House of Commons - Public Accounts

Select Committee on Public Accounts Twenty-Ninth Report

1 Securing the right amount of tax on time

1. The estate of a person who has died may be liable to Inheritance Tax.[3] Bequests to spouses[4] and charities are exempt, as are some heritage assets if certain preservation and public access conditions are met. Reliefs are also available for many agricultural and business assets. The tax is charged at 40% of the value of other assets, above a nil-rate band (£263,000 in 2004-05[5]). To obtain 'probate' and be able to administer an estate and distribute its assets, the representatives of an estate must first submit an Inheritance Tax return and pay any tax due. In 2003-04, 30,000 estates were liable for Inheritance Tax. The Revenue collected £2.5 billion during that year, around 1% of the Revenue's net tax receipts.[6]

2. The number of estates liable to the tax has grown in recent years, reflecting the rising value of assets in estates, particularly of houses and especially of those in London (Figure 1). House prices have grown more quickly than the tax threshold. Around 30,000 estates were liable to Inheritance Tax in 2003-04, or one in twenty estates, compared with fewer than one in thirty in 1999.[7] The Revenue estimates that 32,000 estates were liable for the tax in 2004-05, and that 37,000 will be in 2005-06.[8]Figure 1: A comparison of trends in the Inheritance Tax threshold and average house prices

Source: C&AG's Report, Fig 11; Office of the Deputy Prime Minister housing market data (Tables 505 and 506 for December 2004)

Note: Data from before 1990 is annual. Data from 1990 is quarterly.

Compliance investigations and the 'tax gap'

3. Following risk assessment and the resolution of minor queries, most tax returns require little or no further action by the Revenue. It launched detailed enquiries into some 3,600 cases in 2003-04, around 5% of the returns it received. These enquiries resulted in increases in the net taxable value of estates of £513 million, and additional tax of £126 million. The additional yield from the Revenue's enquiries increased by 32% between 1998-99 and 2003-04, but remained at around 5% of the growing tax revenue.[9]

4. The Revenue cannot give a firm estimate of how much tax is lost through the non-declaration or undervaluation of assets in estates, because it does not have a measure of the Inheritance Tax 'tax gap', the difference between the theoretical tax payable and the actual amount collected. In 2002 the United States Internal Revenue Service assessed the tax gap for its Estate Tax. By analysing a sample of cases it estimated the tax gap from under-declared or under-valued assets to be around 13% of tax receipts. In response to the C&AG's Report, the Revenue is now committed to estimating the tax gap, drawing on the US experience. It has recently started a similar exercise to examine a random sample of 100 cases.[10]

5. To strengthen its compliance work on Inheritance Tax returns, the Revenue has made greater use of information held by different parts of its organisation. This information has helped it to improve the way it has identified cases with undeclared gifts which the Committee identified as a risk area in 1999. In response to the Committee's recommendation the Revenue conducted a special exercise and refined its guidance on risk indicators. It also examines data held on the Income Tax return database and by the Complex Personal Returns section (who deal with highincome individuals) to look for changes in income that might suggest that gifts have been made. Its investigations yielded £14 million of additional tax on gifts in 2003-04 compared with £10 million in 1999. In addition, a Revenue examination of the use of offshore trusts has secured an additional £11.3 million in Inheritance Tax since April 2003, with another £7.5 million in train. The Revenue has undertaken little analysis of data it holds on the composition of estates, however, to highlight estates with unusual mixes of assets and to target them for enquiry.[11]

Artificial avoidance

6. Part of the Inheritance Tax 'gap' arises from the use of artificial tax avoidance schemes. There are various steps people take to organise their financial affairs to reduce their Inheritance Tax liability. There is a wide spectrum ranging from straightforward measures which take advantage of the various reliefs and allowances available, to more complex artificial avoidance schemes. The Revenue does not issue general information or advice on the acceptability of tax avoidance measures but responds to individual enquiries. Where people approach the Revenue for guidance on measures that clearly fall within the law, it confirms their legitimacy. However, where people are seeking to define precisely the boundaries between legitimate tax planning and artificial avoidance schemes, the Revenue does not give a definitive view, not least because it may wish to take action in due course to tackle such artificial schemes. People cannot therefore be certain whether they have legitimately reduced the tax liability of their estate and that a marketed avoidance scheme will not give rise to a tax liability when they die.[12]

7. The Revenue monitors potentially abusive avoidance schemes in tax returns and sometimes challenges them through litigation. The Revenue has also sought changes in the tax legislation to close loopholes. For example, the 2004 Finance Act tackled 'gifts with reservation' schemes by introducing an income tax charge on the notional benefits that continued to be derived from gifted assets. The Act also introduced new disclosure rules requiring notification to the Revenue of some types of avoidance schemes when they are marketed, but so far the regulations do not apply to Inheritance Tax schemes.[13]

Penalties, prosecutions and directions

8. The Revenue has a range of sanctions at its disposal to penalise negligence and fraud and to discourage representatives from submitting inaccurate or incomplete information in Inheritance Tax returns. In 1999 the Committee recommended that the Revenue should take a firmer line in penalising representatives for non-compliance and in using new powers in the 1999 Finance Act to obtain the information it required to progress cases. The Act also increased penalties for negligence and fraud. After an initial rise, however, the Revenue has applied fewer penalties for negligence in recent years, and in 2003-04 applied them in only 100 cases. The Revenue has recently secured its first successful prosecution for Inheritance Tax fraud, and other cases are currently under investigation.[14]

9. The Revenue attributes the level of sanctions to several factors. These include the inherent difficulties in establishing culpability when representatives are trying to deal with the financial affairs of someone who has died, as well as the deterrent effect of publicising and operating a penalty regime which professional representatives perceive to be tougher. The Revenue has discretion to abate the maximum available penalty according to the gravity and nature of the offence, including whether errors have been voluntarily disclosed and the extent of cooperation from the representative. It used abatements to give an incentive for representatives to disclose voluntarily errors which the Revenue might not otherwise discover, and to encourage full and swift resolution of cases which have had inaccurate returns. In practice, the level of penalties awarded has been well below the maximum available even in cases where the Revenue discovered the negligence. In 2003-04 the penalties the Revenue imposed in cases where representatives voluntarily disclosed errors were on average 5% of the maximum available, and the average penalty it imposed in cases where it discovered the negligence itself was 12% of the maximum available (Figure 2).[15]Figure 2: Percentage of the maximum available penalty applied in negligence cases, in 2003-04

Source: C&AG's Report, para 2.16; Ev 11-12

Caseload management

10. In 1999 the Committee recommended that the Revenue should settle cases more quickly, and in particular the longer outstanding cases. In 2003-04, it settled 90% of cases within 12 months, compared to 82% within 15 months in 1999. This improvement has been achieved with a similar level of staffing and during a period in which the overall Inheritance Tax caseload has grown by over 60%. The Revenue has also made progress in reducing the backlog of long-outstanding cases, more than halving the number over ten years old. Nevertheless in June 2004 there were still nearly 900 cases over three years old and 83 over ten years old.[16]

11. The Revenue seeks to strike a balance between settling cases quickly and securing the right tax yield. Some cases can be delayed by disagreement or uncertainty over the assets to be included in an estate, or their valuation, or while the Revenue obtains the information it requires. Since 1999 the Revenue has used its new powers of direction to require information on 82 occasions, securing better co-operation in virtually all of these cases. The threat of issuing directions has also made it easier to progress other cases. The Revenue confirmed that the oldest cases have taken a long time to settle because of their complexity, with litigation or third parties typically involved. It was however considering setting a tougher benchmark of settling all cases within two years rather than three years.[17]

3 Inheritance Tax is also charged on certain gifts, and on assets held in discretionary trusts. Back

4 The 2005 Budget proposed measures that would enable the Revenue to confer on same-sex 'civil partners' the same tax treatment as spouses, from December 2005. Back

5 The 2005 Budget proposed an increase in the nil-rate threshold to £275,000 for 2005-06. Back

6 C&AG's Report, Executive Summary paras 1, 11. Budget 2005, Financial Statement and Budget Report, Table C8 Back

7 C&AG's Report, Inheritance Tax: a progress report (HC 251, Session 1998-99), para 1.1 Back

8 C&AG's Report, Executive Summary para 1, para 1.1; Q 96; Inland Revenue Budget 2005 press notice PN2, 16 March 2005 Back

9 C&AG's Report, paras 2.2-2.4 Back

10 ibid, paras 2.20, 2.23; Qq 2-3, 65 Back

11 C&AG's Report, Executive Summary para 6, paras 2.2, 2.8-2.9, Figure 8, Appendix 2; Qq 49, 67-68, 97 Back

12 C&AG's Report, paras 2.17-2.18; Q 5 Back

13 C&AG's Report, paras 2.18-2.19 Back

14 C&AG's Report, para 2.11, Figure 13; Qq 7-8, 11, 60 Back