Recently the current Chancellor of the Exchequer made a statement regarding inheritance tax, raising a question to its long term future and whether this deeply unpopular tax will be reformed or scrapped altogether. Sadly we will have to wait and see what he meant as the Budget, which was scheduled for 6 November was cancelled because of an impending general election. If the current government is not re-elected then we may never know if and what he was planning to announce.
Trying to predict the future of inheritance tax is therefore a little trickier now as not only do we have the thinking of the current government, but also of the opposition parties, and Labour has already made comments about reforming the current system. They have mooted a replacement based on a lifetime gift allowance of £125,000 for recipients of gifts made during the donor’s life and on the donor’s death. So for example, if a parent made gifts to a child during their lifetime and on death, anything over this amount would be taxable. Estimates claim that IHT receipts would rise to c£15bn each year.
This structure reminds me of the French system whereby recipients have an allowance that they can receive tax free from the deceased. These amounts vary depending on the relationship between the deceased and the beneficiary and a tiered rate of tax on excess gifts, again varying based on the relationship. So the deceased’s child has a larger allowance than say the deceased’s nephew or niece. This also means that the beneficiaries will pay the tax on potentially varying amounts, rather than our current system where the tax falls on the deceased’s estate.
The concept of inheritance tax can be traced back to Roman times but was introduced in the UK around the time of the French Revolution. The Romans used it as a revenue generating tool and the French used it as a way of redistributing wealth as they had noticed wealthy families were getting wealthier as the money passed on from generation to generation. It was felt necessary to interrupt this transfer of wealth and redistribute it to protect poorer families. I think it is fair to say that in the UK, whilst the principles may have been related to the French ideology, it is used for revenue generation.
Its current guise was introduced in 1984 and since then it has been tinkered and meddled with by successive governments and chancellors, going from something understandable to what we have today, a lumbering, over-complicated tool for the government.
The Government must be aware of the inefficiencies of the current IHT system as it asked the Office of National Statistics (ONS) to review it, commissioning two reports looking at both the reporting that is required and the actual functionality of the tax. Even the ONS steered clear of the latest over-complication – the Residence Nil Rate Band (RNRB).
The RNRB [sorry Ed., another acronym) allows the ability to pass on a residence with 0% IHT providing the deceased’s assets did not exceed a £2m threshold and it is going to direct descendants. This threshold, confusingly, uses a different calculation to that used to calculate inheritance tax.
Coupled with the standard nil rate band this will, from next April, allow a married couple to pass on £1m without any inheritance tax being payable to direct descendants or up to £650,000 to other beneficiaries. Despite this, receipts are still forecast to rise. The desire for people to own their own home and the buoyant buy-to-let market has led to a large amount of property wealth being held by individuals. As at the end of July the average property price in the UK was £232,710 with it being much more of a factor in the London and the South-East of England where the averages are £477,813 and £320,454 respectively.
With the growth in property values far exceeding the increase in wages over the long term, future generations may miss out on this valuable benefit. The RNRB could be simplified by just increasing the standard nil rate band, maybe not by £150,000 or £175,000 but by enough to reflect the impact on IHT receipts as a whole. Simpler and easier to understand.
Currently in the UK around 5% of deaths generate an IHT liability. This may not sound like a problem in itself but does highlight the fact that IHT only applies to wealthier individuals. IHT receipts represent a small proportion of the overall tax collected by HMRC and in 2018/19 this was over £5.3bn but compared to the total tax receipts for the year of £619bn, it represents just 0.87%.
This is not an insignificant amount and to put it into perspective if it takes £70,000 to train an NHS nurse then IHT alone could fund the training for over 76,500 nurses.
Those who work in financial services will know the much-quoted saying from Lord Jenkins about inheritance tax being a voluntary tax, and this, to a large extent, is true as there is so much that can be done to minimise or remove altogether, an IHT liability. So we currently have a tax which is unpopular but which, through planning, can be mitigated.
If the Government were to abolish IHT then it would need to generate the lost revenue from other sources. This would not need to be as much as £5.3bn because at present when someone dies and their assets pass on to an heir, there is no capital gains tax liability as IHT applies instead. With no inheritance tax then capital gains tax could apply and this would replace some of the lost revenue. The Government would have to find the balance and this could be as simple as a small tweak to income tax or VAT. If done correctly then it may be harder to mitigate and some individuals would have to pay more tax and would this be as fair as taxing those wealthier individuals I mentioned earlier? – maybe not.
Going back to the ONS report, its findings show, that in some areas, simplification can have a minimal impact to revenue generation but make it easier to understand. Where this is the case why would you not consider introducing these changes?
Abolishing inheritance tax could be a great headline-grabber for the first Budget of a new government but would it be just that - something to grab people’s attention or on reflection would a reformed IHT system provide opportunity for all individuals to plan and pay less tax, increasing the legacy they leave to their heirs?
Whatever a new government plans or announces, advisers are in a great position to engage clients and potential clients on the subject of tax planning.
Conversations with future generations are vital even though the younger generations may not have significant wealth or an IHT liability at present. Whatever the future of inheritance tax brings, if parents or grandparents plan on leaving a legacy to their children or grandchildren during lifetime or on death, then they could find this becoming an issue. Understanding the potential for this can mean these conversations are had now rather than at some point down the line when planning opportunities could be limited.
Neil Jones, Tax and Wealth Specialist, Canada Life