Succession and tax reform

Farmers and landowners have enjoyed a tax system that has allowed succession to take place with little or no tax liability.

Generous reliefs from inheritance tax (IHT) and capital gains tax (CGT) are available, and even on death the family farm usually passes to the beneficiaries with little or no tax due.

The Office for Tax Simplification (OTS) recently reported to the chancellor outlining 11 recommendations for the reform of IHT, therefore some changes to these tax reliefs may be ahead.

The OTS reported findings that show IHT is little understood and when you consider that fewer than 25,000 estates are liable to IHT each year, this is perhaps not surprising. This figure represents less than 5% of deaths, however more than 10 times as many estates are required to complete and submit forms.

The recommendations cover three primary areas – lifetime gifts, the interaction between IHT and CGT, and businesses and farms. Many people are aware of the seven-year clock that starts when one individual makes a gift to another. Many people are also aware of the annual IHT exemption of £3,000, a figure which hasn’t changed since the 1980s.

The OTS has recommended replacing the annual exemption and the marriage gifts exemption with an overall personal gifts allowance, and recommended that the level of this exemption and the small gifts exemption are reviewed. There is also a recommendation to reform the normal expenditure out of income exemption or replace it with a higher personal gift allowance.

A further key recommendation is a reduction in the seven-year period to five years, along with the abolition of the taper relief provisions that apply if tax becomes payable on a gift that has failed the seven-year test. The taper relief provisions are complex and not easily understood.

The second area considered by the OTS relates to the interaction between IHT and CGT. The OTS has concluded that the complexity of this interaction can distort decision-making.

Currently, there is generally no CGT on death. Instead, assets form part of the estate subject to IHT and the value of the assets passed to the beneficiaries is rebased to the market value at the date of death. This means, for example, assets that are inherited by a spouse are free of IHT and can be sold shortly after with little or no gain over the date of death value. There is therefore no CGT due either.

The OTS has therefore recommended that the CGT rules be amended rather than the IHT ones, so that assets covered by any sort of IHT exemption will not be rebased to market value on death but will be inherited at the deceased’s original base cost. This would mean if they were sold by the recipient there would be a far larger gain, most likely giving rise to a capital gains tax liability.

If any of these recommendations are followed through by the government, there are likely to be winners and losers. While the reduction in the seven-year period following a gift would be welcome, the change to the rebasing provisions would almost certainly see the tax liability of beneficiaries rise substantially, perhaps resulting in fewer disposals of inherited assets.

Based on current political uncertainty, a new government could take a more radical approach. A “wealth tax” is a realistic option and probably a vote winner. Several European countries have adopted a wealth tax, where individuals pay an annual tax based on their total wealth or property owned.

Our advice to farmers who have succession options available is to make use of the generous tax reliefs available as they may not be available if legislation changes.

Generous tax reliefs that exist for farmers who want to hand down their businesses may no longer be available if legislation changes.