifesto suggests should be removed, leaving just £325k (but not £125k as some suggest, which is from an earlier report commissioned, but not written, by Labour).
Guidance on record keeping obligations as at 2019 can be found here: https://blackshawtax.com/2018/07/30/hmrc-guidance-on-trust-record-keeping/
This is likely to change and become more onerous once the UK adopts the 5th EU anti-money laundering directive (“5thAML”). The number of trusts affected by this may increase tenfold to 2 million. It will include many dormant trusts simply holding land or other non-income producing assets that currently do not need to formally register. In many cases the trusts will not have cash resources to pay for professional help to complete the database requirements and trustees could face personal penalties for non-compliance.
One hope is that the HMRC trust register will be improved. The current version appears to have been programmed by someone who does not understand the concept of either a trust or a database!
It may also lead to more transparency and information being available on trust asset ownership (which may be a good or bad thing, depending on ones views on privacy).
The use of trusts
As ever, it is worth remembering that trusts are a useful vehicle to protect assets, for example minors, vulnerable persons, plus inheritance tax and wills planning encouraged by the tax legislation.
The consultation can be found here: https://www.gov.uk/government/consultations/transposition-of-the-fifth-money-laundering-directive
The EU directive can be found here: https://eur-lex.europa.eu/eli/dir/2018/843/oj
The ICAEW response to the consultation can be found here: https://www.icaew.com/-/media/corporate/files/technical/icaew-representations/2020/icaew-rep-04-20-fifth-money-laundering-directive-and-trust-registration-service.ashx
This Telegraph article caught my eye. It explains a useful inheritance tax relief that can apply to larger gifts, after three years, in reducing the 40% rate. The original text made a common mistake in not noting that the gift needs to be in excess of the available nil rate band (otherwise it is tapering an already 0% tax rate).
It’s the type of article that can lead to a client saying “…but I read somewhere that…”.
(I sent a tweet to the writer, who corrected the original.)
The behavioural impact of tax on both advisers and taxpayers continues to fascinate me. Let’s say you have the certainty of being taxed at 40% – what percentage risk would you take to reduce that to nil?
An article in the FT (subscription required) suggests that those with inheritance tax (“IHT”) exposure as low as £15,000 are being sold business property relief (“BPR”) investments to reduce tax. As a tax adviser, the tax issues are relatively simple: invest in alternative investment market (“AIM”) shares that qualify* for BPR and survive for for two years. (*not all AIM shares qualify)
But, what about risk? It’s not too much of a tax risk but surely a significant investment risk. That’s outside my area of expertise but there is a general point here: driven by tax, why introduce the danger of overweight exposure in high risk investments to the elderly? I hear alarm bells.
Questions for the investment adviser:
- How high risk are AIM shares?
- Without the tax break, what proportion should an elderly person hold in such investments?
- What is the percentage chance of the investments falling by more than the hoped for 40% tax saving?
- Is there an AIM market bubble, caused in part by tax driven investments?
- How active do the share/portfolio changes need to be to reduce risk (and perhaps rely on the replacement property BPR provisions)?
- If the AIM market collapses, how many will suffer and will liquidity be an issue?
- Is there a less risky way to save IHT?
I recall that insurance against AIM market falls used to be available with such investments. This option seems to have disappeared. If an insurer won’t take the risk, should an elderly client?
I have seen such BPR portfolios work, eg for those who were very wealthy, appreciated the risk, where BPR formed only a small part of their estate, they lived the two years and died soon afterwards and before any major fall in the investments – were their beneficiaries fortunate?
One to look back on in a few years’ time?
Family investment companies (“FIC”) are popular for three reasons. For clients, (i) they can reduce or defer taxes on income from 45% to 19% or less and (ii) give away wealth for IHT purposes but retain some element of control. For advisers, (iii) there are large fees, as such structures are complex and require detailed advice.
Advantage (i) is as a result of the continued fall in corporation tax rates, compared to higher income tax rates. Advantage (ii) is a response to the restriction on the use of trusts via the tax system in 2006. Advantage (iii) may tempt some to “sell” as many FICs as possible to clients, rather than it being part of an adviser’s toolkit, suitable in only some circumstances.
What could go wrong?
The challenges FICs face are:
- complexity – in many cases there is a more simple and cheaper solution than a FIC
- future tax rates change (companies were a very bad idea for private assets several years ago and may be again in the future)
- company law changes
- targeted legislation (see-through legislation taxing the income / apportionment rules?)
- existing settlement anti-avoidance legislation (if there is an element of bounty eg uncommercial loans) or transactions in securities (there are rumours of HMRC attack in this area)
- costs, administration and reporting requirements can be expensive or burdensome
- they are difficult to unravel (more so than trusts)
- publicity, unless an unlimited or offshore company is used to limit that
- will the press see them (rightly or wrongly) as the next tax dodge, resulting in penal taxes in response?
- double tax charge on assets that grow in value and are extracted
- family/shareholder disputes (getting the bespoke company articles and shareholder agreement right first time)
- unknown unknowns (FICs are a very young idea compared to the tested ground of trusts)
These should all be considered in detail before putting a FIC into place, ie not just the advantages now but how future-proof are they, what stress tests and “what ifs?” should be considered?
With that, a fully informed decision can be made. FICs can be very useful in specific limited circumstances but beware having one just because it is in fashion or that somebody wants to earn a nice fee selling you one.
[This note was drafted in December 2016, updated in March 2017 and February 2018]
Some of the best beginners guides to “Why…?” can be found on the STEP* website. Click on the links for pdfs.
Why make a Will?
Why make a Trust?
Why make a Lasting Power of Attorney?
(*STEP is the Society of Trust & Estate Practitioners.)
The HMRC inheritance tax section is part of Trusts & Estates, so the address is:
HMRC Trusts & Estates
PO Box 38
Castle Meadow Road
(Some of us still remember it as the “Capital Taxes Office”.)
Update (2021): the new (and very short) addresss refers to Inheritance Tax again.
HM Revenue and Customs
But the “BX” postcode doesn’t allow recorded delivery on the Royal Mail system, as it is a dummy postcode for post scanning purposes, although couriers may use this:
HM Revenue and Customs
Benton Park View
Newcastle Upon Tyne