The time is right to simplify and reform inheritance tax
25 October 2022
Things have seemingly never moved quicker in the political arena, but it wasn’t that long ago that a treasury minister announced at the Conservative conference that the tax he would most like to see ‘eliminated’ was inheritance tax (IHT). Historically, IHT has not been a major player in terms of revenue generation for the treasury but its contribution to tax receipts has become increasingly important over the last 10 years.
This seems to have happened more by luck than design, with limited changes having been made to the IHT system over the last few decades. Given IHT’s increasing importance to treasury receipts, it seems only right that proper scrutiny and critical thought is applied to its rules.
Whilst some individuals may be able to manage their IHT exposure with advance planning, the average inheritance tax bill due from estates is increasing year-on-year, driven by a 40% tax cost on the inflationary growth in value of homes and assets. Latest figures show the average IHT paid by estates is £216,000 (per figures for the year to 31 March 2020). That average seems set to increase further, with record IHT receipts being recorded this year. In the first six months of the current financial year, IHT receipts are £3.5bn and could feasibly hit £7bn by the end of the year, comfortably higher than a 100% increase over the IHT receipts generated a decade ago.
What doesn’t seem to have shifted in recent years is that IHT remains one of the least popular taxes in the UK, with many people considering it to be overly complex and unfair. Latest statistics from YouGov’s tracker on the fairness of IHT suggests only 21% consider it to be a fair tax.
So, could we see changes to IHT on the horizon? Whilst any tax giveaways are unlikely in the short-term given recent events, the new chancellor is looking to present a longer-term vision in his Medium-Term Fiscal Plan statement on 31 October and consideration of the IHT regime should form part of those plans.
The chancellor has already indicated that any tax cuts are more likely to be targeted. Any reduction in the IHT burden on taxpayers is highly unlikely to involve cutting the headline rate of tax. Given the recent backlash to the proposed 45% income tax rate cut, such a move could provide more political ammunition to his opponents.
A more measured approach is likely to involve changes to which estates pay IHT. Under the current government’s plans, the thresholds at which estates are subject to IHT will remain frozen until 2026. The chancellor could therefore apply the hairdryer to the frozen ‘nil rate band’, which has remained at £325,000 since 2009, and take it out of cold storage.
Given the complexity of the rules relating to the associated ‘residence nil rate band’, a simplification of these rules would be welcomed by many. This could potentially be achieved by simply abolishing it and increasing the standard nil rate band. An increased nil rate band could still be tapered down for larger estates, as the current residence nil rate band does, so that it is more focused on smaller estates.
If the chancellor is looking for more inspiration then he could turn to an all-party parliamentary group’s (APPG) report on reforming IHT, published in 2020. While the report was well received by many, it since appears to have fallen off the agenda and it might be an appropriate time for the chancellor to dust it off.
If the chancellor is to be bold then, rather than reforming IHT and risk adding to the seemingly ever-increasing pages of legislation, he could announce a consultation on replacing it completely. An abolition of IHT seems unlikely to be politically feasible unless there is a suitable alternative that might also help to address what recent research is indicating to be a growing generational gap in wealth.
What could this look like? In IHT’s place, there could be a simpler transaction tax on the transfer of wealth. For example, with two main rates: a standard flat rate of 10% on the transfer of value above £500,000 on an individual’s death, and a reduced flat rate of 2.5% on the lifetime transfers of value above £30,000 per person each tax year. It would still be possible to apply surcharges on death for very large estates and still simplify matters for the larger majority of estates.
This type of approach could do away with the notion of the accumulation of lifetime gifts over a seven-year rolling period to set against nil rate bands, residential nil rate bands, potentially exempt transfers, taper relief, and all those often inconsequential reliefs such as the marriage allowance and £250 gift exemption.
There would need to be safeguards to protect against those looking to find potential loopholes in such a regime. A supplementary rate representing the difference in the tax rates for transfers during lifetime and those on death would likely need to be charged on transfers made within, say, one year of death to prevent ‘death bed planning’.
Whilst there may not be a magic bullet when it comes to IHT, there is merit in considering a complete overhaul rather than a reform of the current system. Looking ahead, the impact of inflation, increasing interest rates, and the cost-of-living crisis are only likely to widen the intergenerational wealth gap further. A more dramatic reform of the IHT regime could form part of the strategy to address this wider issue and encourage more gifting between generations.
This seems to have happened more by luck than design, with limited changes having been made to the IHT system over the last few decades. Given IHT’s increasing importance to treasury receipts, it seems only right that proper scrutiny and critical thought is applied to its rules.
Whilst some individuals may be able to manage their IHT exposure with advance planning, the average inheritance tax bill due from estates is increasing year-on-year, driven by a 40% tax cost on the inflationary growth in value of homes and assets. Latest figures show the average IHT paid by estates is £216,000 (per figures for the year to 31 March 2020). That average seems set to increase further, with record IHT receipts being recorded this year. In the first six months of the current financial year, IHT receipts are £3.5bn and could feasibly hit £7bn by the end of the year, comfortably higher than a 100% increase over the IHT receipts generated a decade ago.
What doesn’t seem to have shifted in recent years is that IHT remains one of the least popular taxes in the UK, with many people considering it to be overly complex and unfair. Latest statistics from YouGov’s tracker on the fairness of IHT suggests only 21% consider it to be a fair tax.
So, could we see changes to IHT on the horizon? Whilst any tax giveaways are unlikely in the short-term given recent events, the new chancellor is looking to present a longer-term vision in his Medium-Term Fiscal Plan statement on 31 October and consideration of the IHT regime should form part of those plans.
The chancellor has already indicated that any tax cuts are more likely to be targeted. Any reduction in the IHT burden on taxpayers is highly unlikely to involve cutting the headline rate of tax. Given the recent backlash to the proposed 45% income tax rate cut, such a move could provide more political ammunition to his opponents.
A more measured approach is likely to involve changes to which estates pay IHT. Under the current government’s plans, the thresholds at which estates are subject to IHT will remain frozen until 2026. The chancellor could therefore apply the hairdryer to the frozen ‘nil rate band’, which has remained at £325,000 since 2009, and take it out of cold storage.
Given the complexity of the rules relating to the associated ‘residence nil rate band’, a simplification of these rules would be welcomed by many. This could potentially be achieved by simply abolishing it and increasing the standard nil rate band. An increased nil rate band could still be tapered down for larger estates, as the current residence nil rate band does, so that it is more focused on smaller estates.
If the chancellor is looking for more inspiration then he could turn to an all-party parliamentary group’s (APPG) report on reforming IHT, published in 2020. While the report was well received by many, it since appears to have fallen off the agenda and it might be an appropriate time for the chancellor to dust it off.
If the chancellor is to be bold then, rather than reforming IHT and risk adding to the seemingly ever-increasing pages of legislation, he could announce a consultation on replacing it completely. An abolition of IHT seems unlikely to be politically feasible unless there is a suitable alternative that might also help to address what recent research is indicating to be a growing generational gap in wealth.
What could this look like? In IHT’s place, there could be a simpler transaction tax on the transfer of wealth. For example, with two main rates: a standard flat rate of 10% on the transfer of value above £500,000 on an individual’s death, and a reduced flat rate of 2.5% on the lifetime transfers of value above £30,000 per person each tax year. It would still be possible to apply surcharges on death for very large estates and still simplify matters for the larger majority of estates.
This type of approach could do away with the notion of the accumulation of lifetime gifts over a seven-year rolling period to set against nil rate bands, residential nil rate bands, potentially exempt transfers, taper relief, and all those often inconsequential reliefs such as the marriage allowance and £250 gift exemption.
There would need to be safeguards to protect against those looking to find potential loopholes in such a regime. A supplementary rate representing the difference in the tax rates for transfers during lifetime and those on death would likely need to be charged on transfers made within, say, one year of death to prevent ‘death bed planning’.
Whilst there may not be a magic bullet when it comes to IHT, there is merit in considering a complete overhaul rather than a reform of the current system. Looking ahead, the impact of inflation, increasing interest rates, and the cost-of-living crisis are only likely to widen the intergenerational wealth gap further. A more dramatic reform of the IHT regime could form part of the strategy to address this wider issue and encourage more gifting between generations.
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