What’s in store for Inheritance tax?

Paul Davies, specialist in inheritance tax (IHT) mitigation, considers the future of IHT.

Inheritance tax has been in the spotlight recently with suggestions that the Conservative Party may include its abolition in their General Election manifesto, although despite rumours to the contrary no mention of IHT was made in the Autumn Statement. To add to the noise around this unpopular tax the Institute of Fiscal Studies (IFS) published a report in September with its proposals on reforming IHT.

The facts and figures

The IFS forecast that the percentage of estates paying IHT will grow to over 7% by 2032/33. In comparison to other tax revenues the receipts from IHT are small but the IFS’s prediction is that they will more than double to over £15 billion by 2032/33. If the government decided to abolish IHT tomorrow the cost would be in the region of £7 billion with half of the benefit accruing to those individuals with estates of £2.1 million, the top 1% of estates.

The IFS’s recommendations

Instead of abolition, the IFS puts forward the following proposals:

1. The Residence Nil Rate Band (currently £175,000) for each individual should be abolished and replaced with an increased nil rate band of £500,000 so that those who benefitted in full from the Residence Nil Rate Band (RNRB) will be in a IHT neutral position. The increased nil rate band would be subject to taper by 50 pence for each £1 of wealth between £2 million and £2.35 million. This is a change that many advisers had hoped might come out of the 2018 review of IHT by the Office of Tax Simplification but did not materialise. The RNRB is complicated and discriminates against those with taxable estates who do not have children or have never owned a home.
2. The IFS also suggests that Business Property Relief should be capped at £500,000 per person, a big reduction on the current potential 100% relief with no ceiling. If this were to be implemented, passing business property in excess of this value during lifetime to the younger generation would be a more popular estate planning strategy. The use of freezer shares to limit the value owned by older family members would in these circumstances perhaps also merit consideration.
3. Agricultural Property Relief should, in the IFS’s view, also be capped. Both the BPR and APR proposed caps are recommended for reform due to the high cost of these reliefs, costing in excess of £1 billion in “lost” IHT on death.
4. Pensions: pensions are currently a useful IHT saving vehicle with assets subject to a pension generally passing to the children IHT free. In addition, if a pension holder dies before the age of 75 any withdrawals thereafter are free from income tax. The IFS suggests that 80% of pension pots should be brought within the IHT net and all withdrawals should be subject to income tax.
5. Finally, the IFS proposes that both the normal expenditure out of income exemption and taper relief on the IHT due on lifetime gifts should be abolished. The abolition of the normal expenditure exemption would remove a useful IHT planning tool for those with high income which if started early enough can remove significant sums from an estate with no requirement to survive for seven years.

The IFS calculate that if all the above proposals were implemented this could fund an increase in the nil rate band to £525,000 or a reduction in the rate of IHT from 40% to around 25%.

Other possibilities

These range from the abolition of IHT to a move to a system used in some other countries where it is the recipient of a lifetime gift or inheritance who is liable to tax. It is also suggested that IHT could be replaced by capital gains tax on death bringing all unrealised gains on assets into charge at that point.