Pressure is growing on Chancellor George Osborne to amend reforms to a controversial new inheritance tax allowance due to come into force from April 2017.
Osborne announced plans to introduce a new main residence nil rate band as part of the July Budget, with the changes forming a crucial plank of the Conservatives’ election promises on tax.
The plans have the effect of raising the IHT-free allowance for homeowners to £500,000 per person, meaning where married couples jointly own a family home, and want to leave it to their children, the total exemption will be £1m.
However, the Chancellor’s plans have been criticised since they were announced, being described as both complicated and unfair.
Last week, Treasury committee chairman Andrew Tyrie wrote to Osborne to reiterate his call for the Government to introduce remedies, describing the plans as “impenetrable to all but professional tax advisers”.
He said: “High-street accountants are likely to struggle with them. Traps lie everywhere in the detail.”
The letter added: “The reform has the hallmarks of unsustainability and therefore instability which is the negation of good tax policy. The March Budget will provide another opportunity to remedy these problems. I urge you to take it.”
But what are the traps that have the senior Tory so exercised? And is there any prospect for a dramatic improvement?
Traps and subterfuge
Conservative MP and Work and Pensions committee member Craig Mackinlay decried the plans when he spoke to Money Marketing in October.
And new provisions to limit disincentives to downsize by allowing proceeds from sales to be included within an allowance has done little to change his mind.
He says: “I don’t see why they can’t just change the IHT allowance to £500,000 full stop and have done with it.”
He adds the Chancellor has done little to change a fundamental unfairness in the policy, which limits the relief to direct descendants.
“What about those who have perhaps stepped into the place of children or those families who have never had children? It comes down to the fundamentals of what is fair. That’s hard to define, but it certainly feels unfair at the moment.”
RSM senior tax partner George Bull says: “It only works vertically down the family tree. So if you have no children but your sister has, that’s the luck of the draw.
“From that point of view the available reliefs are very limited.”
Indeed, tax experts are united in criticising the plans to introduce the new residence provisions.
The new allowance will come into effect at £100,000 per person from 2017, increasing by £25,000 a year until it reaches £175,000 in 2020/21.
It comes in addition to the existing inheritance tax threshold of £325,000, which will be frozen.
Technical Connection joint managing director Tony Wickenden says while the provision will increase over three years, the Conservatives originally announced it would be funded by a gradual tapering of the annual allowance on pension contributions, which is set to come into effect from April.
He says: “There’s an interesting gap there and a bit of subterfuge too, because the new rules are hugely complicated, and it all gets chipped away in ways that people don’t realise.
“It makes for great headlines, and people think it adds up to £1m for a couple so that’s alright.
“But the rules are related to a specific asset, so you have a need for definitions like what constitutes a main residence. The legislation is unbelievable.
“For example, no one who has an estate of more than £2m can qualify for the full allowance. But even in defining the £2m for the purposes of that you need to think about the kinds of relief you might get for IHT generally.
“If you own a farm, for example, it may not be included in the calculation of your estate because you get business property reliefs for IHT, but the Treasury seem to think it will be included in that £2m. It is unnecessarily complicated and most people will need advice to avoid it ending up being a total mess.”
Helm Godfrey chairman Danby Bloch describes the policy as a product of a Government “trying to be too clever by half”, not least because of the limited impact of the changes.
By the time the reforms come into full effect in 2021, the Institute for Fiscal Studies estimates the number of estates liable for IHT will have fallen by 40 per cent – from 60,500 prior to the changes to 34,200.
However, the IFS notes the proportion of estates liable remains relatively high compared with the last 40 years, and is set to reach 6 per cent in 2020/21.
The think-tank says: “While this is lower than the 6.2 per cent seen in 2014/15, it would be higher than any year between 1980/81 and 2013/14 (inclusive), and it remains to be seen whether this can be maintained.”
Bloch says: “The whole thing strikes me as a very considerable complication that won’t save anyone a huge amount of money.”
Prospects for reform
Despite the growing complaints, however, few seem optimistic on the chances of a U-turn from the Treasury. Indeed, experts note this week’s commentary from the IFS, which says there is a one-in-four chance the Chancellor will need to raise taxes to meet his own target of a 2019/20 surplus.
One tax expert says: “Facing a Budget as he does where the Chancellor has so many factors running against him, my guess would be that this would not be very high on his agenda this time.
“Early in Parliaments you don’t want to be spending a lot of legislative time on something that isn’t a big tax yielder, and if you do it later in a Parliament and there are going to be more losers than winners, you don’t want to change the law.”
Bull says the prospects for reform are limited, in part by a Government seeking to juggle political messaging on home ownership and wealth, while also increasing tax take from the richest.
He says: “There’s a whole load of political hot potatoes lurking just below the waterline in this bubbling saucepan. But the approach over the last Parliament and previous ones has been to manage concerns, rather than reform.
“So now the Chancellor has decided on a plan, he will be loathe to change it too much.”
Bloch adds the Chancellor will need a significant reason to retreat on a reform that garnered headlines in the national media as part of the Conservative election campaign.
“I don’t think Osborne has that [significant reason]. The world is not looking any better than it did in the Autumn Statement, and in fact it’s probably slightly worse.”
The main residence nil-rate band announced in last year’s Summer Budget is undoubtedly complex. The RNRB will be phased in from 2017, reaching £175,000 per person in the 2020/21 tax year.
The phasing in will likely cause some degree of confusion, with many assuming the full allowance applies immediately.
Meanwhile, the entitlement can still be claimed where an individual downsizes or sells their primary residence altogether.
This is sensible, preventing individuals from holding on to their main residence for IHT purposes alone. However, there are a series of relatively tricky calculations to apply in order to calculate the entitlement available following a downsize.
The allowance is also only applicable where assets are passed on to direct descendants. Should an individual choose to pass all their wealth on to a charity, for example, they will not be able to make use of the RNRB.
This differs from the existing nil rate band, creating a discrepancy between the two allowances.
It is easy to see why Andrew Tyrie feels the system has become too complex. A far simpler solution would have been to increase the nil rate band to £1m, rather than introduce a separate entitlement. From an adviser perspective, however, complexity in the tax system does create demand for advice.
Rachael Griffin is financial planning expert at Old Mutual Wealth
Martin Bamford, managing director, Informed Choice
We always want tax to be simple and at the moment all of it is horrendously complex, and I can’t see the proposed changes to inheritance tax altering that. There always seems to be an easier route for the Government to take when it comes to these kinds of policies, but they opt for something more complicated, so Andrew Tyrie’s letter is a welcome intervention.
Claire Walsh, financial adviser, Aspect8
People have welcomed the new allowance and it has been a vote winner for the Conservatives, but there are things the Chancellor has done that I would not have gone for. By phasing in the new allowance slowly, Osborne has made it more difficult to plan for. It is also not necessarily fair that when it comes to unmarried couples, they are left out.