July 08, 2019



In January 2018 the Chancellor asked the Office of Tax Simplification (OTS) to review various aspects of inheritance tax (IHT). Their report on the administration of IHT was issued in November. On Friday their second report on the main complexities and technical issues with the tax was released. The OTS have made a number of recommendations for changes with the aim of making the tax simpler and more intuitive, addressing distortions in the operation and scope of reliefs. It is noted in their report that few people are within the scope of IHT, with less than 25,000 estates being liable each year – less than 5% of all deaths. This is due to the reliefs available from the tax with 64% of estates relieved by the nil rate band, 14% by the spouse exemption and a total of 3% by business property relief (BPR) or agricultural property relief (APR). The OTS has made 11 recommendations concentrating in three areas:

1. Businesses and Farms

Two of the main reliefs from IHT are those for businesses and farms – APR and BPR. The rational for these reliefs is to remove the need to sell and break up businesses or farms to finance IHT payments– protecting food production and security, entrepreneurship and the economy. The report noted that the total cost to the Exchequer of APR and BPR over the next 5 years is expected to be £5.85 billion compared to an expected £30.4 billion total IHT yield. There are three main areas that the OTS has made recommendations for change:
  • Diversified Farms and Estates

To qualify for BPR the business must not consist of wholly or mainly holding investments. Through case law this has been argued to be greater than 50% test. Therefore, as it stands, a diversified farming business with farming activities and 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 not a ‘wholly or mainly’ test but a ‘substantial’ test – greater than 80%.

The OTS have recommended consideration be given to whether it is appropriate that BPR should have a lower level test for trading than for holdover and entrepreneurs relief. There is a proposition that these should be aligned and this would suggest it should be to the higher CGT test.

Farms and estates will need to review the structure of their businesses to ensure they would be able to meet the 80% substantially test should this recommendation be taken forward.

  • Furnished holiday lets

The treatment of furnished holiday lets (FHL) has been subject to many legal challenges over the last few years. HMRC’s guidance explains that FHLs will not qualify for BPR as the income consists of rental. However, where the level of additional services provided is so high that the activity can be considered as not an investment then that case will be considered on its own facts. This creates confusion in itself, added to the fact that FHLs are effectively deemed to be trading for the purposes of income tax and CGT.

The OTS has recommended consideration is given to aligning the IHT treatment of FHL with that of income tax and CGT, where certain conditions are met.

This would be very welcome for many diversified farms and estates with FHLs

  • The farmhouse and farmers in care

In order to qualify for APR the farmhouse must be occupied for the purposes of agriculture. Complications arise where the farmer moves out to go into care and does not return. HMRC consider these cases on a case by case basis, leading to uncertainty.

The OTS believes the tests for eligibility in such circumstances should be clearer and more transparent and have recommended HMRC should review their current approach.

Clear legislation providing relief in these circumstances would provide more certainty for the farming family.

2. Lifetime Gifts

There is no doubt that the array of different gift exemptions together with the tax treatment of a gift which comes into charge to IHT on death is both complex and widely misunderstood. The OTS has recommended replacing the annual gift exemption and gifts in consideration of marriage with an overall gift allowance. However, they have also recommended this single allowance replaces the useful exemption for normal gifts out of income. As the reliefs have not increased for many years they have also recommended consideration is given to the level of the allowance. Of most note in the press is their recommendation to decrease the current 7 year period, during which a lifetime gift may become subject to IHT, to 5 years together with the abolition of taper relief. This would be a welcome change and would reduce a lot of the misunderstanding particularly with taper relief – many people do not appreciate that taper relief is only relevant to gifts of value made over the nil rate band (currently £325K). Further, the OTS has recommended alternative ways to change the way IHT operates on lifetime gifts. This is another area of common misunderstanding - many people are not aware that the recipient of a lifetime gift is liable for the IHT payable on that gift when the donor dies within 7 years. In addition, the nil rate band is first allocated to gifts in the 7 years before death before any remaining is available to relieve the assets left on death.

3. Interaction with capital gains tax

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 have recommended the CGT uplift is removed where a relief or exemption from IHT applies. Interestingly, the most complex area of the IHT legislation is the residence nil rate band (RNRB) and the transferable RNRB. Whilst the OTS agreed that this area is too complex it commented that, as this is a new relief, more time is needed to evaluate its effectiveness before making recommendations to simplify it. In summary the OTS recommendations, in the main, are ones that should simplify a very complex area. If this government or any future government take the recommendation forward, the major impact on farming estates will be the recommendation to align the IHT BPR test with the CGT test. Therefore farm and estate owners should consider their own position and whether they would be affected by this potential change. Please do not hesitate to contact us if you need to discuss the latest Inheritance Tax Changes.


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