AIM investment IHT

The Office for Tax Simplification (OTS) has published its second report into inheritance tax. It makes 11 recommendations across three key areas; lifetime gifts, interaction with Capital Gains Tax (CGT) and businesses and farms.

Business Relief

The first report made no recommendations about Business Relief (BR) and there was positivity about its general complexity and usage, finding, “the reliefs are broadly working in a straightforward way.”  The second report is also broadly positive on BR.

Business Relief’s original objective was to remove the need for the sale or break up of family businesses to finance Inheritance Tax payments. But, the OTS questions the BR qualification of AIM shares by third party investors, where Business Relief is not necessary to prevent the business from being broken up or sold in order to fund the payment of Inheritance Tax. 

Despite this anomaly, the OTS makes no specific recommendation on this topic. Instead, it  recognises BR’s other important role of supporting growth investment in AIM, as stated by the government in its response to the Patient Capital Review consultation in 2017. This is clearly a reason not to adjust the interaction of BR and AIM.

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Several of the recommendations in relation to BR are intended to remove inconsistencies across the tax landscape. For example, it recommends bringing BR qualifying trades into line with those for CGT. More than 50% of a company’s trading activity must currently be in BR-qualifying trades, with investment activities included among those that are non-qualifying. But CGT relief by way of gift holdover relief or entrepreneurs’ relief, requires an 80:20 split of trading vs investment. 

Another of the inconsistencies identified is how the activity of running furnished holiday lets is treated. For the purposes of BR, this is generally not a qualifying trade. Since such companies are treated as trading for income tax and CGT purposes, the OTS has recommended that this is extended to Business Relief.

This would immediately remove substantial complexities in BR and could have positive implications for multiple other land-based activities and their Business Relief qualification. But it would likely be expensive to implement, and at a time when politicians are usually trying to penalise the ownership of second homes as part of their efforts to free up housing stock, this would be a surprising turnabout.

Then there is the issue of limited liability companies (LLPs): An LLP that owns a company wouldn’t be treated as having a trade for Business Relief purposes. For income tax and CGT calculations, they are generally considered as trading and the OTS questions why this isn’t the case for Business Relief. 

A more significant change would be amending current rules that allow a person inherit assets at the market value of those assets on the date of death of the donor, rather than when the deceased acquired them, for CGT purposes. So, any gain made by the deceased is wiped out. The same does not apply to a lifetime gift given with the application of CGT holdover relief; while there is no immediate charge to CGT, the recipient is treated as acquiring the asset at the donor’s historic acquisition costs. As a result, when the asset is disposed of, any gains made by the donor are taken into account for CGT purposes (and Business Relief could also apply for IHT purposes).

The OTS concern is that this inconsistency might encourage business owners to retain their company until death, whether it’s best for the business or not, in order to qualify for both CGT and IHT mitigation. The OTS’ recommendation is therefore that where Business Relief applies, the recipient is treated as acquiring the assets at the historic base cost of the person who has died.

This could force estate planners to choose between IHT and CGT mitigation, although the likely higher value of tax mitigation attributable to IHT at 40% of total asset value vs. 20% of asset growth (based on current rates for higher or additional rate taxpayers on a sale of assets other than residential property) would point to IHT mitigation as the winner. 

BR has the most recommendations of any of the IHT areas examined in the report. But overall, it’s clear that Business Relief remains relevant and important and the OTS recommendations could largely be considered as technical tinkering.

Interaction with CGT

There is a short and what seems a rather pointless discussion of the possibility of abolishing IHT and replacing it with CGT to remove the overlap and confusion that exists between the two: Based on 2015/16 figures, the OTS estimation is that up to 182,000 people as opposed to 24,500 people would be drawn into a CGT charge. This would be far from a straightforward solution and since the OTS calculations suggest it would reduce the Treasury’s take by between a third and two thirds in comparison to IHT receipts, it seems unlikely to be popular at ministerial level. No wonder no recommendations are made regarding this.

Lifetime Gifts

To simplify the gift exemptions and thresholds and their interactions, the OTS recommendation is that a personal gift allowance replaces the annual gift exemption with rollover and marriage gifts. It would also cover the abolition of the exemption for normal expenditure out of income, removing the uncertainty about what constitutes ‘normal income’ and removing the need to keep detailed records.

There is no suggestion as to the value of this personal gift allowance and this would be critical as the OTS acknowledges that, “There would clearly be winners and losers from such a change. The very small number of people currently using the exemption in relation to large gifts could pay more Inheritance Tax, subject to those gifts falling within other exemptions. Consequently, it is difficult to fully assess the impact of this change.” 

This points to the swings and roundabouts of knock-on effects and the almost constant potential for taking from one group and giving to another. It also highlights that the critical factor here is the level of any replacement exemption, having already noted that the majority of gift allowances have been frozen for years, if not decades.

The OTS also proposes that gifts to individuals made more than 5 years before death should be exempt from IHT, thus removing the difficulties of finding bank statements going back more than 6 years. In addition, taper relief should be abolished along with the ’14 year rule’ (so that all gifts made more than 5 years before death should be ignored when calculating the Inheritance Tax on death). Since OTS calculations show that,”in 2015-16, only £7 million out of total IHT of £4.38 billion related to gifts to individuals made more than 5 years before death” taper relief abolition seems low-impact where the Treasury is concerned, although it would also lead to an ability to give away (to individuals or into trust) an amount equal to a person’s nil rate band every 5 years without a charge to Inheritance Tax, rather than every 7 years. 

For lifetime gifts, OTS suggests a reversal is made so that IHT due on lifetime gifts is payable by the estate rather than the recipient. This could alleviate administrative issues and an associated suggestion is that executors are liable to pay IHT relating to lifetime gifts only out of assets they handle, rather than up to the value of the estate that has come into their hands. This seems more intuitive and equitable, but wouldn’t relieve a lifetime gift recipient of IHT liability if there aren’t sufficient funds in the estate to cover the IHT. This would leave a lingering potential for a recipient to have spent the gift by the time they realise IHT is due on it, which is a current concern. 

This is also the case under current rules where the nil rate band is allocated to the earliest gift first. Not only can this create unintended inequality between beneficiaries as some unexpectedly benefit from the nil rate band while others don’t, it can lead to situations where gift recipients have spent the funds given to them but then find themselves liable for IHT. The OTS’ potential solution is to allocate NRB proportionately across the total value of all the lifetime gifts on death, with any remainder then being available to the death estate. 

Again, this could actually lead to further complications, such as in establishing IHT payable on certain immediately chargeable lifetime transfers such as transfers into trust as well as the amount of ’10 year charges’ and exit charges payable by the trust. The nil rate band is used in these already difficult calculations. 

While the concept of making gifts is a very simple one, tax reliefs and exemptions in relation to them are certainly not. And while government IHT receipts continue to rise, any changes that tip the balance in favour of further IHT take, whether intentionally or not, would not be popular. Consequently, the possibility of making many, if any changes at such as delicate political juncture seems remote, if only because there may currently be insufficient focus to eliminate the potential for significant unintended consequences.  

Other recommendations

On the subject of unintended consequences, although it is well known by professionals that insurance policies written in trust take the assets of the trust outside an estate, thereby reducing the IHT bill of that estate, many people still do not do this. Of course, the Treasury then reaps the rewards, although, given that many death benefits are likely to pass to a surviving spouse and be exempt from IHT, those rewards are likely to be limited. Hence the recommendation that death benefit payments from term life insurance are IHT free on the death of the life assured without the need for them to be written in trust. 

Given the complexity of anti avoidance legislation, including the introduction of the General anti-avoidance rule (GAAR) and Disclosure of Tax Avoidance Schemes (DOTAS) rules for IHT provisions, there is also a call for a review of the POAT (Pre-owned asset charge to Income Tax) rules and to consider whether they function as intended and whether they are still necessary. Even if POAT was repealed, this is still likely to be an area requiring expert navigation.

No recommendations in two very complex areas

While noting that the residence nil rate band is very complex, OTS states, perhaps disappointingly,  that more time is needed to evaluate its effectiveness before recommendations can be made on how to simplify it. There is also no question of the complexities involved with trusts and IHT, but it is concluded that the current HMRC trust consultation is better placed to consider these in the round alongside other taxes.

It’s important to remember that there is no obligation for the government to follow any of the OTS recommendations, although this report casts an interesting light on some of the contradictions and idiosyncrasies that inhabit the IHT universe. And while the next prime minister, Brexit and its aftermath all remain top of the agenda, there is a real possibility that it could remain just an enlightening exposé, rather than a real driver of improvement. 



This material is not intended to constitute legal or tax advice. Intelligent Partnership is not authorised and regulated by the Financial Conduct Authority, is not a tax adviser and does not give advice. Although every reasonable effort has been made to ensure the accuracy of this material, it should not be relied upon.

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