Simplifying Inheritance Tax (IHT)
The Office of Tax Simplification (OTS) has recently reviewed several key aspects of IHT and put forward recommendations to HMRC. If adopted, these recommendations could have significant implications for farmers and landowners.
The OTS’s report acknowledges that “there are many areas where IHT is either poorly understood, counter-intuitive, requires substantial record keeping, creates distortions, or where the application of the law is simply unclear”. The key recommendations in resolving these issues which could affect famers and landowners include:
1. Where assets pass on death and the assets benefit from IHT relief or exemption, the recipient should be treated as acquiring the assets at the historic base cost of the deceased.
Currently it is possible that a farm, acquired many years ago at a fraction of the current value, could be inherited on death with no IHT being payable. The beneficiary could then sell the farm without incurring Capital Gains Tax (CGT), having acquired the farm at probate value.
If the farm were to be gifted during lifetime, rather than on death, it is likely that CGT could be deferred by a claim for Hold Over Relief. As a result, the beneficiary would acquire the farm at the historic low base cost. If the beneficiary were to then sell the farm, it is likely that they would suffer a substantial CGT liability.
Holding the farm until death can therefore provide a ‘CGT uplift’ and this often means that some farmers retain ownership of the farm and continue as partners until their death, purely for tax purposes. The OTS suggest that this is distorting decision making and business succession. They therefore recommend that the legislation is altered so that the tax implications of gifting assets such as a farm, are the same whether the gift is during lifetime or on death.
Whilst such a change may simplify decision making when considering the appropriate time to pass assets on to the next generation, it has the potential to significantly increase CGT liabilities on farm sales or reorganisations of asset ownership within the family.
2. The level of trading activity of a business required for it to benefit from Business Property Relief (BPR) from IHT, should be increased to align it with the level of trading activity required for CGT purposes.
Currently BPR can apply where a business is ‘mainly trading’. Providing the investment activities constitute less than 50% of the overall business, BPR can apply to relieve the full value of the business from IHT. This can, for example, allow let cottages to benefit from IHT relief where they are held within a mainly farming business.
When considering the availability of CGT reliefs, however, HMRC consider that the investment activities cannot constitute more than 20% of the overall business. The OTS recommends that these thresholds are aligned for IHT and CGT. Whilst this would simplify matters, it could significantly worsen the IHT exposure for many farmers with rental properties and other non-trading assets that constitute more than 20% of their business.
3. Treat Furnished Holiday Lets (FHLs) as a trading activity for IHT purposes.
FHLs are currently treated as a trading activity for Income Tax and CGT purposes, but are generally considered to be an investment activity for IHT purposes and therefore do not generally benefit from BPR (unless they are held within an overall trading business). The OTS has suggested that the tax treatment is aligned such that FHLs are also treated as a trading activity for IHT purposes and therefore benefit from BPR. With many farmers having diversified into FHLs, this could be a very beneficial change if implemented and could reduce the impact of the potential increase in the level of trading activity required for BPR purposes set out above.
4. To reduce the ‘7 year clock’ to 5 years so that gifts to individuals made more than 5 years before death are exempt from IHT. This would be a welcome change and could facilitate making further use of lifetime gifts, with individuals being able to make substantial gifts every 5 years to mitigate IHT.
These are just the OTS’s suggestions at this stage. The Budget on 11 March 2020 may provide indications as to whether the government have chosen to implement any of the recommendations. With IHT reform on the horizon, with some positive changes but coupled with some punitive changes, it remains sensible to periodically review the overall tax position of the business and the family.
The content of this article is for general information only and does not constitute tax advice. It should not be relied upon and action which could affect your business should not be taken without appropriate professional advice.
Victoria Paley ACA CTA
Senior Tax Manager
Victoria joined the practice in July 2019 having worked in accountancy and tax in the rural sector since 2010. As a Chartered Accountant and Chartered Tax Adviser Victoria spends most of her time advising family farming businesses on Capital Gains Tax and Inheritance Tax matters primarily in relation to succession planning and capital transactions.
When Victoria isn't working she enjoys being outside with her dog or riding her horse. She also loves to travel and try and make the most of holidays having been to India, Cuba, South America and South East Asia over the last few years. However this is soon to be put on hold as Victoria is expecting her first child in 2021!