Dawn Joughin: Beware - HMRC inheritance tax probes are on the rise

Over its 30-year history in the UK, inheritance tax (IHT) has never been straightforward. Since a new allowance for family homes was introduced in April 2017, however, thousands of new IHT investigations were opened by HMRC in the 2018/19 tax year, according to a freedom of information request by wealth management group Quilter.

In total, there were 5,537 investigations among the 22,000 estates that were liable for IHT in that period - a figure that equates to nearly 25% of the total. The figures is some 8% from 5,354 in 2016/17, the previous tax year.

Despite only 5% of estates being liable for IHT, the system is unnecessarily complicated. This is confirmed by a recent report from the Office of Tax Simplification (OTS), which stated that some solicitors choose not to advise clients on allowances in relation to IHT because of their complexity.

Most notably, the system relating to residence relief is contrived, creating a minefield for those who have to navigate it. News the introduction of the residence nil rate band has spurred an increase in HMRC investigations is therefore unsurprising.

Prior to introducing the scheme, the government had made statements it would enable up to £1m to be left tax-free, after many families had complained about the enforced sale of the family home in order to pay IHT. Instead of simply increasing the nil-rate band threshold to £500,000 for each individual (which would have resulted in reduced revenue for HMRC), however, a system was introduced for family home/residence relief, tapered over several years.

HMRC's District Valuer has always been vigilant over declared property values, investigating and disputing them when a valuation has not been agreed. Historically, lower property values were declared for IHT purposes since the capital gains tax (CGT) rate charged on any gain on the agreed probate value at the point of sale was lower, and accordingly, beneficial to the estate.

Furthermore, if the property had been assented to the beneficiaries prior to sale, each had their own individual CGT allowance, which in some instances could negate any CGT payment becoming necessary.

Since the residence relief on property (provided it is left to direct descendants) was introduced - and given the relief is reduced on estate values over £2m - it has become even more important for families to produce, and to have accepted, a lower-end property valuation.

The rules concerning the new main residence nil-rate band (MRNRB) stipulate that, if the first spouse's estate is worth in excess of £2m, then the surviving spouse will see their MRNRB tapered by £1 for every £2. In practice, this means an estate need only have a value of £2.35m in the tax year 2020/21 (when the allowance rises to £175,000) in order to see the relief reduced to zero in real terms.

Suite of recommendations

As part of a suite of 11 recommendations it recently made to the government, the OTS  has suggested amendments to the longstanding annual gift allowance of £3,000 and the small gift annual exemption (per donee) of £250, both of which have been frozen since 1980/81. The OTS recommendation is to replace multiple forms of lifetime gifts with a single personal gift allowance.

When advising clients who are high-income earners, lawyers and their financial advisers should explore the potential to make regular gifts from income which, provided the gifts do not result in the client using capital in place of income, are tax free and exempt from the seven-year survival rules. The OTS has also recommended reducing the seven-year rule to five years.

Notwithstanding the potential of this and other OTS recommendations being implemented, IHT remains a particularly delicate issue. Before acquiring assets, clients have already paid income tax throughout their lives, together with CGT on any subsequent gains they have realised. A further tax levied on a family, when an asset is passed on to them, only serves to constitute an unfair additional burden.

Dawn Joughin is a specialist private client lawyer at Excello Law

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• Topics
• Tax planning
• IHT
• HMRC
• Excello Law