Death and taxes: Creating a simpler and fairer inheritance tax

The rules have been long criticised for being complicated and confusing.

The UK government asked the Office of Tax Simplification (OTS), an independent statutory organisation that advises the government on the tax system, to review IHT. The review was limited to how IHT rules could be improved, not whether it should be scrapped and replaced with something else, such as a wealth tax, as some believe.

The OTS published two reports on IHT reform: in 2018; and 2019.

Financial secretary to the Treasury, Jesse Norman, has responded to these reports. Key recommendations that will be taken forward are: changing reporting regulations so more than 90 per cent of non-taxpaying estates will no longer have to complete IHT forms for deaths when probate or confirmation is required; and easing the signature requirements.

However, while light in detail, Mr Norman has suggested that further recommendations will be implemented on a longer-term basis. So, what did the OTS call for in its original reports? Here’s a recap.

The first report

Recommendations from the first report included:

• Reducing or removing the requirement to submit forms for smaller or simpler estates, especially where there is no tax to pay;
• Simplifying IHT administration and guidance; and
• Automating the whole system by bringing it online, ideally including the ability to complete and submit a probate application.

Paul Morton, OTS tax director, said that digital technology should “transform the experience” of those dealing with the tax.

Second OTS report on reforming IHT

The report recommended changing some IHT rules, including making them simpler and removing “distortions” in some IHT reliefs for business property and agricultural property.

The biggest change it recommended is replacing the “seven-year” rule, whereby if a person lives for seven years after giving away assets, they don’t pay inheritance tax on it. The OTS recommended that the seven-year rule be changed to five years and that tapered tax inheritance tax relief on gifts made between three and seven years before the person making it dies, should be scrapped.

The OTS’s 11 recommendations, were about three inter-connected parts of IHT: Tax on “lifetime gifts”; how IHT interacts with capital gains tax; and IHT rules for businesses and farms.

Recommendations included:

• The government should consider simplifying and clarifying rules on liability for the payment of tax on lifetime gifts to individuals and the allocation of the “nil rate band” – a tax allowance for assets someone can inherit without paying inheritance tax on them;
• HM Revenue & Customs (HMRC) should review its current approach to the eligibility of farmhouses for agricultural relief IHT either during their lifetime or through their will in “sensitive cases” −for example, if a farmer needs to leave their farmhouse for medical treatment or to go into care, the OTS said; and
• HMRC should be clear as to when a valuation of a business or farm is required for IHT and, if required, whether this needs to be a formal valuation or an estimate.

Most accountants and other advisers on IHT welcomed recommendations to simplify inheritance tax.

Until the government says what it will do about all the OTS’s recommendations, especially in the second report, accountants will probably not make any major changes to their advice on inheritance tax. If the government introduces a five-year rule, some experts have said that some people may take out an insurance policy to protect against the possibility that they do not live past five years when passing on assets.

Regardless of the government response, in the longer-term, bigger changes to IHT may be necessary, some tax experts reckon.

“…The question of whether IHT should be replaced with a more comprehensive wealth tax is unlikely to go away soon,” Iain McCluskey, tax partner at accounting firm PwC, wrote in 2019 about the second OTS report.

“The UK government needs to grapple with addressing inequality, a rapidly evolving labour market, and increasing spending demands in areas such as health, education and social care. The role of wealth taxes in addressing those issues will be a key part of the debate."