How divorcing couples are affected by tax

• 28 February 2020
• News

For couples facing divorce, the tax consequences of their financial settlement are unlikely to be at the forefront of their minds.

This blog post was first published in the FT Adviser and can be accessed here.

Nevertheless, the implications of failing to take good tax advice can have a significant impact on a couple’s finances at a time at which they are likely to be under pressure anyway. Changes being made to aspects of the capital gains tax regime with effect from 6 April 2020 may also affect the tax analysis. Thus, anyone considering separation or divorce should seek tax advice as early as possible. Specialist advice should always be taken where one or other party is domiciled outside the UK.

Please note that we refer throughout this article to spouses, but all the issues touched on apply equally to civil partners.

Capital Gains Tax

The most significant tax consideration in the context of separation or divorce is likely to be a potential capital gains tax (CGT) liability when assets are sold or transferred from one spouse to the other as part of a financial settlement. For many couples, the marital home is likely to be the most valuable asset to be considered in a divorce, but other assets and investments, including second homes, may also be significant in any financial settlement.

Outright transfer between spouses

Timing is the key here.

Assets of all types that are transferred between spouses during a tax year in which they have lived together at some point, pass on a “no gain, no loss” basis, so the recipient spouse is treated as receiving the asset at the value at which the transferring spouse acquired the asset.

However, if such a transfer takes place in a tax year after the couple has formally separated, assets will be treated as passing at market value, and accordingly any gain in value since acquisition will be taxable on the transferring spouse, subject to any available relief. This is despite the fact that there may have been no financial consideration involved from which the tax might otherwise be paid.

As the CGT liability arises to the person disposing of the asset (the transferring spouse) one might argue that the recipient spouse has little interest in timing the transfer to avoid a CGT charge. However, it is generally in the interests of both spouses to minimise the tax payable in order to maximise the pool of funds available to be shared between them.

While tax will not be the only relevant issue, if it is possible to ensure that any transfer of assets between spouses is made in a tax year in which they have lived together, in most cases this is likely to be preferable. If not, then negotiations of any financial settlement should always take into account any prospective CGT liability of either or both spouses, in respect of transfers of assets between them.

Principal Private Residence Relief for the family home

In the case of a couple’s main residence, Principal Private Residence Relief (PPR) may be available to exempt any gain arising after the year of separation.

However, for PPR to apply to the full gain, any sale or transfer must take place within 18 months of the transferring spouse leaving the property and it ceasing to be their main residence. The 18-month period of absence will reduce to nine months with effect from 6 April 2020, which will make the timing even tighter to secure full PPR for the departing spouse.

This period of absence can be extended indefinitely under relevant CGT legislation if the disposal of the property is to the former spouse, and the following three conditions are satisfied:

• The transfer is made under an agreement between the spouses in connection with their permanent separation, divorce or dissolution, or under a court order;
• Throughout the period from the individual leaving the property to its transfer or sale, it continues to be the only or main residence of the other spouse; and
• The individual who left the property has not elected for another property to be their main residence for any part of that period. These will include a change to lettings relief, which in future will be available only to property owners living in a property while it is rented out.

The third condition is the one most likely to prove to be a stumbling block, as it will not always be advisable for the non-occupying spouse to forego PPR on any new main residence. There are a couple of other changes to the ancillary rules for PPR due to take effect from 6 April 2020 that may affect the tax analysis in certain circumstances in respect of any transfer of the family home.

A second proposed change aims to ensure that where a transfer takes place under the no gain no loss rule, the recipient spouse always inherits the full history of ownership of a property from a transferring spouse for the purposes of calculating PPR. As a result, in certain situations, full PPR could be claimed on a subsequent sale of a property by the recipient spouse, despite the fact that the property might, for example, have been a buy-to-let property for years in the transferring spouse’s hands. PPR is not available for transfers of second homes, and the only relief from CGT in this case, or in respect of other non-business assets, would be the individual’s annual exemption (£12,000 in tax year 2019/20), if available.

Deferred trust of land

Courts do not always order an outright sale or transfer of the family home.

Instead a “Mesher” or “Martin” order may be made, whereby the property is held in both parties’ joint names on trust until a specified event occurs, for example (in the case of the former) the youngest child reaching 18 or leaving education. Until that point, the occupying spouse has the right to reside in the property.

For tax purposes, the two spouses are regarded as making a disposal into trust at the date of the court order in respect of which PPR is available. When the property is later sold, provided the conditions to extend the period of absence apply, PPR should be available to the non-occupying spouse, if he or she wishes to claim it, regardless of the period that may have elapsed since he or she left the property.

From an IHT perspective, the creation of a trust under either a Mesher or Martin order should have no immediate adverse effects provided it is entered into before the decree absolute or dissolution order.

However, IHT is discussed further below.

Deferred charge

A deferred charge differs from a Mesher or Martin order in that the property moves into, or remains, in the sole ownership of the occupying spouse.

The interest of the non-occupying spouse is represented by a charge over the property. This charge is enforceable on the occurrence of a specified event, again likely to be the youngest child reaching 18 or leaving education. The charge is either a percentage of the eventual sale price or a fixed sum.

Generally, a percentage is considered preferable in order to permit the non-occupying spouse to share in any increase in value of the property in the intervening period. The CGT analysis will vary according to the alternative chosen and tax advice should be taken before any decision is made.

Inheritance tax

For most couples, the inheritance tax (IHT) implications of divorce are limited, as any transfer of assets between them should be covered by the spouse exemption, provided it is made before decree absolute or a dissolution order.

Even after that event, transfers are likely to escape an IHT charge on the basis that they are not intended to confer gratuitous benefit, for example, because they take place as a result of a court order or compromise agreement between the parties. However, where an ongoing trust is created, including a deferred trust of land depending on its terms, there may be a risk of future IHT charges arising.

Therefore, it is important that IHT advice is always taken as part of any financial settlement. For couples where one spouse is UK domiciled and the other is not, the spouse exemption is limited to £325,000 (in tax year 2019/2020) for transfers from the UK domiciled spouse to the non-UK domiciled spouse.

Any sum transferred in excess of that amount will be treated as a “potentially exempt transfer” and will also be exempt from IHT provided the transferor spouse survives for seven years following a transfer. Taper relief is available to reduce IHT liability in respect of transfers made between three and seven years prior to the death of the transferor.

While the IHT implications of separation or divorce itself may be limited, once any financial settlement is finalised, both parties should take their own estate and tax planning advice to ensure that their wills and other financial arrangements are updated to reflect their new status and to be as tax-effective as possible.

Income Tax

As married couples are taxed separately on their income, the tax implications of divorce are generally limited to any income-producing assets that are transferred as part of the financial settlement. However, everyone’s circumstances vary, and it is important always to take advice.

Stamp duty land tax

Stamp Duty Land Tax may be payable on transactions involving land, including the purchase of a residential property.

Transactions in connection with divorce or dissolution of civil partnerships and made in pursuance of a court order of divorce, dissolution or separation are generally exempt from SDLT. This would include transfers of the family home between spouses.

However, SDLT will be payable on acquisition of any new residential property, for example if the non-occupying spouse decides to buy a new property in which to live. In normal circumstances, the acquisition of a property (or “dwelling”) while also retaining an interest in another one (for example, in the family home) would give rise to an additional SDLT charge at the rate of 3 per cent of the value of the property.

This charge would be payable in addition to the standard rates of SDLT. However, where a couple is getting a divorce, a spouse who owns an interest in a dwelling in respect of which a property adjustment order has been made for the benefit of another person is not treated as owning that interest for the purposes of the additional charge, provided that the dwelling is not his or her main residence, but it is the other person’s main residence.

Conclusion

This article has touched on some of the most common tax considerations for couples considering separation, divorce or dissolution of a civil partnership, and while not exhaustive, this should illustrate the vital importance of taking tax advice at the earliest opportunity in order to ensure that adverse tax consequences are avoided or mitigated as far as possible.

Simon is a partner in the Family team and Guy is a partner in the Private Client team at Forsters

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• How to split the pension on divorce

How to split the pension on divorce

• 27 February 2020
• News

It is twenty years since the family courts in England and Wales were given the power to share pensions on divorce (Welfare Reform and Pensions Act 1999).

This blog post was first published in the FT Adviser and can be accessed here.

This is a unique power, and is the only circumstance in which a living individual can transfer all or part of their pension fund to another individual.

When a divorcing couple apply to the court to resolve the financial aspects of their divorce, the court has the power to make a wide range of orders, for sale or transfer of property, for payment of lump sums and regular monthly maintenance. In appropriate cases, the court can make a Pension Sharing Order (PSO). Such an order may be imposed by the court following contested proceedings, but more usually it will form part of an order made by consent following a settlement negotiated by the parties with the assistance of lawyers or a mediator. The universal valuation method for pensions is the Cash Equivalent

A PSO is an order directed to the trustees of a pension, requiring them to transfer all or part of the pension fund to the holder's ex-spouse. Together with the order, the trustees will be served with a Pension Sharing Annex, containing specific instructions, including the percentage of the value of the fund which may be transferred. It is possible for PSOs to be made against more than one pension, in different proportions.

Pensions in divorce settlements

In the twenty years that the family court has had the power to share pensions on divorce, thousands of pensions will have been divided, and thousands more will have been offset against other assets as part of a divorce settlement. A financial settlement on divorce is always a compromise, balancing the needs of the individuals concerned and their children, in both the short and the long term. The ability to share or offset pension assets can provide welcome flexibility, and can help structure a settlement in a way that is tax-efficient.

However, pensions are complex instruments. They can be difficult to value, and even more difficult to compare with other assets on a like-for-like basis.Family court judges, divorcing couples and their lawyers frequently have to make decisions under pressure, with consequences that will not play out in full for many years. A pension pot, accumulated over many years and representing an aspiration to a comfortable retirement, can be very difficult to give up, particularly in an acrimonious divorce, despite potential tax incentives to do so. It is telling that an alleged failure properly to understand pension assets is the largest source of negligence claims against family lawyers.

However, an eagerly awaited report by a group of legal and financial experts has highlighted some of the pitfalls, and provides useful guidance in this complex area. It is fair to say that pension sharing is one of the less well-understood aspects of matrimonial financial practice. In a most welcome development, Sir James Munby, the former President of the Family Division, convened an inter-disciplinary working party to investigate how pension sharing works in practice in the family courts, to highlight difficulties, and to make recommendations to improve inter-disciplinary working, the Pension Advisory Group (PAG).

The PAG's report, "A Guide to the Treatment of Pensions on Divorce" was published in July 2019.

Valuation

The universal valuation method for pensions is the Cash Equivalent (CE). A divorcing couple will inevitably be required to obtain CEs for each pension scheme of which they are or have been a member. A PSO will be expressed as requiring the trustees to transfer a proportion of the CE value to the other spouse. The advantage of CEs is that they are easily obtainable, and provide an approximate "snapshot" value of a pension fund.

The difficulty is that the CE can provide a wildly inaccurate valuation, in some circumstances. The CE, which will be calculated by the trustees of each scheme in accordance with their own rules, is a calculation of the cash sum that the scheme will pay to discharge their obligation to pay income in retirement. The value of the pension benefits to the individual member may be very different, and it may cost far more to purchase equivalent benefits on the open market. This can be important in a divorce context, where using only CEs can produce unfair outcomes.

For example, a couple each age 40 where the self-employed husband has a Defined Contribution pension with a CE of £150,000 and the teacher wife has a final salary Defined Benefit pension with a CE of £150,000. On the face of it, the pensions are of equivalent value. In practice, the wife's teachers' pension will provide a guaranteed tax-free lump sum and guaranteed pension, plus a widowers' pension. If the husband were able to purchase equivalent benefits on the open market, the cost would be significantly higher than £150,000.

The PAG strongly recommends that suitably qualified experts should be instructed far more frequently to assist couples and the courts in valuing pension assets.

Offsetting

The Pension Advisory Group concludes that relatively few PSOs are made.

Instead, in the majority of cases, pension assets are dealt with by way of offsetting. In effect, one party's pension is traded for a greater share of non-pension assets.This is very frequently the situation in a "needs" case. Stereotypically, and very frequently, where there are young children, a non-working wife will retain the sale proceeds of the family home, to enable her to re-house without a mortgage. The husband will retain his pension and business assets and will use his mortgage capacity to re-house. In such a situation, it is unlikely the value of assets retained by the husband will come close to those retained by the wife. The value of his pension is of little relevance, and there is little need to focus on the value to be attributed to it for offset purposes.

There will be occasions, however, where pensions form a significant part of the family assets, where correct valuation of the pension for offset purposes will be key. In addition to the known difficulties with CE values, it will also be necessary to factor in the cost to the pension holder of extracting benefits. Other than the 25 per cent tax-free lump sum common to most pensions, funds drawn down from a pension will be subject to income tax at the recipient's marginal rate.

There is a longstanding debate as to whether offset values should be further discounted for "utility". In other words, whether a liquid asset is more valuable than a pension, which represents a future income stream.

The PAG is sceptical as to whether such a discount for utility is ever appropriate, while accepting it may on occasion be necessary as an encouragement to settlement. The PAG highlights concern in the industry that offsetting is often considered the default position, perhaps because parties, their lawyers or even judges are reluctant to grapple with issues of pension valuation. They point out that a failure properly to understand pension assets is the largest source of negligence claims against family lawyers. In some cases, pension sharing can be a helpful, and tax-efficient aid to settlement.

A party who is likely to reach their lifetime allowance (£1,055,000 in 2019/20) before retirement, can transfer all or part of their pension pot to a spouse as part of their divorce settlement, up to the spouse's lifetime allowance. The transferor then has the opportunity to re-build their pension pot, taking advantage of tax relief.

However, the recent reduction in the annual allowance will reduce the number of individuals for whom this is a viable option. Those considering this option need to be aware that the valuation used for calculating the Lifetime Allowance is not necessarily the same as the CE, particularly in the case of Defined Benefit schemes. The so-called "pension freedoms" have introduced an element of flexibility into the treatment of pensions on divorce.

In certain situations, it can be helpful for one party to be able to release capital (perhaps to help fund a property purchase), or to draw down funds from a pension to supplement income from employment of maintenance. However, there are potentially serious pitfalls for the unwary. For instance, it is all-too easy inadvertently to trigger the Money Purchase Annual Allowance (MPAA), thus reducing the amount that can be reinvested into a pension to a maximum of £4,000 per year.

The PAG once again emphasises the need for parties to seek professional advice before seeking to use pension sharing as part of an overall financial settlement.

Advice

The PAG repeatedly urges that parties seek specialist advice in relation to this complex area. Failure to do so can have very serious consequences. However, the PAG notes that there is no clear means of identifying who is qualified to give such advice. There are acknowledged experts in pensions on divorce, among them some actuaries, financial planners and independent financial advisers.

In the absence of a specific accreditation, the PAG suggests that a proposed expert should be asked to sign a statement of truth, in effect self-certifying that they have the requisite expertise, that they have systems in place for peer-review and handling complaints, and suitable insurance. The PAG report provides fascinating insight into the treatment of pensions on divorce, and highlights a significant number of issues requiring further consideration or reform. Twenty years after the introduction of pension sharing, it feels like a first step in dealing with many of the complex issues the legislation has thrown up.

Simon is a partner in our Family team.

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Estate Planning: Your Digital Footprint

• 26 February 2020
• News

This article looks at what happens to your digital assets after your death and considers any actions you can take to safeguard against any misdirection of assets, or loss of sentimentally or financially valuable materials. It will consider service providers’ responsibilities to users, and their likely approach to certain scenarios, as well as looking toward what the future may hold.

• Do you know what will happen to your cloud-stored photographs when you die?
• Have you considered how your executors will know if you have any crypto-currency?
• What can you do to make sure your information ends up in the right hands on your death?

What are digital assets?

There is much discussion of “digital assets” these days, but when it comes to inheritance, there is actually no statutory definition of the term. We tend to mean things held otherwise than in a tangible sense, including emails, photographs, and social media accounts. Like bank accounts, digital assets are often controlled by intermediaries. In the former case, this will be the bank; in the latter, an internet service provider (ISP).

When you die, your tangible assets (e.g. jewellery, cash, and cars) pass to your executors or administrators, and are distributed in accordance with your will (or the laws of intestacy). Where necessary, intermediaries will demand a death certificate or grant of probate, and then release the assets held by them. It is therefore unsurprising that many people presume that their cloud-stored photographs and other digital assets will pass to their spouse or children in the same way as a photo album might. Unfortunately, this is not always the case when ISPs are involved, and it is not always possible to ensure your loved ones are able to access your digital assets.

What’s the problem?

As far back as 2005, problems started to arise with the shift to digital storage of assets. Justin Ellsworth, a 20 year old marine was killed in combat. His father sought access to his e-mail account as it contained a pseudo-diary narrating his life, but Yahoo declared that it was contrary to the terms of service to release e-mails. It was not until his father obtained a court ruling in his favour, that Yahoo provided him with a CD of all e-mail documents.

Those digital assets were purely sentimental, as were the photos of her daughter and late husband that Rachel Thompson sought from Apple in 2015. So too were the photographs of Greek widower Nick Scandalios’s late husband. In all three of these cases, the ISPs demanded a court order before they would release the photographs.

The problem goes beyond the sentimental value of photos and e-mail content. It has previously been easy to ascertain the extent of a deceased’s assets by going through their papers. Today, someone may have numerous bank accounts or investments, the only evidence of which is in their Outlook folders (particularly when the asset in question is a crypto-currency). Additionally, for convenience an individual may hold company documents in cloud storage, which is then blocked on their death. This could have wide-ranging and worrying consequences, particularly in the case of family businesses.

Why are digital assets more tricky to deal with?

More traditional assets, such as cars or bank accounts, are dealt with under long-established laws put in place to effect the transfer of property after death. Part of the issue here is that such laws do not extend to all types of digital assets and new laws have not been introduced to fill the gap. ISPs have not yet had the time (nor the inclination) to streamline the process of accessing assets after death. Each ISP has a different procedure which must be followed, and different actions which must be taken before death (these are discussed below). It was not until 2018 that most high street banks signed up to the Death Notification Service allowing personal representatives to notify more than one financial institution at the same time of an individual’s death. Given this, and the relatively inchoate nature of the digital world, it is unsurprising that streamlined processes are not yet in place.

It is not just the practicalities of notification which make dealing with digital assets more cumbersome, but also the attitude of the intermediary. Banks will accept the will, death certificate, and grant of probate as adequate evidence of entitlement to the account, as will NS&I for Premium Bonds. In contrast, ISPs’ behaviour suggests that they may be willing only to accept a court order. However, practical considerations aside, there are two arguments raised by ISPs: privacy and contracts.

Privacy

For any number of reasons, a deceased individual may not have wanted his or her spouse (or other relatives) to have access to their emails. Yet while it is necessary to remain sensitive to the wishes of the deceased or the reactions of the beneficiaries, it is not for the intermediary or the executors to determine what is or is not suitable for beneficiaries to receive.

There are also potential data protection concerns for ISPs with regard to allowing access to email accounts, particularly in light of the Cambridge Analytica scandal and other similar breaches. However, the General Data Protection Regulation 2016/679 applies only to the data of living individuals, so it is not a valid argument with which to refuse access to data of a deceased person. In addition, the German Federal Supreme Court ruled last year that Facebook’s contractual obligations to maintain confidentiality did not conflict with an heir’s right to access. It ruled that confidentiality related to the account, rather than to the user personally. Facebook could, therefore, make the correspondence available to the user account (and consequently to the heirs) without breaching its confidentiality. It should be noted that this is a German ruling, and does not form a precedent in the UK.

Terms and Conditions

The terms and conditions of Apple’s iCloud provide that “Unless otherwise required by law, you agree that your Account is non-transferable and that any rights to your Apple ID or Content within your Account terminate upon your death. Upon receipt of a copy of a death certificate your Account may be terminated and all Content within your Account deleted.” Microsoft’s service agreement prevents a user from “transfer[ring] your Microsoft account credentials to another user or entity.” These provisions are not unique to those two ISPs. This results in a frequent contradiction between the terms and conditions governing the relationship between an ISP and a user during life, and the expectations of a user as to what will happen to their data on death, a conflict that can only be resolved by a Court.

The case of Scandalios, touched on above, is interesting. The US court ruled that electronic communications would pass to the heirs only through a legitimate will, and as there was no legitimate will, the surviving spouse would have no right to such communications. However, it also ruled that photographs were not “electronic communications”, and so could pass even without a will. Accordingly, the court compelled Apple to release the photographs to the widow. It is important to note that Scandalios is a US case and so of limited use in the United Kingdom. It does, however, act as a litmus test to show the direction of thinking in terms of digital assets.

So what can you do?

One suggestion made by many online will-writing software programmes is to write down your passwords in a list and give this to your executors. This is highly inadvisable, not least because of the practicalities of keeping this updated. It presents a real security risk, and executors are unlikely to want to take on this risk. Instead, it may be more secure to sign up to a “password manager”. These are heavily encrypted software programmes which allow you to store your passwords securely, and to gain access through a long and complex password. This master password may be written down and stored in a safe, or other safe place, perhaps with your will. Clearly this still carries with it an element of risk as your password is no longer known only to you, but it is significantly more secure than the first alternative.

In addition, until the government carries out a review on the operations of ISPs in relation to probate, users should follow the in-service recommendations from each ISP in order to streamline the process for your executors, and ensure that your chosen beneficiaries receive the information you want them to have.

If you read the terms and conditions of many ISPs, you will find that they promise nothing after your death. Twitter will “work with a person authorized to act on behalf of the user”. Apple states in its terms and conditions of service as mentioned above, that upon receipt of a death certificate “your Account may be terminated and all Content within your Account deleted”, and that “any rights to your Apple ID or Content with your Account terminate upon your death”.

As a slight sweetener to this hard-line approach, some ISPs have created their own post-death processes. Often, a user may nominate an individual who will have limited access to their data after their death. However, not all ISPs make such a provision, and many simply offer an email address for executors to contact, in the hope that they may be allowed to access the data of a deceased person.

To make things as easy as possible for your executors, you may wish to review your digital assets (email accounts, cloud storage, social media) and follow each ISP’s in-service provisions dealing with the situation following a user’s death. Where ISPs do not provide for access to data after death, it may be necessary to consider retaining hard copies of vital information.

What does the future hold?

As time passes, the problem is only going to get bigger. However, it does not seem to be a current priority for the government. As more and more of our daily personal and business lives move online, we lose a level of control over them, often without realising. Until the government introduces legislation to regulate the procedures of ISPs in respect of a user’s data following their death, it is for the individual and their legal advisers to ensure that suitable planning is undertaken.

Final thoughts

It is vitally important to perform a regular health-check of all your assets, digital and otherwise, to consider what you want to happen to them after your death, and seek advice if you are not sure. If you do not do this, your executors’ job becomes significantly more challenging. We recommend that you review your will regularly, and include in this a review of all your assets, both tangible and intangible.

We will report further as the law in this area develops. In the meantime, if you have any questions in relation to the issues raised in this article, please do not hesitate to get in touch with your usual Forsters contact.

Reform of IHT – All-Party Parliamentary Group proposal paper

• 17 February 2020
• News

The snappily titled All-Party Parliamentary Group for Inheritance and Intergenerational Fairness (APPG) has published a paper proposing a complete overhaul of the existing UK inheritance tax (IHT) rules.

The APPG is essentially a discussion forum, set up to address concerns relating to the complexity, and perceived unfairness of the current system. Such concerns were highlighted recently by the number and strength of feeling of responses to a review of IHT made in 2018 by the Office of Tax Simplification (OTS) which, the paper indicates, received more responses than any other OTS review.

Given the APPG’s remit, it is important to be aware that the proposals made in its paper should not be regarded as current UK Government policy, nor even necessarily as likely future policy. Nonetheless, those contributing to the paper included senior representatives from the major professional bodies in the UK in the area of trusts and estates and, as such, it is quite possible that some or all of their ideas may be picked up by the current or a future administration.

Summary of the principal proposals

The paper is radical in its proposals, the most significant of which are as follows:

Individuals

• To replace the current IHT regime with a tax on lifetime and death transfers of wealth, with very few reliefs and a low flat rate of tax. The paper suggests a rate between 10% and 20% (potentially, on death, the higher rate might apply to estates over £2 million). This would replace the existing rate of 20% on lifetime taxable transfers and 40% on death. The reference to “very few reliefs” effectively means that business property relief (BPR) and agricultural relief (APR) would be abolished. The spouse and charitable exemptions would remain.
• All transfers of wealth, in excess of an annual gift allowance, would be taxable. It would no longer be possible to make potentially exempt transfers (PETs), whereby a lifetime gift of any value may be made free of IHT provided the donor survives for 7 years following the gift (and the rate of IHT reduces progressively in the period between 3 and 7 years after the gift).
• An annual gift allowance, suggested to be £30,000, should replace all existing allowances. This allowance would not be capable of being carried forward to a later tax year, as is possible with the existing £3,000 annual exemption.
• In the case of lifetime gifts of cash, the donor would withhold 10% of the gift to pay the tax. For gifts of an illiquid asset, there would be an option to pay any tax in interest-bearing instalments over 10 years. For farms and businesses, instalments could be paid over the same period, but on an interest-free basis. This is intended to go some way towards mitigating the proposed loss of APR and BPR.
• The tax-free uplift on death for capital gains tax (CGT) purposes should be abolished. Instead, rather than assets passing to heirs at their market value on the date of death, they would pass on a no-gain, no-loss basis. The recipient would take the assets subject to any gain in value since the deceased acquired them, but any tax charge would be held over until the recipient disposed of them in the future. Hold over would also be available on the same basis for lifetime gifts of assets.
• The IHT nil rate band (NRB) in its present form should be replaced with a “death allowance”, which the paper suggests could also be set at the existing NRB value of £325,000, or a similar value. The paper assumes that this would continue to be transferable between spouses as it is now. The residential nil rate band would be abolished. This is generally regarded as excessively complex in its terms, and is relevant only to residential properties passing to direct descendants.
• Anti-avoidance rules, such as those applying to gifts where the donor retains a benefit in the gifted assets, would no longer be necessary as all gifts would be taxed. Such rules could be abolished, significantly simplifying the IHT legislation.

Trusts

• Gifts into trusts, whether life interest or discretionary in nature, should be taxed in the same way as gifts to individuals, i.e. at 10% (or 20% as applicable) once the donor had exceeded his or her annual £30,000 allowance.
• Discretionary trusts would pay an annual charge based on the value of the trust fund.
• In the case of interest in possession trusts, there would be a further tax charge on the life tenant’s death, as there would on the death of an individual in respect of his or her estate. Interestingly, this proposal reflects the rules that applied to life interest trusts before the last significant (and highly controversial) changes to the IHT legislation in 2006.
• Unless passing to a spouse or civil partner, all pension funds left at death would be taxed at the flat rate of 10%, or added to the estate and the excess taxed at 20% if the value was over £2 million.

Foreign domiciliaries

• An individual’s domicile should no longer be an issue for the purposes of IHT and, instead, residence should become the relevant factor.
• Those who have been UK resident for more than ten out of the last 15 years should pay tax on all subsequent lifetime gifts and transfers on death on a worldwide basis at 10% or 20%, as appropriate, in the same way as those UK residents who were born in the UK.
• Once foreign domiciliaries have been UK resident for more than ten of the previous 15 years, any discretionary trusts set up by them would be subject to the annual tax if any UK resident could benefit. The paper notes that consideration would need to be given to the application of an annual tax on the entire capital value of a trust in a situation where a UK resident only benefits on a discretionary basis and may not receive anything.

Reporting obligation

• For the purposes of obtaining more information about the extent of lifetime transfers taking place, the paper suggests that HMRC and HMT should be given greater powers to collect more meaningful data about transfers of property through compulsory electronic reporting of lifetime gifts over the current annual exemption of £3,000, even if they are not immediately taxable.

Discussion points

While the paper makes a number of detailed proposals for reforming IHT, as described above, it is essentially a discussion paper. The authors set out the background to the taxation of wealth in the UK and elsewhere, the reasons for its taxation and the widespread resentment that such taxation engenders, despite the fact that relatively few households are affected.

In addition to their proposed reforms of IHT, the authors also consider a number of alternative methods for taxing wealth, including an annual wealth tax, an expansion of the existing system for taxing capital gains and the alternative option of a capital accessions tax (CAT). A CAT (a version of which exists in Ireland among other jurisdictions) would be imposed on the donee of a gift or inheritance, rather than the donor or the estate of a deceased person, as is the case with IHT. The advantages and disadvantages of each taxation method are reviewed, and the authors recommend that, alongside their proposed IHT reforms, policymakers should consider carefully the option of a CAT, given its potential benefits.

Our view

The APPG’s proposals are interesting. In terms of simplifying the legislation, they have a number of points to recommend them. Not least, and as the paper recognises, they would make the role of the personal representative easier, as there would be no requirement to take into account lifetime gifts made by the deceased within seven, or sometimes 14, years of his or her death in calculating the estate’s liability to IHT.

Whether the proposals, if implemented, would achieve the desired object of improving the public’s perception of the fairness of the tax is a matter for debate. To the extent that people perceive IHT as a second tax on the same assets, retaining it but reducing the rate may be unlikely to change that view. The popularity of a proposal to remove reliefs and the opportunity to make PETs, even with the increase of the annual exemption to £30,000, may also be in doubt. Businesses and farms would be significantly impacted by the proposed removal of BPR and APR. The need to pay tax on death, even with a ten year interest-free period to do so, could affect the ability of some families to carry on trading or farming.

The suggestion that all lifetime gifts above a minimum value should be registrable raises significant issues in relation to privacy. Unless there is a liability to tax, it should be possible for people to manage their assets and transfer them to whomsoever they wish without having to report to HMRC.

With regard to foreign domiciled individuals and their families, the paper is clear that its intention is not to discourage foreign investment in the UK. Nevertheless, coming so soon after several years of constant changes to the taxation system for foreign domiciliaries and non-UK residents, if the proposals in this paper were to be taken up by this or a future Government, it would not be surprising if this was seen as yet another attack on them.

Clearly at this stage, the APPG’s paper is effectively a discussion document and, as such, there is no indication that the proposals will be taken forward at the forthcoming Budget on 11 March or at any future time. Nevertheless, the paper makes a number of thought-provoking suggestions and it will be interesting to see whether any of the group’s ideas appear in Government policy or lead to a consultation in the future.