IHT abolition – what happens next?
03 October 2023
We’ve all seen the stories about inheritance tax (IHT) being dubbed ‘Britain’s most hated tax’, despite the fact that according to statistics published by HMRC in July 2023, only 3.73% of estates actually paid IHT in 2020/21. This apparent widespread animosity may be due to the fact that IHT taxes everything on death, including wealth that has already been subject to tax as it arose. Income that has suffered 45% tax on receipt and loses a further 40% on death suffers an effective 67% tax rate overall.
Abolition would therefore appear to be politically attractive, but there are complications. One obvious point is that in 2020/21, IHT raised £5.76bn in tax, and we estimate it will generate close to £8bn in this financial year. If IHT is abolished, this tax will either be lost or require replacement.
IHT has a big impact on capital gains tax (CGT) as well. Currently, assets are revalued for CGT purposes on death, so that the recipient gets them at their probate value. If there is no IHT, presumably there would be no CGT revaluation either, and in that case, IHT charges will simply be replaced by a CGT charge instead. When you die, all of your assets pass to somebody else, so there is a disposal of everything by your estate. With no rebasing on death, a CGT charge will arise on the market value of all of these assets (although your family home may ordinarily be exempt).
This could create some distinct issues that taxpayers may not appreciate.
All taxpayers benefit from a ‘nil rate band’ for IHT, worth £325,000 each. This can be increased by a further £175,000 in relation to residential property in many cases, and for couples who are married or civil partners, this will exempt up to £1m of value from IHT. By contrast, CGT exemptions will be limited to £3,000 a year from 6 April 2024. An estate comprising a house worth £300,000 and shares worth £200,000 would pay no IHT, but would be subject to CGT, so the effect will be to increase the number of estates subject to tax charges on death very substantially.
In many cases, IHT already creates a ‘dry’ tax charge, where the estate of the deceased includes assets that the family want to retain (such as a house) but no cash to pay the tax. It is possible in some cases to spread the cost of IHT payments over a period of up to ten years, and a similar approach would probably be necessary for CGT. This could feel very much like an annual wealth tax for many families, who could find themselves having to pay tax on inherited assets over a long period.
A solution would be for assets to be inherited at their original cost, ‘holding over’ any growth in value. This sounds straightforward but could be a nightmare in practice. How will you identify how much uncle Ernest paid for his stamp collection? CGT has rules allowing for assets held in 1982 to be rebased, but where it is not possible to show when the assets were acquired or how much was paid for them, CGT could be payable on their full value on disposal, with no deductions.
To avoid this, CGT rebasing on death could be retained, but that would make a big dent in tax receipts, as it would encourage assets to be held to death and then sold tax-free by the estate.
Abolishing IHT sounds like a crowd-pleaser, but it could easily have the opposite effect to the one intended. Instead of removing a tax burden on death, abolition could actually spread it wider, capturing more estates and creating liabilities for families who would currently never be affected. IHT may be today’s ‘most hated tax’, but it could easily be replaced with an alternative that’s even less popular.
Abolition would therefore appear to be politically attractive, but there are complications. One obvious point is that in 2020/21, IHT raised £5.76bn in tax, and we estimate it will generate close to £8bn in this financial year. If IHT is abolished, this tax will either be lost or require replacement.
IHT has a big impact on capital gains tax (CGT) as well. Currently, assets are revalued for CGT purposes on death, so that the recipient gets them at their probate value. If there is no IHT, presumably there would be no CGT revaluation either, and in that case, IHT charges will simply be replaced by a CGT charge instead. When you die, all of your assets pass to somebody else, so there is a disposal of everything by your estate. With no rebasing on death, a CGT charge will arise on the market value of all of these assets (although your family home may ordinarily be exempt).
This could create some distinct issues that taxpayers may not appreciate.
All taxpayers benefit from a ‘nil rate band’ for IHT, worth £325,000 each. This can be increased by a further £175,000 in relation to residential property in many cases, and for couples who are married or civil partners, this will exempt up to £1m of value from IHT. By contrast, CGT exemptions will be limited to £3,000 a year from 6 April 2024. An estate comprising a house worth £300,000 and shares worth £200,000 would pay no IHT, but would be subject to CGT, so the effect will be to increase the number of estates subject to tax charges on death very substantially.
In many cases, IHT already creates a ‘dry’ tax charge, where the estate of the deceased includes assets that the family want to retain (such as a house) but no cash to pay the tax. It is possible in some cases to spread the cost of IHT payments over a period of up to ten years, and a similar approach would probably be necessary for CGT. This could feel very much like an annual wealth tax for many families, who could find themselves having to pay tax on inherited assets over a long period.
A solution would be for assets to be inherited at their original cost, ‘holding over’ any growth in value. This sounds straightforward but could be a nightmare in practice. How will you identify how much uncle Ernest paid for his stamp collection? CGT has rules allowing for assets held in 1982 to be rebased, but where it is not possible to show when the assets were acquired or how much was paid for them, CGT could be payable on their full value on disposal, with no deductions.
To avoid this, CGT rebasing on death could be retained, but that would make a big dent in tax receipts, as it would encourage assets to be held to death and then sold tax-free by the estate.
Abolishing IHT sounds like a crowd-pleaser, but it could easily have the opposite effect to the one intended. Instead of removing a tax burden on death, abolition could actually spread it wider, capturing more estates and creating liabilities for families who would currently never be affected. IHT may be today’s ‘most hated tax’, but it could easily be replaced with an alternative that’s even less popular.
