Everybody will eventually die, and in doing so every deceased adult will have to part company with their worldly assets. In England and Wales, these assets fall under the purview of the inheritance tax (IHT). Just as a General Election looms on the horizon, a struggling UK government is wooing potential voters to improve its chances of survival. It has thus set in its sights on the IHT, one of the reportedly most disliked of all taxes, to attract much sought-after votes.
Death duties, an alternative name for inheritance tax, were first imposed in England in 1796 to fund military action during the Napoleonic Wars. These death duties came to include legacy duties, succession duties, and estate duties. Estate Duty, the forerunner to today’s Inheritance Tax (IHT), was introduced in 1894 and was the first substantive tax on the capital value of land. Estate Duty was replaced by Capital Transfer Tax in 1975. The current tax regime, introduced in 1986, is guided by the Inheritance Tax Act 1984, which runs to a mere 272 Sections.
IHT is a redistributive tax, designed to supposedly transfer wealth from the well-off to the more deserving, thereby encouraging social mobility through intergenerational wealth redistribution and preventing the perpetuation of inherited wealth. It is also a progressive tax, being extracted on a sliding scale rather than at a flat rate. Even though IHT ultimately applies only to a relatively small number of people, many more appear to be concerned about the likelihood of being taxed unfairly.
IHT is considered a form of double taxation, which taxes assets that have already been legally acquired through a taxed income. But house-price inflation has pulled increasing numbers of not-so-wealthy people above the IHT threshold by passively- acquired, unearned wealth. IHT receipts continue to rise as this growth in property wealth far outstrips the existing financial assets of prudent people of relatively modest means who desire financial security for their children and grandchildren but feel compromised by the existing tax regime. At the same time, many available exemptions, including placing their assets within a trust, allow the wealthiest to reduce their tax liabilities while keeping on the right side of the law.
IHT is paid by the beneficiaries rather than by the estate of the deceased. The administrative process of valuing an estate, paying IHT, and distributing the residual assets to beneficiaries is referred to as probate. It is the responsibility of the executor of the deceased person’s Will, or the appointed estate manager in the absence of a Will, to ensure that the amount payable in taxes is calculated accurately and paid in full, within six months of the person’s death.
IHT is levied in England and Wales on the net value of all assets in an individual’s estate on the day of death, which is obtained after deducting any liabilities (debts-loans, mortgages, overdrafts, credit card expenditure-and funeral expenses), exemptions, and reliefs. Assets include money, property, savings, investments, and possessions such as jewellery, paintings, and antiques. Pension pots are exempt from IHT. It is worth noting that, for most people, the family home is their most valuable non-pension asset.
IHT does not have to be paid if the value of the estate is below £325,000, which is referred to as the nil rate band. This threshold was set in 2009 and most recently extended to 2028 by the Chancellor of the Exchequer in his Autumn Statement of November 2023. The threshold was increased in certain circumstances by £175,000 to £500,000- the residence nil rate band-from April 2017 onward, when all UK property became subject to IHT. This covers situations where the deceased person’s home is given away to their children or grandchildren and was meant to reduce the likelihood of having to sell an inherited family property to pay for IHT. For an estate worth £2 million or more, the additional £175,000 is reduced by £1 for every £2 of the estate’s value in excess of £2 million. Married couples, or those in a civil partnership, but not those unmarried and cohabiting, can add to each other’s unused IHT allowance when they die, to a maximum of £1 million.
The standard IHT rate is 40 per cent, which is charged only on the value of the estate that falls above the threshold. This is reduced to 36 per cent if 10 per cent or more of the estate is left to charity in the deceased’s Will. Fewer than 4 per cent of all estates were eligible to pay IHT during 2020-2021. Apart from estates that are valued at under £325,000, IHT does not apply to transfers between married spouses or civil partners, to agricultural property relief or business property relief, and to gifts made during one’s lifetime to most UK- registered charities or to political parties with at least one MP. IHT liabilities can be reduced by distributing one’s wealth among family and friends, by making gifts to charity, or by investing in a life assurance policy which is then placed in trust. A total of £3,000 of gifts can be dispensed, ever since 1981, during each financial year as part of an annual tax-free gift exemption. All of this tax avoidance activity is best supported by reliable financial and legal advice.
While the Government has the power to adjust bands, rates, and exemptions of IHT to benefit more of the nation’s citizens, it would seem that their focus on abolishing IHT is largely of symbolic value. The takings from IHT amounted to £7.1 billion between April 2022 and March 2023 and are projected to reach £7.2 billion in 2023-2024, which equates to just 0.3 per cent of national income. Those most disadvantaged by the demands of the IHT are a select group of residential property owners in London and the Southeast of England, who have gained the most from rampant house-price inflation.
As it is, the IHT does not appear to efficiently redistribute wealth, nor effectively target those most capable of carrying the burden of raised taxes, and not even make a major contribution to the Treasury’s coffers. Just like much of England’s tax complex and convoluted system, it demands reform through simplification and by closing the many existing loopholes for better returns. Either way, the wholesale abolition of IHT is likely to have little measurable impact on the economy as a whole and can be considered as best a political gimmick, pandering to somewhat ill-informed opinions and perceptions among the general public with respect to the British economy.
Ashis Banerjee