What next for inheritance tax (IHT)?
If the British press is to be believed, the Conservative Party is actively considering the abolition of UK inheritance tax (IHT).
On the basis it is ‘the most hated tax in Britain’, they are said to be planning to reduce the current 40% IHT rate in the Budget in the spring of 2024 with a view to abolishing the tax entirely in due course.
By contrast the Labour party, supporting ‘iron-clad fiscal rules’, is reported to be looking at expanding the scope of IHT by removing valuable exemptions that currently apply to certain types of property.
The rumours that persisted over the summer about IHT produced a lot of attention-grabbing headlines, as they were plainly designed to do, but did not in fact translate into any specific pledges during the autumn party conferences. This may not be surprising given that we are heading towards a general election (which could be as early as May next year), and the Chancellor of the Exchequer and Shadow Chancellor will want to play their cards close to their chests. More detail may (or may not) emerge in each party’s manifesto.
Arguments for IHT reform, with specific proposals for change, have recently been made in one of the chapters of the ‘Green Budget’ for 2023. This is a report, published annually by the Institute of Fiscal Studies (IFS), that evaluates the state of the UK economy and is intended to provoke discussion about fiscal policy. It is interesting that the IFS chose to include an examination of IHT (despite the very modest contribution to total UK tax revenue), and the in-depth, objective analysis serves as a useful platform for debate.
Some of the key findings on IHT are:
- Inherited wealth is growing. For those born in the 1980s the value of inheritances will equate to roughly a third of their lifetime income.
- Only around 4% of deaths in 2020 / 21 resulted in IHT but this is predicted to rise to over 7% by 2032 / 33. To hold the average at 4%, the nil rate band (currently £325,000) would need to rise to £380,000 and this would cost the Exchequer about £900 million. The cost would reach £2.7 billion by 2032 / 33.
- IHT raises about £7 billion per year (0.3% of GDP) and this is the current cost of abolishing it. By 2032 / 33 it is thought that IHT receipts will be just over £15 billion as a result of increasing wealth.
- The design of IHT is faulty in that agricultural (APR) and business property (BPR) reliefs and the exemption that applies to pensions provide an opportunity to avoid IHT and distort economic decisions. If APR and BPR were abolished, and pensions were taxed to IHT, potentially around £1.5 billion could be added to tax receipts.
- The residence nil rate band of £175,000 applying to property passing to direct descendants provides a greater benefit to those living in London and the South of England where property prices are higher. Removing it and extending the nil rate band from £325,000 to £500,000 would cost about £700 million per year and would hold down the proportion of deaths triggering IHT to around 4% (see 2 above).
- IHT as currently designed has only a small impact on the distribution of wealth and would need to be expanded considerably if it were to have a larger impact on intergenerational wealth mobility, i.e. a change in the wealth status of family members between generations.
- It is recommended that the exemption applying to gifts that come within normal expenditure of income should be removed, and also the taper relief that restricts the IHT charge to a percentage of the full rate if the gift is made more than three years from the death.
- As regards the interaction of capital gains tax and IHT on death, the recommendation is that the uplift in the base cost of assets should be removed.
The Green Budget is the latest in a number of reports on possible IHT reform published in recent years, none of which has to date resulted in any significant changes, and it remains to be seen whether any of the IFS proposals will be adopted by whichever party finds itself in government in 2024.