Whether you are steering a business through the trading restrictions of the coronavirus lockdown, navigating the furlough scheme or currently planning for a safe return to work; whether you are juggling care for children or vulnerable family members whilst working from home, or trying to manage anxieties about your own health and finances; estate planning for many has taken a back seat.
However, with likely tax increases on the horizon, depressed asset values and the biggest proposed overhaul of inheritance tax since its introduction, for those whose circumstances allow it, now is actually a unique opportunity for estate planning.
"In this world nothing can be said to be certain, except death and taxes"
Whilst it is still too early in this crisis to know what the true economic impact is going to be, the Office for Budget Responsibility (which reports on the sustainability of public finances) has predicted that the economic impact from the coronavirus pandemic for this year alone could be as much as £298 billion. No decisions have been taken yet as to how to deal with this deficit, but this will most likely result in an increase in borrowing, spending cuts and an increase in taxes. With the Conservative 2019 manifesto promising not to raise income tax, national insurance and VAT, inheritance tax and capital gains tax would both appear to be likely targets.
Many people right now will be facing financial uncertainty. However, for those in a position to consider reducing their estates, doing so now may potentially avoid assets being dissipated by tax rises.
Inheritance tax: "unpopular" and "complex, ineffective, riddled with anomalies, distortionary and unfair?"
The probability of changes to inheritance tax and capital gains tax on the horizon is further compounded by the recent publication of a number of eminent reports on the capital taxes. The reports, by the Office for Tax Simplification (OTS) and the All-Party Parliamentary Group for Inheritance and Intergenerational Fairness (APPG), do differ somewhat in terms of their proposals. Nonetheless, there are some striking similarities in the areas identified for overhaul, most notably lifetime gifts, business property relief (BPR) and the interaction between inheritance tax and capital gains tax. These key areas of proposed reform are looked at in further detail below:
In July 2019, the OTS published their second report following a request from the Chancellor to review a wide range of administrative and technical aspects of inheritance tax. The report explores the main complexities and technical issues that arise on the basis of the “unpopularity” of inheritance tax. Its main findings can be summarised as follows:
- With regards to lifetime gifts, the report suggests reducing the “7 year rule” to 5 years, and counteracts this with the proposed abolishment of “taper relief”. It suggests reform or abolishment of the “normal gifts out of income” exemption and proposes a higher annual personal gift allowance. Finally, it recommends a review of the rules for allocating the nil rate band between the death estate and pre-death transfers and a shift of the burden of inheritance tax on lifetime gifts from the recipient to the estate of the person who makes the gift.
- In relation to the alignment of treatment of assets for inheritance tax and capital gains tax purposes, the report suggests that, on death, assets should not be universally re-based for capital gains tax. Instead, this should happen only if and to the extent that there is an actual charge on death to inheritance tax. For example, there should be no capital gains tax re-basing on assets qualifying for the spouse exemption or assets qualifying in full for BPR.
- Continuing with the alignment of inheritance tax and capital gains tax, the OTS suggests a review of the interaction between BPR and the capital gains tax reliefs, namely entrepreneur’s relief and holdover relief. In particular, it suggests increasing the threshold of trading activity necessary for BPR to match that used for the capital gains tax reliefs. This has the potential to significantly impact those holding business assets as it would mean that the test for BPR on death would shift from “wholly or mainly” (ie, above 50% trading) to “substantial trading activity” (which HMRC indicates is 80% or more trading).
- Notably, the OTS also questions the qualification of BPR on shares traded on the Alternative Investment Market.
The report makes a number of other key recommendations, including a review of the current approach to the eligibility of farmhouses for agricultural property relief (APR) in sensitive cases. The suggestion that term assurance benefits should by default be outside the charge to inheritance tax whether or not they are written into trust and finally a review of pre-owned assets tax (POAT) to consider whether it functions as intended and is still necessary.
Whilst it should be noted that the OTS is an independent adviser to the Government and so it does not necessarily follow that the government will accept these recommendations, the possibility of reform to the capital taxes has been strengthened, as noted above, by the subsequent publication of the APPG report in January this year.
This report (which has the support of both Houses as well as the Society of Trust and Estate Practitioners, and therefore carries significant weight) considers whether inheritance tax is "complex, ineffective, riddled with anomalies, distortionary and unfair" in its opening summary. Like the OTS report, it focuses on proposed amendments to inheritance tax including lifetime gifts, BPR and the interaction between inheritance tax and capital gains tax. In these areas, the report suggests the following:
- Replacing the current regime with a flat rate of tax at 10% for all lifetime gifts, as well as those on death, with a possible higher rate of 20% applying to assets over £2 million.
- Introduction of a lifetime giving allowance of £30,000 per annum, with gifts in excess of this being subject to an immediate tax charge.
- Abolition of BPR and APR, along with the abolition of all other exemptions and reliefs, with the exception of gifts to spouses and charity.
- The removal the current CGT uplift on death, with assets instead passing to beneficiaries at the deceased’s own base cost rather than at probate value. A similar provision would apply on lifetime gifts of assets, so that any gain arising would be held over and the recipient would take on the donor’s base cost.
The report also proposes significant reforms to pensions, with all pension funds left at death being taxed at the flat rate of 10% (or added to the estate and excess taxed at 20% if the value was over £2 million) unless passing to the spouse, and an overhaul to the taxation of trusts. Funds added to trusts would be subject to the same 10% tax charge as outright gifts, and discretionary trusts would be subject to a new regime comprising of annual charges calculated as a percentage of the trust’s value, as well as charges on assets leaving the trust.
The APPG’s report, if implemented, would the biggest reform to inheritance tax since its introduction in 1986. Whilst it is difficult to say which report carries greater weight, the similarity between the proposed areas for reform would certainly suggest that it is these aspects of inheritance tax that the government will focus on in order to raise money as a result of this unexpected economic crisis we now find ourselves in.
If the proposals from either report are introduced, they will undoubtedly impact on estate planning. In particular, the way gifts are made and the order in which a person draws on the assets in their estate are both likely to be significantly altered, along with the way in which estate planning is undertaken by those who hold business assets. Anyone who is therefore in a position to consider making potentially exempt transfers (PETs), or transfers into trust now, would be extremely wise to consider them.
Leading on from this is the fact that a global recession and depressed asset values means that, for those who can afford to make gifts in the current climate, it is advantageous from a capital gains tax and inheritance tax planning perspective. Lower asset values mean reduced capital gains tax on dispositions. It is also possible to transfer more assets into trust tax free (as family trusts are limited by a tax free cap of £325,000 per person, or £650,000 for a couple).
For an individual wishing to make gifts, many will already be aware that if they fail to survive seven years from the date of the gift the value is brought back into their estate on death. However, what they may not know is that it is the value at the date of the gift, and not the value at the date of death that is brought into account.
Historically, economic crashes are followed by periods of faster economic growth, so asset values may bounce back, and therefore any gift made now will have a much lower potential inheritance tax liability if the donor were to die within seven years than if they wait until the market begins to recover and asset values rise again.
At this time of economic and political uncertainty, it is important to emphasise that you should not give away more than you can afford. You should also be mindful of relying on existing inheritance tax exemptions such as making gifts out of excess income, where your current income levels may be lower. Estate planning in the current climate should be undertaken in conjunction with trusted estate planning advisers. Our private client team is able to discuss your estate planning over the phone or using videoconferencing, and we would be more than happy to assist.