Inheritance TaxMar 10 2020

Simplify inheritance tax this Budget

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by
comment-speech

Inheritance tax (IHT) is one the UK’s most unpopular taxes.

A YouGov poll once found it was rated the least ‘fair’ personal tax, compared to the other levies we pay for things like stamp duty, national Insurance, income tax and tobacco duties.

It penalises our desire to bequeath wealth to our offspring, and opponents also criticise it as a form of double taxation, arguing that once the state has taken a slice in the form of income tax, personal choice should dictate who inherits your wealth.

Governments are generally not inclined to make more people pay such an unpopular levy.

A simpler, flat rate approach to IHT might pass muster

Indeed, although guilty of suspect implementation, the government sought to extend exemption from IHT in 2017 through the Residence Nil Rate Band.

In recent weeks, however, the All Party Parliamentary Group on Inheritance and Intergenerational Fairness proposed an overhaul of the system.

Its aim is not to reduce the impact of IHT, but instead to make taxes on wealth transfer harder to avoid.

The report noted that IHT is often referred to as ‘voluntary’ because of the reliefs and exemptions that exist.

According to the APPG’s findings, the wealthier the family, the easier it is to make use of gifting to mitigate IHT.

It says the largest estates pay on average 10 per cent in death duties, while those with more modest wealth pay an average of 20 per cent.

And it says the system can be most punishing for middle class homeowners, who have the majority of their wealth tied up in their primary home which cannot be readily gifted.

The report says it would be fairer to apply a flat rate tax of between 10 per cent to 20 per cent on any money and assets gifted during someone’s lifetime, with the same rate of tax applicable to their estate on death.

The only exemptions would be a £30,000 annual allowance for gifts and a £325,000 death allowance, with no tax payable under these thresholds.

The APPG argues there are a number of advantages associated with the proposal, several of which could appeal to the Chancellor and his advisers.

By flattening the headline rate of IHT to just 10 per cent, the policy could alleviate concerns among mass affluent homeowners that decades spent paying off the mortgage will be punished with a 40 per cent tax rate on death.

The changes could also be badged as a tax simplification measure, which is popular with voters.

IHT itself is in fact very simple: a flat rate tax of 40 per cent above an inflation-linked threshold.

However, the high headline level rate has led the Treasury to gradually introduce multiple avenues through which individuals can gain relief.

The end result is that people view estate planning as an overwhelmingly complex exercise.

A flat 10 per cent tax on all gifts and inheritance would almost certainly feel simpler to the layman, even if, in reality, most people with concerns about death taxes would still need professional advice.

Lastly, the report notes that one of the complaints about IHT is the perception that ‘the rich get away with not paying it’.

It argues that by abolishing the complex web of exemptions and putting in place a simpler system that ensures more estates pay at least some IHT, the measures could  positioned as a progressive, re-distributive reform. 

That could appeal to a government that is under pressure to demonstrate it is seeking to address economic imbalance.

HM Treasury has already indicated a desire to reform IHT.

Under Theresa May’s Chancellor, Phillip Hammond, the government commissioned an Office for Tax Simplification review of IHT.

It found widespread dissatisfaction at the complexity of the system.

A simpler, flat rate approach might pass muster.

However, ministers know it is politically sensitive.

It is unpopular and can produce an emotive response, which makes it a risk to put IHT on the agenda at all.

Cutting the headline rate of IHT to 10 per cent could in fact attract opposition across the political spectrum.

With a less punitive headline rate of IHT and fewer reliefs, the report reckons it would reduce the incentives and opportunities to plan around the tax.

But that could agitate both those expecting to mitigate IHT under the current regime, as well as others that see cutting the IHT rate to 10 per cent as a gift to wealthy households.

There is also a catch-22 in the APPG’s plans.

Their proposals would minimise the tax advantages of lifetime gifting, implying that individuals would be more likely to hold assets till death.

Research has shown that inheritance is often passed on too late to be useful already – one estimate suggests the average age at which we inherit assets is 61 – and these plans would likely see intergenerational wealth transfer happening later in life.

That could be counter-productive if it reduces the supply of capital to younger generations, further inhibiting their chances of purchasing property and building savings.  

Finally, some will see the flat rate tax as regressive and might favour a tiered approach, with increasing tax rates applied on larger estates.

The aforementioned complexity and exemptions mean the effective rate of IHT paid today often does not correspond directly to wealth, but opponents would likely argue that larger inheritors could and should pay more than just 10p in the pound.

Rachael Griffin is tax and financial planning expert at Quilter