John Humphreys: Planning for IHT changes - great or small

You may recall that recently-replaced chancellor Phillip Hammond requested the Office of Tax Simplification (OTS) review IHT in January 2018. Earlier this month, it published its final report into the tax, noting 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".

Perhaps not surprisingly, it also reported an unprecedented level of engagement into its review, including a submission from myself, which resulted in a meeting with the OTS at Whitehall to discuss my suggestions. The current IHT rules may be complex but there is certainly no shortage of opinions as to how they should be changed.

The OTS came up with 11 recommendations, clarifying that they were on simplification rather than policy issues (although the distinction between the two can seem a little blurred). These included substantial reforms to the gifting rules; replacing the annual gift exemption and the marriage gift exemption with an overall personal gifts allowance; and a recommendation that the government "considers the level of this allowance".

It also recommended reducing the seven-year gifting period to five years, abolishing taper relief, and reforming the ‘normal expenditure out of income' exemption or replacing it with a higher personal gift allowance.

Separately, prior to the OTS publication both Labour and the Liberal Democrats had also generated headlines by proposing replacing the current IHT rules with a system based on lifetime gifting. The changes that are being discussed are significant and would be likely to influence behaviour - in both predictable and unpredictable ways.

Yet the difficulty in planning ahead is that, right now, it is uncertain exactly what changes might end up going through the necessary Parliamentary processes to come into force and when. There is also certain to be an election within the next three years - or sooner - with anyone confidently stating the outcome putting confidence above certainty. This is a notably shorter timeframe than the gifting period for IHT - even at its recommended reduced length.

With this in mind, it is worth reflecting on the importance of planning for the right reasons. Simply put, families should pass on wealth to the younger generations because that is their intention. It is also reasonable for families to consider at what point in time such an action would make most sense - from the point of view of both the giver and the receiver.

Many young and growing families may find themselves struggling to get on the property ladder, wondering how to pay for various forms of education - from early years childcare to university - or perhaps looking for investment to start a business. It is reasonable to ask if a financial inheritance would benefit them most at the point of death of their parents, when the beneficiaries themselves may be at retirement age, or whether it would be more useful at an earlier stage of their family life.

For parents who know they will eventually pass on an inheritance, there may be an equal number of reasons why they would rather hold back on passing on any money. Perhaps they are hoping for a little extra maturity to develop in their children, are concerned about their children's relationships, or worried that if they pass money on there will be nothing left to cover any future care costs. Or perhaps they have plenty of their own bills to pay and things they wish to spend their money upon.

It is also worth reflecting on the benefits of a little prudent planning. On the topic of business property relief (BPR), the OTS has recommended the government reviews the treatment of indirect non-controlling holdings in trading companies, while observing the main policy rationale for BPR and agricultural property relief is to prevent the sale or break up of businesses or farms to finance IHT payments following the death of the owner.

As I have written about previously, advisers need to remember that some of the investments currently being promoted to take advantage of the current rules for BPR are inherently higher-risk and potentially less liquid than more mainstream investments. They also only qualify for the exemption after two years, so need to be held by a client continually until death for the exemption to apply - and hope the rules do not change in the interim.

It is not like an inter-vivos period, where once the donor has survived the inter-vivos period (currently seven years; with the OTS recommending a reduction to five years), the gift is removed from the donor's estate.

Under scrutiny

Following the OTS report - and HMRC's The influence of Inheritance Tax reliefs and exemptions on estate planning and inheritances, published in May 2017 - it would appear the future of the rules for BPR are under some scrutiny.

Following the release of its final IHT review report, OTS tax director (and report co-author) Bill Dodwell said: "We think AIM is the only market in the world where investors can receive an Inheritance Tax benefit. Supporting a market in this way is a different policy objective from supporting passing a business down the generations."

It was already the case that the suitability of these investments needs very careful consideration for every client as to whether or not they suit their appetite for risk - being mindful the potential ‘tax tail', should not wag the ‘investment dog'.

Providing guidance in such unpredictable times is certainly challenging. As and when any of the proposed changes to IHT come into force, clients may need to adapt their plans. Trusts that can adapt to changing circumstances (and invest in mainstream investments) may be vital to enable them to do so. If plans have been made in line with clients' wishes and intentions, prudently and in plenty of time, families may find the changes not so difficult to weather after all.

John Humphreys is inheritance tax specialist at WAY Investment Services

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