For a tax that makes up less than 1% of total tax and impacts on only 4% of estates, inheritance tax (IHT) receives a lot of attention – not to mention a lot of dislike from the general public. Research carried out by the Fabian Society in 2015 ranked IHT as the least popular form of taxation compared with 11 major taxes.
The three reasons given for this were: it is negatively perceived as a tax on the dead and as double taxation on those who have earned and saved their wealth; the rate of 40% is seen as excessive; and it is seen as a voluntary tax which the wealthy and welladvised can easily avoid.
In addition, the amounts of IHT receipts are not keeping pace with the amount of wealth being bequeathed/ gifted. According to the Exchequer, between 2006/07 and 2022/23, IHT receipts are forecast to grow less than a quarter as fast as inheritances. The total amount of wealth bequeathed/gifted in 2015/16 was £127bn and this figure is estimated to double by 2035. It is also worth mentioning that only £5bn of IHT was raised in 2015/16 – equating to an effective rate of just 4%.
Finally, IHT has the largest tax gap of all taxes. HMRC monitors the amount of tax it expects to receive against the amount it actually collects. The shortfall for IHT is 11.5% but the average among all taxes is 5.7% – officially making IHT the leakiest of all taxes.
Given all these facts, it may come as little surprise that the chancellor of the Exchequer wrote to the Office of Tax Simplification (OTS) in January 2018 asking it to review IHT. And, in April 2018, the OTS duly published a call for evidence.
On examination of the questions it asked, it was clear nothing appeared to be safe from change. The OTS was overwhelmed by the number of responses it received. Normally it would expect between 250 and 350 responses but, in this instance, there were a whopping 3,600. To give proper consideration to all the points raised, the OTS decided to split its response over two separate papers.
The first was issued in November 2018 and headed Overview of the tax and dealing with administration, which focused on ways of simplifying the administration of IHT. The mere fact that, on average, 570,000 individuals die per year in the UK – while, in 2015/16, a mammoth 275,000 estates had to complete IHT forms yet fewer than 25,000 estates actually paid IHT – emphasises the need to significantly simplify the process and reduce the amount of paperwork required.
The second paper, meanwhile, will look at the technical aspects of the tax and that will be of more interest to advisers and may lead to radical changes in how the transfer of wealth is taxed.
Now, my track record on predictions of possible changes to tax legislation is pitiful so I tend to try and avoid making them. Tucked away, however, in economic thinktank Resolution Foundation’s Intergenerational Commission Report published in May 2018 were recommendations for radical reform of our IHT system. These recommendations were also given support by the Institute for Public Policy Research’s Commission on Economic Justice, giving the proposed changes very sharp teeth indeed.
The key recommendation is that the current IHT regime be scrapped and there is a move to a lifetime receipts-based tax assessed on the recipient. Similar receipts-based schemes are in operation in France and Ireland, so it is not a new concept. The view here is such a change would deliver both practical and perceptual benefits and, not surprisingly, also increase tax receipts.
How would it work?
Individuals would have to keep track of cumulative receipts – although gifts of £3,000 or less per donor per year; gifts between spouses and civil partners; and gifts to charities would be excluded. The cumulative gift allowance would initially be £125,000 received tax-free, with the allowance being indexed in line with inflation.
A basic rate of 20% would apply on gifts received between £125,000 and £500,000 with a top rate of 30% applying thereafter. The estimate is that such a change would generate £11bn annually, compared with the forecast of £6bn under the current system.
If that came to pass, it would be farewell to both the seven-year cumulative gifting rule and the normal expenditure out of income exemption, thus removing many of the tax-planning opportunities currently available.
Business relief and agricultural relief, which currently cost the Treasury £1.22bn, would also come under the cosh and be better targeted to remove any predominantly tax-driven motivation for owning the assets.
The suggestions here are to cap the relief, increase the minimum ownership period and limit the relief to ‘real’ farmers and business owners. The trust tax regime, which is perhaps the most complex, would meanwhile be redesigned to reflect the lifetime receipts rules.
What is more – if none of that appears to be enough – the Resolution Foundation also recommends the tax-free treatment of pension funds inherited on death of the member before 75 be removed and, in addition to being subject to the new regime, also be liable to income tax. Finally, it suggests also applying capital gains tax on death – though principal private residence relief would still apply.
It may be that only some or even none of these recommendations are taken up. It does however give us an indication that the days of referring to IHT as a ‘voluntary tax’, on the basis that, with careful planning, an individual’s liability may be reduced or even wiped out, may be numbered.
One thing that can be said is that the time may have come for action from individuals who have held off making gifts for IHT-planning purposes. This is definitely a case of better the devil you know …
Neil MacGillivray is head of technical support at James Hay