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The Labour Government have not set out their stall in respect of IHT policy, beyond their intention to bring in a new residence-based regime. With a £22bn ‘black hole’ to fill, and manifesto pledges constraining the Government’s options for tax rises, there is widespread speculation on potential IHT reform and its nature, especially given the Prime Minister’s recent comments that “those with the broadest shoulders should bear the heavier burden”.
For those trying to navigate this uncertainty, we’ve explored the key components of the IHT regime and what any reform could look like.
Business and Agricultural Property Reliefs
For many entrepreneurs and farming families, Business Property Relief (BPR) and Agricultural Property Relief (APR) play an important role in succession planning. It enables businesses and farms to be passed on to future generations with 100% (or 50% depending on the nature of the property being transferred) relief from tax.
The Institute for Fiscal Studies (IFS) (April 2024) estimated that capping this relief at £500,000 per person would raise £1.4 billion in the current tax year, rising to £1.8 billion in 2029-30. This is not the first time that reform in this area has been considered. The Office of Tax Simplification’s (OTS) Inheritance Tax Review report (November 2018) noted that the reason higher-value estates have a lower average effective IHT rate is that a greater proportion of their assets are likely to be covered by a relief (e.g. BPR or APR). Their 2019 follow-on report on simplification highlighted a number of areas the Government could consider for reform of these reliefs.
If the Chancellor decided to reform these reliefs, what could happen to them? Short of scrapping them altogether (or imposing a per-person cap as suggested by the IFS) one option is to make the tests more stringent for the reliefs to apply (e.g. requiring the level of trading activity for BPR to be set at a higher level, which was one area suggested in the 2019 OTS report on simplification), or to introduce clawback provisions if assets are sold on. Alternatively, the BPR holding period could be extended from two years.
Shares in companies listed on the Alternative Investment Market (AIM) also qualify for BPR with the OTS 2019 report raising whether it is within the policy intent of BPR to extend the relief to such shares, in particular where they are no longer held by the family or individuals originally owning the business. The IFS estimates that the removal of BPR for AIM shares could raise around £1.1 billion in the current tax year, rising to £1.6 billion in 2029-30.
IHT nil-rate bands and gifting
The nil-rate band is currently set at £325,000 (with an additional £175,000 residence nil-rate band available, which is gradually reduced by £1 for every £2 that the net value of an estate is over £2 million).
The reduction of the IHT nil-rate band would be one option to bring more estates and gifts into trust, into the IHT net, although the freezing of the nil-rate band threshold since 6 April 2009 has effectively achieved this. The freeze is currently legislated to continue until 2025-26. In addition, the residence nil-rate band is often viewed as overcomplicated, so it's another area the Chancellor could look to reform.
A bigger shake-up could be the reform of IHT rules in respect of gifting. Currently, gifts between individuals are exempt from IHT after seven years, but this period could be extended or replaced with a lifetime limit. Introducing a new gift tax would be a fundamental shift in the UK IHT regime, though it’s currently used by other countries such as the United States.
Pensions
There is no shortage of ideas hitting the headlines regarding potential reform to the taxation of pensions, including ending the IHT exemption on pension pots. Currently, the rules work so that no tax is payable if death occurs before the age of 75 when a pension is transferred to a non-spouse, and tax is payable at the beneficiary's rate of income tax if death occurs after this age. Reform in the area of transfer of pensions to a non-spouse could be introduced, similar to how other assets are treated.
Trusts
The current tax system for discretionary trusts sees trusts paying IHT at a maximum rate of 6% every 10 years on the value of assets held in the trust (in addition if the trust makes capital distributions to beneficiaries in the intervening period between the 10-year IHT charge, IHT is levied at the time of the distribution).This combined with the 20% entry charge when assets go into trust is intended to result in an IHT liability of 40% every generation. However, the OTS’s review of The Taxation of Trusts highlighted that for second- and third-generation trusts broadly only 18% IHT is paid every 30 years, so significantly less than 40% on death. This has led to speculation that the 6% rate could potentially be increased to bring the overall effective rate per generation closer to 40%.
How has the Autumn Budget affected the tax landscape?
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There is no right course of action in navigating the uncertainty we’ve outlined above, including whether to take action in the limited window ahead of 30 October 2024 while there is certainty over the current reliefs and exemptions that will apply. It is important though, for individuals and entrepreneurs to consider their individual circumstances and understand the potential impact of reform on them and their plans.
Where individuals have planned gifts or actions that rely on the current reliefs and exemptions, bringing those actions forward before 30 October 2024 will provide greater certainty of tax treatment.
However, this should be tempered with caution, both as the possibility for reform is speculative in nature and if there were to be reform there has been a history of previous Governments having introduced transitional provisions where significant tax changes were announced. Some of these were beneficial to taxpayers, such as when large-scale changes were introduced that affected non-doms and overseas trusts in 2008 and 2017. Waiting to see what will be announced may provide an opportunity that would be missed if actions were brought forward.
An item on our wish list is for the Government to provide a roadmap for individuals and trusts, as they intend to do for businesses, providing greater clarity as to what to expect over the next five to ten years.
