Both the All-Party Parliamentary Group on Inheritance & Intergenerational Fairness and the Office of Tax Simplification have recommended inheritance tax (IHT) reform. With the feeling that reform is overdue, added to the need to raise funds to pay for coronavirus, the recent report on inheritance taxation in OECD member countries identifies possible radical changes which would allow the Treasury to simultaneously meet twin objectives of reducing inequality while increasing tax revenues.
For most OECD countries the effective tax rate for larger estates is higher than that for smaller ones. This is however not the case in the UK or the US, where exemptions and tax planning mean that the very rich pay a lower effective rate than the merely wealthy. This seems counter-intuitive, and it is. Only 4 per cent of estates in the UK are subject to IHT, contributing a mere 0.7 per cent of total tax revenue. The report proposes that a key aim of IHT reform should be to discourage wealth concentration within a small group of people and increase equality. If this is the case the current UK IHT system is failing.
The report suggests that a tax on recipients rather than estates could be more effective, as it would encourage wealth being gifted more widely, improving equality. Moreover, the current tax-free IHT allowance, which effectively renews every seven years, allows the very rich and those with easily transferrable assets to make substantial tax-free gifts over several years. A lifetime IHT allowance would provide a more equal system.
A number of assets receive preferential treatment for IHT. Many of these – such as family businesses and pensions – make sound practical sense, but some need to be reviewed to see whether they are fit for purpose. Each exemption restricts the tax base and reduces returns, so it must be underpinned by a sound policy justification.
Of course, the reform of IHT would be complex and challenging. If the political will is there the system could raise more tax and achieve a fairer society. The problem is that IHT planning is often part of a long-term strategy, so people who have arranged their assets and wills based on the current system may find the changes a headache. In particular, those finding that their existing arrangements no longer reduce tax, or possibly even increase it, would expect transitional help. As the report observes, inheritance tax is not a silver bullet.
Politically, changing people’s long-term expectations will be challenging. Whatever is done to IHT there will inevitably be winners and losers. It is vital that the government considers all the options, rather than just adding more complexities to the existing structure. It will be interesting to see whether the Autumn Statement will bring the radical changes to personal taxation that we have not seen so far.