Inheritance tax (IHT) has often been voted one of the UK's most disliked taxes, despite the fact it’s only paid on the deaths of around 4 per cent of the population. Many regard it as outdated and unfair because it is applied to money that has already been taxed at a time when families are most vulnerable.
It’s no surprise then, that the £6.1bn receipts from IHT between April 2021 and March 2022 hit the headlines last week, as this was a 14 per cent rise on the previous year and more than double death duty receipts a decade ago. This is partly because the level beyond which IHT is paid has been stuck at £325,000 since 2009. To rub salt in the wound, the government has said that this threshold will be frozen until 2026 at the earliest – despite elevated inflation – leading to the Office for Budget Responsibility forecasting that annual IHT receipts will hit £7.6bn by 2026.
Inequality in the UK has been creeping up in recent years and redistribution is important for social mobility. But the problem with the UK’s current IHT set-up is that the super rich can escape much of the burden by making gifts, and taking advantage of some special exemptions on businesses and land. According to research by the Organisation for Economic Cooperation and Development (OECD), the effective IHT rate is just 10 per cent of the fortunes of the deceased with £10mn or more in the UK, compared with 17 per cent of those with an estate value between £1mn and £2mn.
Looking to other countries provides clues on how the system could be made fairer. To start, a progressive tax might help – an approach taken by two thirds of OECD countries. The range across them is big, with Chile’s rate starting at 1 per cent and Belgium hitting a top rate of 80 per cent, but the rate paid is typically linked to how much money you have and how closely related you are to the deceased.
The OECD found that the effective tax rate (ETR) for most countries is lower at the bottom end of wealth distribution. But it singles out the UK and US, which levy a flat rate of IHT, as the two countries where ETRs decline on the largest estates. The UK and US along with Denmark are also the only members of the rich countries’ club to tax the estate of deceased donors rather than recipients, with the OECD favouring the latter as a way to “promote equality of opportunity”. A crackdown on assets that benefit from tax relief would also be likely to narrow the gap, as would tightening up on lifetime gifts – currently excluded from IHT in the UK if the donor lives at least seven years after making the gift.
In practice though, significant reform does not seem imminent as changes would not be sufficiently lucrative to be worth the political hassle. So acquaint yourself with the nuances of the UK regime to help lower your potential IHT bill. But make sure you read the small print. The Telegraph reported that almost 2,000 families have had to pay back £600mn over the past five years after being found to be in breach of the so-called “gift with reservation of benefit” laws. Examples include parents gifting houses to children and not paying market rents for continuing to live there.
