What does a world without UK inheritance tax look like?

05 August 2023

The abolition of inheritance tax (IHT) would certainly make for an eye-catching manifesto pledge ahead of the next general election. The political merits of such a move would no doubt be the subject of much debate, but let’s imagine a scenario in which IHT is actually scrapped. What are the potential repercussions of such a move?

In terms of the number of estates impacted, the most recent statistics from HMRC indicate around 23,000 deaths resulted in an IHT charge, just under 4% of the total UK deaths, in the year to 31 March 2020. So clearly the scrapping of IHT would benefit those families affected but the impact of the IHT rules go much further than that.

IHT can distort taxpayer behaviour in different ways. One might assume that IHT encourages individuals to make gifts earlier in life so as to mitigate its impact. That is not always the case. In particular, it can have the reverse effect where an individual owns business or agricultural assets which qualify for relief from IHT.  

Take, for example, an elderly shareholder in a family company who is no longer involved in the day-to-day operations. Ordinarily, it might make commercial sense for the shares to be gifted to another member of the family to incentivise them to continue running the business. However, the current IHT rules can encourage individuals to hold on to their shares in the business until death, when under current legislation the shares may qualify for full relief from IHT and any capital gains associated with the shares are effectively wiped out. There have been calls for changes to the tax rules to stop this distortion of behaviour and the scrapping of IHT ought to have this impact. Capital gains on inherited assets would likely pass to the beneficiary receiving them instead.  

The scrapping of IHT could also spark a revival in the use of family trusts and mark the decline of other structures, such as family investment companies. The use of trusts has declined substantially since 2006. Changes were made to the IHT rules which meant trusts were often limited as to how much could be settled without incurring an upfront IHT liability at a rate of up to 20%. Trusts can play an important role in allowing family members to pass assets and wealth to the next generation, whilst retaining some control over the assets gifted during their lifetime. With no concerns over IHT costs, trusts could see an upturn in their fortunes.

We could also see more inward investment into UK assets. Overseas individuals can be subject to IHT on any UK situs assets, even if they are not resident or domiciled in the UK, and that could represent a barrier for some. However, not all overseas investment into the UK is necessarily welcomed by the government. That has been demonstrated by various tax policies that have been introduced to make acquiring UK residential property more costly for overseas investors. 

Finally, it would be interesting to see what impact the scrapping of IHT would have on pensions. The lack of an IHT charge on pension pots acts as a tax incentive for some individuals to save more into pension funds where possible. So removing IHT on other assets could act as a disincentive to tying up funds long term in this way. Alternatively, you could see individuals sceptical about whether the abolition of IHT would stand the test of time and, with no lifetime allowance, looking to maximise their pension pot while they can.

Whilst the primary beneficiaries of an abolition of IHT may be homeowners in London and the South East, it’s clear the consequences of such a move would be much more wide-ranging.