Inheritance Tax: for or against?

TaxTalk - August 2023

read timeRead time: 17 mins

The Conservative Party are weighing up the option to do away with Inheritance Tax (IHT) before the next general election. Andrew McCready considers alternative strategies.

In recent months, The Telegraph has led a concerted campaign calling for the abolition of IHT. The campaign has garnered support from former cabinet ministers such as Jacob Rees-Mogg and Nadhim Zahawi. Even Liz Truss is on record saying that she was set to abolish IHT during her ill-fated premiership.

How is IHT applied?

IHT was introduced in 1986 to replace the capital transfer tax. Although championed by the then Chancellor Nigel Lawson as a tax simplification measure, the IHT regime is stuffed with exemptions and reliefs that can be notoriously difficult to navigate.

In a nutshell, while IHT can be payable during lifetime on gifts to trusts, it is most commonly payable after a person’s death by the executors of their estate. The standard rate of IHT is 40% and may apply if the value of an estate exceeds the nil-rate band of £325,000. Any unused element of the nil-rate band can be transferred to a spouse or civil partner on death, effectively doubling the allowance to £650,000.

If you bequeath your main residence to a direct lineal descendant (such as your children or grandchildren), the residence nil-rate band of £175,000 may also be available, increasing the maximum nil-rate band to £500,000 each. But if the total value of your estate exceeds £2m, the residence nil-rate band will be tapered at £1 for every £2 over the £2m threshold.

There are various IHT gift exemptions available to individuals, such as the £3,000 annual exemption and the £250 small gifts exemption.

Should IHT be abolished?

The status quo is not an option for future governments, given IHT’s position as Britain’s most hated tax. But I am not convinced by the arguments of those who call for its abolition. My own view is that the public’s hatred for IHT stems largely from a resentment of double taxation (although double taxation is present in many forms throughout the tax system) and a general misunderstanding of how IHT is levied. 

Fewer than 5% of deaths result in an IHT charge by HMRC. Although we can expect this percentage to increase given the nil-rate band freeze until 2027/28 at the earliest, most estates will not suffer IHT at its current rate.

IHT is also becoming increasingly lucrative for the Treasury. The Office of Budget Responsibility forecasts that IHT receipts will raise £8.4bn by 2027/28, up from £7.2bn in 2022/23. If the current Government (or a future one) were to abolish IHT, it would be required to raise this money through different means.

Alternatives for reform

The IHT regime needs major reform. For any future government to show it is serious about tax simplification, it must consider the IHT regime as one of its first targets.

I would make three suggestions for simplifying the current regime:

  • Abolish the residence nil-rate band and increase the standard nil-rate band to £500,000 per person. This would mean that most spouses could jointly bequeath £1m free of IHT to their chosen beneficiaries following the death of the second spouse.

  • Cut the headline rate of IHT to 20% from its current 40%. This could be funded through the removal of various IHT reliefs such as business property relief and agricultural property relief, or by abolishing the tax-free Capital Gains Tax uplift on death.

  • Abolish the various lifetime IHT gift exemptions and 7-year rule, replacing them with a single annual gift allowance. Any lifetime gifts made over-and-above the gift allowance could be subject to a lower rate of IHT.

It goes without saying that there is no silver bullet when it comes to IHT, but I believe The Telegraph is wrong in calling for its abolition. Instead, future governments should stop tinkering around the edges or ignoring the problem altogether, and carry out significant reform to the current IHT regime.

For more information on issues raised in this article, please contact Andrew McCready.