Inheritance Tax (IHT) is a part of the UK tax system which creates a great deal of debate. For many it’s long been seen as an unfair penalty – set at an eye-watering flat rate of 40% on all worldwide assets. Yet a swathe of the wealthy have been able to structure their finances to avoid it, creating justifiable concerns for those who have been forced to pay huge sums. But with huge post-Covid debts, and a new report on how IHT is applied in developed countries, the time may be ripe for change. Peter Webb, our Head of Tax Advisory, takes a look.
The UK has a peculiar approach to Inheritance Tax including a very high flat rate, together with a number of unusual allowances. With the cost of the pandemic continuing to climb, IHT is a likely area of scrutiny for the government. The need to generate revenue to help begin to pay off enormous debts mean taxes offer a ‘quick win’, and unsurprisingly, many experts think IHT will be a core area of focus in the coming months.
Recently the OECD – the international organisation working towards a set of universal standards across its members – published a report on Inheritance Tax. Although the OECD doesn’t have any direct ability to change UK legislation, its advice matters to the UK government and points to how attitudes and trends may change across its members. The report noted some of the UK’s very unique ways of dealing with IHT including special exemptions for landowners and farmers, and applying tax on those leaving their estates rather than taxing beneficiaries.
The OECD’s recommendations included reshaping IHT systems to help raise tax revenue and increase equality. One of the report’s key findings was how the pandemic had impacted equality, noting that it “has affected different demographic groups differently, may exacerbate difficulties for some households and increase the divide between older asset-owning households and younger households.” Clearly this is an area which many governments, including the UK’s, may be considering. As well as raising revenue, increasing taxes can also drive desired behaviours and help address inequality.
Is the UK’s Inheritance Tax system really that different from other counties?
The UK is one of 24 countries in the OECD to tax wealth transfers and inheritance, and one of just three which tax the deceased rather than the recipients. The remaining 12 – including Australia, Canada, Israel, and New Zealand – don’t use this type of system at all.
The UK is also in the minority of just seven countries when it comes to IHT rates – employing a flat rate approach. And at 40% it’s the joint highest rate in the OECD, in line with US rates. Other countries opt for progressive rates. In Belgium, for example, the rate rises in line with the inheritance value, up to a maximum of 80%. Other distinctions for those using flat rates use the relationship between the donor and beneficiary to determine the tax rate – in Italy rates range from 4% for close family to 8% for other recipients, and in Denmark the rates range from 15% to 36.25% respectively.
Interestingly most OECD countries have a system which automatically entitles certain family members, usually spouses and children, to a share of the estate. The UK generally differs here too enabling those leaving their estate with the ultimate decision about to whom they wish to pass it on to, although there are obligations to provide for a spouse. It’s also worth remembering that an unfair Will can always be challenged.
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The future for Inheritance Tax
The OECD research found those in richer households were more likely to have received an inheritance, and this trend is set to continue. As property prices rise, the values of inheritances are increasing too. Yet, the flip side is that younger generations may struggle to get on the property ladder, which may impact inheritances in the future. As a result, the recommendations are clear that taxing the recipients of an estate is fairer than taxing those who are passing on wealth to their intended beneficiaries. But this goes against a deep-rooted cultural belief in the UK borne from attitudes towards landed property – the general feeling is that those with wealth want to pass it on with as little tax as possible. Yet it’s certainly a fairer approach to pay tax on an inheritance when you receive it than when you gift it. Even so, there’s unlikely to be much traction in the UK for such a change – it is not certain that IHT revenues will be increased by any changes, and they are unlikely to gain much public or political support.
Taxing lifetime gifts
The UK’s tax system includes an exemption on wealth which is given away during your lifetime. This “potentially exempt transfer” or seven-year rule means that generally no tax is due on any assets given away as long as you live for at least seven years afterwards. For those with substantial assets, the opportunity to gift away portions during their lifetime can help circumnavigate IHT very effectively. The OECD report singled out the UK here, suggesting instead a “lifetime wealth transfer tax” or a lifetime allowance for receiving wealth tax-free, with tax charged once the threshold was reached. Interestingly this approach has already been suggested in the UK both by the Office of Tax Simplification (OTS) and by MPs on an all-party parliamentary group on inheritance and intergenerational fairness.
Will the OECD recommendations play out in law?
Many experts think the recommendations on taxing heirs or changing lifetime gifts are unlikely to be considered seriously in the UK. What does seem more likely is a focus on reducing exemptions. As well as the OECD, the OTS also identified two main IHT reliefs — for business and agricultural assets — which primarily help only the wealthiest households. Any proposed changes here will of course cause significant concern from those who would be affected, but it’s clear than some kind of reform is needed – both from an economic and equality perspective. The effects of the pandemic will create change much sooner than perhaps would have been expected, but it’s yet to be seen which direction the UK government will take.
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