How would you mend inheritance tax?
HM Treasury hopes to simplify inheritance tax, but Donald Drysdale notes that root and branch reform of the tax is being advocated by some observers.
A bad tax
Inheritance Tax (IHT) has all the hallmarks of a bad tax. It must have Adam Smith turning in his grave.
IHT raises only modest revenues, contributing a meagre 77p to every £100 of taxes raised UK-wide. It also applies at a very low effective rate – currently yielding some 3.5% of all inheritances and gifts.
For taxpayers with substantial means, IHT is largely voluntary because it can be so easily circumvented through legitimate use of reliefs and exemptions. However, it falls unfairly on those who die with only moderate wealth.
For ordinary taxpayers, IHT is difficult to understand. Even the differing exemptions for gifts are hard to deal with – especially the rules for normal expenditure out of income. Changes in recent years – such as the transferable nil rate band, the residence nil rate band and the reduced rate for those making significant charitable bequests – have added further complexity.
The tax is actually payable by a relatively small proportion of deceased’s estates – around 4% at the last count. However, in lifetime it causes a much higher percentage of taxpayers to worry excessively about its possible imposition, especially in regions where property prices are high. It leads many of these people to incur significant professional fees on estate planning – perhaps an opportunity for accountants, lawyers and valuers, but not a good thing for society as a whole.
For those who would like to see IHT achieve partisan political ends, it patently fails to “squeeze the rich until the pips squeak” (as former Chancellor Denis Healey wanted to do) since it has so many let-out clauses. It also fails to redistribute wealth effectively, because it is levied on each deceased’s estate and offers no immediate incentive to bequeath wealth to multiple beneficiaries.
How might IHT be changed?
Views on the future of IHT vary widely. Some would like to see it abolished completely, arguing that it targets wealth that was already taxed when it was created, discourages the future creation of wealth, and fails to contribute significantly to the public finances.
Others argue that IHT exemptions and reliefs should be restricted, and the tax rate on death increased.
Between these two extremes, suggestions are put forward from time to time that IHT should be replaced by a ‘pure’ inheritance tax. This would not tax the deceased’s estate on what they had gifted or left behind on death. Instead, it would tax each individual on the cumulative value they receive as gifts and inheritances during lifetime, after allowing a specified exemption.
Many such proposals have been made over the years. To pick just one example, a report ‘Passing On: Options for reforming inheritance taxation’ was published earlier this month by the non-partisan Resolution Foundation.
‘Passing On’ advocates that IHT be replaced by a ‘lifetime receipts tax’ levied on each beneficiary on cumulative gifts and inheritances exceeding £125,000. Cumulative transfers up to £500,000 would be taxed at 20%, and above that at 30%. All lifetime gifts would be taxed, except those of £3,000 or less and transfers between spouses.
Ominously, the report suggests that reliefs such as business property relief and agricultural property relief, the treatment of inherited pensions and the “forgiveness” of capital gains tax on death should all be “tightened” to reduce the scope for tax avoidance. I suspect that such tightening might threaten the continuance of many businesses, and dramatically increase the number of taxpayers who would be losers from the introduction of such a tax.
Surprisingly, the Resolution Foundation believes that moving from IHT to their new lifetime receipts tax would not present too many transitional problems. On a more realistic note it suggests that the new tax would be more prone to avoidance that IHT, and in today’s climate I suspect that this might make it a non-starter.
HM Treasury has asked the Office of Tax Simplification (OTS) to carry out a review of a range of aspects of IHT and how it functions today, including its economic incidence, to identify simplification opportunities. To inform this review, the OTS has published a call for evidence, inviting input by 8 June 2018.
The review will look at existing IHT return and payment procedures, including those that apply where it is clear from the outset that there will be no tax to pay. It will examine the various gift exemptions, looking at how they interact with each other and the wider IHT framework.
The OTS will consider other administrative and practical issues around routine estate planning, compliance and disclosure, including relevant aspects of confirmation or probate procedures.
If you advise clients on IHT, you may be able to provide valuable input on the complexities arising from reliefs and exemptions, and their interaction with the wider tax framework. You may have observations on the scale and impact that IHT can have in distorting your clients’ affairs – for example, their decisions, investments, asset prices or the timing of transactions, use of trusts, or interactions with other taxes such as capital gains tax.
We can expect the OTS to adhere fairly closely to its key remit, which is simplification rather than wider reform. However, its findings will be considered by the Chancellor and his Treasury team, who might be tempted to make more far-reaching changes. Tax specialists with an interest in the future shape of IHT should not miss this opportunity to make their views known.
How to respond
With the call for evidence, the OTS has issued an online survey designed to obtain input from ordinary taxpayers rather than professional advisers. It asks about their awareness of the IHT death rate and nil rate band. It asks whether they have used various exemptions for gifts, and the extent to which their business and investment decisions have been affected by IHT reliefs – e.g. for business property, agricultural property and AIM shares.
Practitioners with experience of IHT are likely to want to go beyond the confines of the online survey.
ICAS will be responding to the call for evidence, and ICAS members, affiliates and students with views they’d like to contribute should email these to email@example.com no later than 28 May.
Article supplied by Taxing Words Ltd