The 2023 Autumn Statement – a missed opportunity for Inheritance Tax reform?

What is Inheritance tax?

Inheritance Tax is a tax on the estate (property, money and possessions) of someone who has died. If the value of the estate is below the tax-free threshold, (the “nil rate band”, currently £325,000), then there will normally be no tax to pay; and this is also the case if anything above the threshold is left to a spouse, civil partner or charity.

For this reason, only a relatively small number of estates will pay inheritance tax (IHT) and IHT revenues are consequently quite low, coming in at around £7 billion (or just 0.3% of GDP) per year. However, an Office of Tax Simplification (OTS) survey of nearly 3,000 people in the UK revealed that 26% of respondents believed that 20% or more of people would pay IHT, compared to the reality of under 5%.

This misconception aside, the nil rate band has been frozen since 2009 (and extended at this rate to 2028), which coupled with higher property prices means more estates are in fact likely to be liable to IHT in the future.

Irrespective of the low numbers of estates subject to the tax, IHT is often reported to be “Britain’s most hated tax”. A 2015 YouGov poll found that only 22% of respondents believed inheritance tax was “fair” and it was the least popular among the eleven major taxes featured in the survey.

The government is clearly aware that there are serious issues around IHT and have been looking at its simplification and reform for some time. So what reforms might be in order and why has the government not introduced them in the latest budget plans?

What Inheritance Tax reforms could have been introduced?

One suggestion for reform has been to replace the current tax regime with a simpler, lower flat rate gift tax that would be payable on both lifetime and death transfers. Other proposals would see an end to reliefs such as those on agricultural and business property, there would be no reduced rate on the estate where more than 10% is given away to charity (as is currently the case), and the seven-year rule around potentially exempt transfers and chargeable transfer would also be abolished.

Finally, there are suggestions that the relatively new Residential Nil Rate Band (a hugely complex relief applicable to qualifying residences left directly to certain categories of relatives which was introduced in 2017) should be abandoned altogether.

A new, low flat-rate tax and the streamlining of lifetime gifting and IHT would not only make the tax regime simpler and fairer, but could also help bring the UK into line with tax regimes in other countries. The UK is unusual in applying flat rates to inheritance taxes with most countries that levy this form of tax applying progressive rates, where the tax rate rises with the value of the inheritance. Nearly all countries with progressive tax rates apply different rates (and tax-free allowances) depending upon the proximity of the relationship between donor and beneficiary. Progressive rates for spouses and children are lower and vary less widely than the higher rates that usually apply to other family and non-related persons. In addition, most countries that impose inheritance taxes also have a gift tax on lifetime transfers, again typically levied on the beneficiary.

What are the arguments against doing away with IHT altogether?

A number of countries that previously taxed their citizens on inheritances and gifts have taken this step and one of the reasons given for abolishing this form of tax in those countries is that they have found the revenue inheritance tax generated was not significant enough. On average only 0.51% of total tax revenues are sourced from these taxes in countries that still levy them.

It is not surprising then, that in response to a recent international “Questionnaire on Inheritance, Estate and Gift Taxes” (prepared by the Organisation for Economic Co-operation and Development), the most common rationale cited by countries for continuing to impose an inheritance tax was not revenue-generation, but social justice: the redistribution of wealth and a wish to increase equality of opportunity and to tax unearned windfalls.

The suggested lower flat rate of tax would address this by seeking to maintain the revenue stream, but in a way that is generally fairer than the current IHT regime.

Changing the way inheritance tax is charged will not in itself be sufficient to level things up, as by the time inheritances are received, wealth inequality is already substantial. The Institute for Fiscal Studies advise that in the age bracket 50–54, the children of the wealthiest one-fifth of UK parents will have an average of £830,000 in wealth, with the parents bequeathing around £380,000 per child; whereas children of the least wealthy one-fifth will have average wealth of around £180,000 and the parents will bequeath less than £2,000 per child. More needs to be done at governmental level to make an impact on intergenerational wealth mobility, but IHT reform may be a good starting place.