Capital taxes on death could increase beyond 50% in Labour’s Budget

With the summer recess for parliament seemingly scheduled for 30 July 2024, Rachel Reeves looks likely to present the Treasury’s assessment of the government’s ‘spending inheritance’ early next week. The tone being set by Treasury ministers appears to be that the state of the country’s finances is much worse than was anticipated. The fact UK public sector borrowing figures for June came in higher than anticipated could be used as further evidence of the challenges ahead for the new chancellor.

Whilst many options for potential tax rises were ruled out by Labour in their manifesto, there is still the opportunity for the new team at the Treasury to review the capital gains tax (CGT) and inheritance tax (IHT) rules. A starting point may be to look at some of the suggestions previously made by the now-disbanded Office of Tax Simplification (OTS).

The OTS report in November 2020 on CGT has already provided some inspiration for Rachel Reeves’ immediate predecessor Jeremy Hunt when he was searching for additional revenues to balance the government’s books. It recommended that the CGT annual exemption could be reduced and it has since been cut from £12,300 to £3,000.

One further recommendation which could be under consideration is the ‘capital gains rebasing’ on death. At the moment, there is no CGT charged on assets held by someone when they pass away. IHT may be due but for CGT purposes, the person inheriting an asset is treated as if they acquired that asset at its market value on the date of death. In effect, any capital gains or losses on assets held up to the date of death are wiped out. 

This tax rule ensures that there is not a dual hit of both IHT and CGT on assets held by someone on their death. This rule can however act as a disincentive for making gifts of assets during someone’s lifetime. A lifetime gift could trigger a CGT liability and then if the gift is not survived by seven years, a further IHT liability could arise to the estate. Some might prefer to hang onto assets, knowing that a CGT exposure is reduced to nil on their death rather than suffer the risk of two layers of tax. 

Amongst its recommendations, the OTS suggested that the government should consider removing the CGT ‘death uplift’ entirely. It did not go as far as to suggest that CGT and IHT should be payable immediately on death, but rather that the CGT liability could be inherited. Others, such as Arun Advani and David Sturrock in their work for the Institute of Fiscal Studies last year have outlined alternative approaches that go further. 

Instead of someone effectively passing on their gains with the inherited asset, their death could be treated as a disposal of the asset and potentially trigger a CGT liability. The net value of the estate’s assets after CGT could then be subject to IHT.

If this was introduced, someone owning a rental property with a net value and capital gains of £100,000 at the time of their death could trigger a CGT liability of up to £24,000, ie a 24% CGT liability. The remaining £76,000 might then be subject to IHT at a rate of up to 40%, giving rise to a further tax liability of up to £30,400. Taken together the potential total of the two taxes would amount to £54,400 and an effective tax rate of up to 54.4% at death on such an asset.

By comparison, a similar example using unlisted shares, instead of residential property, could potentially give rise to a total effective tax rate on death of 52%. 

A change like this could prove tempting to the chancellor as it could raise much-needed funds for spending plans. Given the complexity of the rules, it is unlikely to be as well understood as a simple change in tax rates and might appear a safer political path to tread. It would undoubtedly result in more families having to consider tax on a loved one’s death and could result in more assets having to be sold to fund the associated tax liability, rather than the asset itself being inherited.