Suggestions to simplify ‘clear as mud’ inheritance rules welcomed

A shake-up of “unpopular” inheritance tax, so that executors would only need to account for gifts made within five years of death rather than seven years currently, has been proposed by an independent review.

The Office of Tax Simplification (OTS), which was commissioned by Chancellor Philip Hammond to review current rules around the tax, said there are many areas where inheritance tax is poorly understood and requires substantial record keeping.

Its suggestions to simplify the system were welcomed by tax experts – who said current rules can be as “clear as mud to most people”.

The OTS report said: “Inheritance tax is often said to be unpopular and raises strong emotions, not least because it affects people only occasionally, in sometimes significant and surprising ways, and at a sensitive time.”

Inheritance tax is primarily levied on the value of the assets of someone who has died – but gifts made before death may also be liable.

There is normally no inheritance tax to pay if the value of someone’s estate is below a £325,000 threshold, or if everything above this goes to a spouse, civil partner or charity.

People receiving gifts can find themselves liable for inheritance tax if someone gives away more than £325,000 in the seven years before their death.

Gifts can include anything that has a value – such as money, property and possessions.

Inheritance tax is charged at 40% on gifts given in the three years before death, with gifts made three to seven years before death charged on a sliding scale of smaller percentages, known as “taper relief”.

However, people can give away £3,000-worth of gifts each tax year, without this being added to the value of their estate.

The OTS said it recommended that the seven-year period is reduced to five years.

It said the seven-year period “requires a large amount of record keeping but raises little tax”.

It also said the tapered rate of inheritance tax should be abolished.

Bill Dodwell, OTS tax director, said: “The tax paid on gifts six or seven years before death is low.”

In 2015-16, only £7 million out of total inheritance tax of £4.38 billion related to gifts to people made more than five years before death, the report said.

It also said that a large number of exemptions and thresholds for gifts also creates confusion – and suggested these could be streamlined with the creation of a single relief with a higher overall figure.

The OTS makes recommendations for the Government to consider and does not implement changes, which would be a matter for Government and Parliament.

Commenting on the report, Rachael Griffin, tax and financial planning expert at wealth management firm Quilter, said: “At the moment when an estate is added up it works chronologically, starting from seven years prior to death.

“That means gifts made in the seven years prior to death use up the nil rate band of £325,000 before the rest of the estate.

“If you have already used your nil rate band of £325,000 – through gifts or otherwise – and you continue to gift above this allowance, then die within seven years, how much tax has to be paid depends on a tiered structure linked to when you die.

“This is as clear as mud to most people and so a simplification is welcome and sensible.”

But she continued: “The OTS also recommended removing the taper relief which, while complicated and confusing, did have its place as it reduced the amount of tax people paid depending on how long they lived.”

Sarah Coles, personal finance analyst, Hargreaves Lansdown, said: “The current system requires too much record keeping, and forward planning.”

Laura Suter, personal finance analyst at AJ Bell, said: “The inheritance tax system has become so complicated that many people simply do not understand the system, so any simplification to make it easier for families to navigate would be a positive development.”

She continued: “The OTS rightly acknowledges that the seven-year taper rule is hideously complex, and can cause people to be landed with an unexpected inheritance tax bill years after they were gifted money.

“However, the suggestion of reducing the seven years down to five and scrapping taper relief entirely looks like a bald tax grab and revenue-raising move.

“Instead, the taper could be simplified into a two-step process for example, or if it is scrapped entirely then the period should be shorter than five years.”