Update on Inheritance Tax (IHT)

The Office of Tax Simplification (OTS) has recently published their second report following the review of Inheritance Tax (IHT) which included 11 recommendations.  These recommendations can broadly be categorised into three areas, namely, lifetime gifts, interaction with Capital Gains Tax (CGT) and IHT reliefs associated with businesses and farms. Some of the key recommendations have been summarised below.

Lifetime Gifts – time limits and taper

When an individual makes a gift to another individual for IHT purposes this gift is only a Potentially Exempt Transfer (PET) because it is necessary for the donor to survive seven years from the date of the gift to be completely free of IHT.  If the donor does not survive the gift by seven years the IHT that may be chargeable is reduced on a sliding scale (known as taper relief) depending on how long they survived.

At the time of death, obtaining information relating to gifts made seven years ago can be challenging as it is difficult for executors to obtain bank statements and other financial records more than six years old.

Furthermore, the application of taper relief is complicated and not understood properly – it is a reduction in the tax payable not a reduction in the value of the PET.

OTS therefore recommends that taper relief should be abolished and that the survivorship period is reduced from seven to five years.

If this recommendation is introduced, although we would lose the benefit of taper relief, according to the OTS’ findings only 20% of estates that were liable to pay IHT benefited from the relief.  As a result, the reduction of the requirement to survive a gift from seven to five years would most definitely be a welcome change.

Lifetime Gifts – normal gifts out of income

Another significant reform that was included in the report relates to exemption for normal expenditure out of income.  Where an individual has excess income, they can gift that excess income free of IHT if a pattern can be established.

OTS recommends that this relief is reformed to reduce the administrative burden in calculating the excess income.  One of their suggestions is to limit the amount of income to a fixed percentage based on the most recent tax return.

The alternative recommendation is that the relief is abolished altogether and replaced with a higher personal gift allowance.  OTS has not suggested a limit but a £25,000 personal gift allowance apparently covers the value of 55% of all normal expenditure out of income claims.

Should the Government decide to introduce a change to this exemption there will undoubtedly be winners and losers.  Those that are able to maintain the same level of income to be gifted will benefit from the reduction in the administrative burden.  However, those that gift away a significant amount of income are likely to see a reduction in the amount they would be able to give away.   The annual and small gifts exemptions of £3,000 and £250 have not changed since the introduction of IHT – by way of contrast the personal allowance for income tax and annual exemption for capital gains tax are increased nearly every tax year.

Interaction with CGT

Currently, when an individual inherits assets on death, these assets benefit from a market value uplift for CGT purposes so that the inherent gain is wiped out.  The reason for this uplift is to mitigate double taxation on the basis that the asset would be subject to IHT on death.  Therefore, the individual inheriting the asset does not pay CGT in relation to the growth in value associated with the asset whilst it was previously owned by the deceased.

The capital gains uplift applies to all assets and therefore it also applies to assets that would not otherwise be subject to IHT by virtue of certain exemptions.  These exemptions could include spouse exemption, or other IHT reliefs such as Business Property Relief (BPR) and Agricultural Property Relief (APR).  Where assets qualify for IHT reliefs, the recipient of the inheritance would inherit the asset free of IHT and is potentially able to sell the asset with no CGT.  In this situation there is zero taxation.

The OTS mentions in their report that the CGT uplift on death distorts decision making when it comes to giving assets away.  This is because, if an asset qualifies for IHT relief, it is usually more beneficial for the individual to pass these assets on death to benefit from both the IHT exemption and the CGT uplift.

The OTS therefore recommends removing the CGT uplift for assets that benefit from IHT exemption so that the recipient acquires the asset with the original acquisition cost of the deceased.

If the Government implements this recommendation, it will be necessary for individuals to revisit their objectives and potentially reconsider the timing of passing their assets to others.  The recommendation would almost provide taxpayers with the choice of paying IHT or CGT on the transfer of assets by way of inheritance.

IHT reliefs

Many business owners and farmers have relied on a form of IHT relief called Business Property Relief (BPR) and Agricultural Property Relief (APR) when planning to pass their business to the next generation.  One of the main conditions for BPR to apply is that the business must be wholly or mainly trading.  This test considers a trading business to be one where its trading activities are greater than 50%.

For CGT purposes, when an individual gives away or sells their business to a third party, they may qualify for CGT reliefs such as gift relief or Entrepreneurs’ Relief.  To qualify for such reliefs, the business must also qualify as a trading business.  However, unlike BPR, to qualify for CGT reliefs the bar for assessing the trading activities is higher as it is necessary for the business to be substantially trading which HMRC suggests is greater than 80%.

OTS recommends that the Government should consider whether it is appropriate for the business test to be different for IHT and CGT.

In the event this recommendation is legislated, so that the hurdle for meeting BPR is increased, this will have a significant impact on some business owners that would otherwise have qualified for IHT relief and it will be necessary to carry out a review of the business to consider if any action can be taken to continue to qualify for BPR.  The alignment of the ‘business’ test for CGT and IHT may not be appropriate as Entrepreneurs’ Relief is designed to reward business owners on exiting their business whereas BPR and APR are structured to assist business owners with large capital values but relatively low yield income.


It is still early days whether these recommendations may be introduced as law but they are certainly suggestions the Government will consider in an attempt to simplify the IHT regime.  This can only mean that changes are afoot and it will be necessary to consider the impact on an individual’s estate and review one’s Will.

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