The Office of Tax Simplification (OTS) has hinted at where it believes inheritance tax is ripe for reform as part of its review into how the inheritance tax system works.

    The OTS published the first part of its review in November, which focused on the administration of IHT.

    The second part of the review is expected later this year and will be more policy focused.

    Speaking at an FT Adviser Masterclass event in London this week, OTS tax director Bill Dodwell outlined some of the body’s findings so far, and where there might be room for improvement or challenge as to how IHT works in practice.

    The OTS received 3,000 responses to its public survey on IHT, as well as 500 personal emails from individuals.

    Mr Dodwell said: “It’s definitely a subject that excites public interest and definitely something that people feel quite concerned about, despite the evidence that currently only about 5-7 per cent of estates are actually liable for the tax in the first place.

    “We shouldn’t dismiss this, because many people who have concerns about inheritance tax are probably in their 40s and 50s and are thinking about the value of their house and other assets could be over the £325,000 threshold, or £650,000 for a couple, and are potentially therefore liable to pay it.”

    The findings 

    Here are some of the findings from the OTS research, which suggest the areas the second part of the review is likely to focus on.

    Gift allowances – Mr Dodwell described gift allowances as not well understood, complicated and “in some ways, a bit pointless." He said: "For example, why do we have a £250 exemption when obviously people aren’t going to be counting up every time they give a child or grandchild £100 for Christmas?”

    He suggested an exemption that was more in line with inflation, and suggested there may be a case for combining some of these kinds of allowances which would be an easier system to operate.

    Normal expenditure out of income – The OTS said it has received a lot of feedback from advisers on how complicated the normal expenditure out of income relief is. This is where transfers or gifts are exempt from IHT if they’re made as part of normal spending, out of ‘natural’ and excess income, and fit into a regular payment pattern.

    Mr Dodwell said: “This is the only relief that works in this way, it’s complicated to understand, and there seems no obvious reason that you should want to give away similar amounts of money to the same individual three years in a row.

    “I hope that our second report later this year will have some more data about how some of these allowances work, as well as some recommendations for how they could be made easier to operate in practice.

    "That would make it more straightforward for people to know they fit into a particular exemption, and that they don’t need to worry about massively complicated record-keeping that executors hardly wish to cope with.”

    Taxation of gifts within seven years of death – Here, the example was given of a parent giving money away to their children. The eldest child gets a deposit to put towards buying a flat, and a couple of years later the second child is also given a house deposit.

    If the parent dies within the seven-year period, the recipient of the money is the one who is taxed, rather than the estate which is most people’s understanding.  Also, because of the way the nil rate band of £325,000 is applied, the eldest child has received the money first and has the lowest liability to pay.

    Mr Dodwell said: “This hardly seems fair or straightforward, or hardly what the parent would have thought, unless they’d had advice in this area. Maybe that whole area ought to be looked at to find something that’s more rational, and is easier to understand.”

    Taper relief – This states that if an individual dies within three years of a gift, the full amount of inheritance tax is payable, and if death is within four to seven years there are tapered amounts to pay. The OTS survey found that most people think the gift is tapered, when it’s actually the tax liability that the taper applies to.

    Mr Dodwell said: “Not many people claim the benefit of this at all, so maybe we should look at reform in that area just to make the system simpler and more intuitive.”

    He added: “I’m not suggesting for a moment that we would recommend abolishing anything, that is absolutely not our role. But I think it is worth at least asking some of these questions about how reliefs operate, and how they meet the wider policy intents.”

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