03 May 2023
A recent YouGov poll shows that inheritance tax (IHT) is increasingly perceived as a very unfair tax. In recent years, polling shows that around 50% of those surveyed think that IHT is either unfair or very unfair. However, over the last year, there has been a clear shift with the proportion of those polled who consider it to be very unfair moving from 20% in May 2022 to 24% in April 2023.
As the strength of negative feeling seemingly grows and the number of estates that need to pay IHT looks set to increase due to fiscal drag, it’s perhaps no surprise there are reports that changes to IHT may form part of tax reforms to be announced by the chancellor in the future. But what changes should be made?
Increasing the nil rate band
IHT is payable on the value of assets held in a person’s estate at their date of death which exceeds the nil rate band (NRB). The NRB is currently £325,000 per person and the rate of IHT is 40%. The value of the NRB has remained frozen at this level since 2009 and so could be described as a long-standing stealth tax. The residence nil rate band (RNRB) of £175,000 per person augments the main NRB for estates with a value of less £2 million, tapering down for estates with a value above this, and is available for property passed down within the family to direct descendants.
Increases in house prices have helped drive significant increases, with IHT receipts for the year to 31 March 2023 rising above £7bn for the first time. On the face of it, it might make sense to simply increase the RNRB so more family homes fall outside of the IHT net.
However, more is needed than just tinkering with the headline value of allowances. In particular, the RNRB rules are complex and much maligned by many who have had the unfortunate opportunity of dealing with them. Any changes to the RNRB should encompass more than just uplifting the band. In particular, the chancellor should consider if the scope of the RNRB should be widened, as it is presently not available where a taxpayer is not survived by any of their direct descendants. It will also be necessary to simplify the rules significantly if they are going to be well understood by taxpayers.
Reducing the rate of IHT
Whilst a cut in the rate of tax is often attractive politically as it is simple to understand, it seems likely that it would miss the mark for IHT. It isn’t so much the tax rate that many taxpayers take issue with but the principle itself. Many taxpayers resent having a slice of accumulated family wealth taken away that may have already been subject to income tax or capital gains tax in the past. It would also be regressive in that the very largest estates paying IHT would also benefit from a cut in the tax rate, rather than targeting any IHT advantage to smaller estates.
Abolish IHT entirely
A radical approach would be to scrap IHT altogether and replace it with something else, as it seems unlikely that the country’s books could take a £7bn hit. The All Party Parliamentary Group have previously suggested a gift tax as an alternative. Similarly, there are increasing calls in the US for a ‘billionaire tax’ but wealth taxes have been unsuccessful in many countries that have tried to introduce them. If IHT is completely abolished, a wealth tax may well prove to be popular with the majority of the surveyed population but the appearance of unfairness may persist depending on where the line is drawn.
The path of least resistance appears to be to simplify the nil rate bands and increase them substantially. However, the most interesting aspect of all of this may be the response of the opposition to such proposals, who are no doubt considering their own options.