Inheritance Tax (IHT) has been in the financial press a fair amount recently. Everyone agrees that it is no longer fit for purpose and needs to be reformed, but the key question is how. Whilst it is likely to remain a tax for the wealthy minority, that is about the only thing that the various strands of the debate agree on.
Keir Starmer and his army marched into Downing Street a couple of months ago with a raft of proposals on tax, but during the election Rachel Reeves ruled out both a new wealth tax and a mansion tax. Our new Chancellor was uncharacteristically silent on the two existing wealth taxes: inheritance tax and capital gains tax (CGT). Both these taxes are extremely inefficient, with IHT affecting fewer than 4% of estates and raising a mere 0.7% of the UK’s tax revenues.
I touched on this subject 4 weeks ago in my Blog: “How do you fill a black hole?”, but the debate has moved on apace since with various bodies issuing reports on the subject. These include the Institute for Fiscal Studies, Office of Tax Simplification, the All-Party Parliamentary Group for Inheritance & Intergenerational Fairness and think tank Demos and they’ve all recommended changes to IHT.
The main thrust of the reports is that IHT is broken and needs fundamental reform, ideally leading to a situation where more estates (or beneficiaries) pay IHT, with a consequential rise in tax revenues. This is both financially and politically expedient for Labour, as it needs to increase tax revenues and satisfy the party’s rank and file who almost to a man or woman, believe the ideological mantra, first coined by Denis Healey, of ‘tax the rich till the pips squeak’.
Is IHT a wealth tax or an estate duty?
Despite its name, the UK’s inheritance tax is actually an estate duty, and the UK is only one of four OECD members that does this, along with the USA, Denmark and Korea. Every other country in the OECD taxes the beneficiaries instead of the estate, many incorporating a gift tax during lifetime of the donor.
Death tax rates are generally higher than for lifetime gifts and most countries aggregate over a set period, e.g., in Germany there is a gift threshold per person which aggregates over a 10-year period and then renews, unless death occurs within that 10-year period, in which case the gift is added into the death tax.
Taxing lifetime gifts would clearly accelerate the tax take, as you don’t need to wait for the taxpayer to die in order to collect. While this might be attractive to the government, there are serious concerns about administration and collection. Can we really expect UK taxpayers to declare all lifetime gifts, never mind the practical problems of just how would HMRC police it?
The rate of IHT Tax and its reliefs
The UK is only one of a handful of countries to impose a flat rate of tax (40%), with every other country using progressive rates. For instance, France has many marginal rates (from 5% to 60%) which depend on both the amount given and the relationship of the beneficiary to the donor.
In the UK business property relief and agricultural property relief can reduce the value of a business or agricultural assets being passed during the lifetime of the donor or on his/her death by up to 100%. The IFS and Demos reports suggest promoting the abolition of these two reliefs, or at least restricting the amount to say £500k.
None of the various reports seem to have considered the harm that abolishing or reducing these reliefs could be caused to family-owned businesses or farms if they have to pay the full rate of IHT. The point of this relief was to prevent the break-up of businesses to pay large IHT bills and the government needs to bear this in mind.
Points for the Chancellor to consider
The UK could easily transition to the European model of IHT, with the tax paid by the beneficiaries, with progressive tax rates that are dependent on both the relationship to the donor and the amount received. It is also important to appreciate that in the European model, thresholds start very low and rise gradually. This results in the amount of IHT raised in these countries around double what the UK raises and far more people end up paying it.
Equally, a tax on lifetime gifts could be introduced, but the intrusion and administration involved would have significant costs attached and probably be seen as “un-British”. Furthermore, you would need to address the interaction with Capital Gains Tax and re-introduce a general gift relief for CGT.
The simple fact is that whatever you do with IHT, it will need to remain a tax for the wealthy minority as any attempt to widen its reach to encompass “ordinary” taxpayers would be very unpopular. Furthermore, if business reliefs are curtailed this could lead to adverse impacts on family-owned businesses and farms. The new government should therefore think carefully before leaping into a new inheritance tax regime.
Accountant’s view
The pressure for reform is very strong, possibly irresistible, so It is therefore likely we will see some proposals for reform, perhaps as soon as the Budget on 30 October, but I don’t expect significant changes.
Finally, there is some good news, if we can call it that, as not a single one of the various reports published recently have suggested the removal of the exemptions for spouses or charities.
