Simplifying inheritance tax – radical changes may be coming

Last summer the Office of Tax Simplification (OTS) issued their recommendations for changes to inheritance tax (IHT) with the aim of making it simpler. I have reported on these in previous newsletters with the main concern for farming businesses being:

1. Changes to business property relief

Two of the main reliefs from IHT for businesses and farms is agricultural property relief (APR) and business property relief (BPR). To qualify for BPR the business must not consist of wholly or mainly holding investments. Through case law this has been argued to be a greater than 50% test. Therefore, a diversified farming business with a rental business, will qualify for BPR on the combined business (including rentals) if the investment (rental) business is not greater than 50% of the combined business, looking at the value of the capital invested, turnover and profits as well as the time spent in each area. For capital gains tax (CGT) purposes, to claim holdover relief or entrepreneurs’ relief, the test is a ‘substantial’ test – greater than 80%. The OTS recommended the BPR test should be aligned to the CGT test which, subject to businesses planning for this change, would result in many farming and estate businesses ceasing to qualify for BPR.

2. Removal of capital gains tax uplift on death

On death no CGT is payable but the assets are uplifted to market value. Therefore assets can be sold shortly afterwards without CGT. Further, where an asset is exempted or relieved from IHT through APR/BPR the CGT uplift means the asset can be sold without either IHT or CGT payable. The ability to receive a CGT uplift on death can put people off passing assets on to the next generation during their lifetime. To remove this distortion the OTS recommended the CGT uplift is removed where a relief or exemption from IHT applies. Since then, on 29 January the all-parliamentary group (APPG) released their report, Reform of Inheritance Tax. The APPG recommendations go much further and include recommendations to:

• Decrease the IHT rate from 40% to 10% for estates worth less than £2M
• Decrease the IHT rate from 40% to 20% for estates worth more than £2M.
• Annual gift allowance of £30K
• An IHT rate of 10% on gifts in lifetime over the annual gift allowance
• No further charge on lifetime gifts at death
• Removal of the gift with reservation of benefit rules
• To remove all reliefs including APR and BPR
• To charge un-used pension funds
• No CGT uplift on death
• An annual charge for trusts

The APPG asserted ‘a flat-rate gift tax and few reliefs would be simpler.’ This is difficult to argue against, however the removal of APR and BPR would have far reaching implications for owners of farming businesses, with the value of farms likely to exceed £2M, resulting in IHT at 20% payable on death. Whilst the IHT would be payable over ten years, and they recommend this is interest-free, it would require farming businesses to generate sufficient profits to cover this or to take out borrowing, reducing their ability to invest in their business. Further, the tax on gifts in lifetime may delay the handover of farming assets to the next generation, with the family preferring to keep cash now and pay the tax later on death. This would not be good for the progression of farm businesses. Like the OTS the APPG suggest the CGT uplift on death is abolished and beneficiaries should inherit the deceased’s acquisition history. As a result CGT would be payable on a sale of assets, after death, in addition to the IHT paid on death. There would also be practical issues to substantiate the CGT base cost. Many were expecting these changes in the spring budget so perhaps the Chancellor felt they were a step too far at this stage. However, it is unlikely the recommendations will be ignored forever. The government is likely to consult carefully on any major change in tax policy so it may take a couple of years for complete reform. Given the increased need for the government to raise funds, I would expect some interim changes. Therefore farm owners should take advice and, where appropriate, consider banking the current APR and BPR by gifting property during lifetime, before the existing measures change.