Laura Suter: The taxing task of IHT simplification

The OTS had a difficult job on its hands balancing the need to simplify complex IHT rules while keeping them fair for consumers and affordable for the government, writes Laura Suter

The long-awaited report on how to simplify the inheritance tax (IHT) system came out this month, and it is not an overstatement to suggest the financial services sector was actually excited to see how the plans to battle through the complex web of rules had panned out.

The Office of Tax Simplification (OTS) was tasked with coming up with different ways of fixing the system and making it easier for consumers to understand. Not just consumers would benefit from the changes, however, as the report also revealed there are some areas of the system that are so complex even professionals do not understand them fully.

The OTS had a difficult job on its hands balancing the need to simplify complex rules while keeping them fair for consumers and affordable for the government. Generally speaking, then, the report is a step in the right direction, with some good proposals such as combining all the gifting allowances into one, although removing the ability to give away excess income would be a big loss for some people.

Arguably one of the biggest changes proposed was ditching the seven-year taper. A recent poll of the public found that almost half of those gifting money do not understand the IHT rules around it, so it is certainly a prime area for the red tape to be slashed.

The OTS instead suggested a “package” of measures, insisting one part of it would not work without the other. It suggested cutting the seven-year time period down to five years, but also getting rid of the taper altogether. So if someone gifted money and died within five years, the full 40% inheritance tax would be due. If they survived beyond five years, no tax would be due.

It is undeniably simpler but, on the face of it, it does look like a revenue-raising move. Where previously, under the taper, in years three to four someone would pay 32% tax and in years four to five they would pay 24%, now they would pay the full 40%. That said, in the last two years of the taper rather than paying 16% and 18% tax, they would admittedly now pay nothing.

The OTS argues, however, that the two moves go in opposite directions and should balance each other out. The reduction from seven to five years would cost the Exchequer, while the removal of the taper will raise money. They do not yet have any modelling on how much each move would raise or save – that will be work for HM Revenue & Customs to do further down the line if it takes on board the recommendation.

Other big unknown

The other big unknown is how these moves would influence, if at all, the likelihood of someone deciding actually to gift money. The OTS argues the cut to five years would make more people likely to give away their money at an earlier stage, potentially avoiding more IHT.

One thing that is certain is that the taper is rarely used among estates where IHT is actually due. HMRC figures from 2015/16 show fewer than 5,000 estates had made lifetime gifts within seven years of death. That is about 20% of all estates that owe IHT.

It remains to be seen what the government decides to do with the OTS report but let’s hope policymakers finally get around to taking some action.

Laura Suter is personal finance analyst at AJ Bell