The British press has recently reported rumours that, in a bid to win over voters at the next General Election, the Conservative Party may look to make a new addition to their manifesto pledge, namely, the abolition of Inheritance Tax (IHT).
The current position – a brief overview
Under the current rules, IHT is charged on death, on the value of the assets in your estate. Subject to any available exemptions and reliefs, the current rates of tax are 0% on the first £325,000.00 (the 'nil-rate band') and 40% on the balance.
An additional residence nil rate band was introduced in 2017, and it currently stands at £175,000 if you leave your interest in the family home to direct descendants including children, grandchildren, stepchildren and foster children (although this is tapered if your estate is worth over £2 million).
Record IHT receipts
HMRC have recently reported record IHT receipts of £7.1 billion in its annual figures, up nearly £1 billion from the previous year and close to £4 billion from ten years ago. Often branded the 'most hated tax', many struggle with the ideology that their assets (ultimately comprising their estate on death) have, in one way or another, been subject to all manner of taxations (Income, Stamp Duty, Capital Gains, VAT to name a few) during their lifetime. As house prices have risen over recent decades (far outstripping the nil rate band, unchanged for over ten years), more and more have been drawn into the IHT net. However, interestingly, as of 2021, HMRC reported that only 3.73% of estates actually pay IHT.
Potential impacts of abolishing IHT
How, therefore, would scrapping the 300+ year old tax (first reportedly charged in 1694) impact the British taxpayer? The answer may be obvious; simply, 3.73% of estates will no longer pay IHT. However, and for now, ignoring the impacts of reduced Government public spending, there could be other knock-on effects, with a few such areas explored below.
- Lifetime gifting
A commonly used strategy for mitigating a potentially significant IHT liability on death is to make gifts during lifetime. Provided the donor survives seven years from the date of the gift, the value will be removed from the donor's estate for IHT purposes.
On disposal of certain assets during lifetime, Capital Gains Tax (CGT) may be payable. Whilst the rate of CGT depends on the nature of the assets being gifted and the donor's Income Tax bracket, even at the highest rate charged, it is less than the 40% rate of IHT. At present, on death, any gain on assets during lifetime is 'uplifted' to the date of death value so that effectively your heirs inherit the asset CGT-free. That said, CGT on a lifetime gift can be mitigated by a transfer into trust. Provided that the amount gifted into trust is below the nil rate band, no IHT will be payable on the lifetime gift, and any CGT can be "held over" until the asset is subsequently disposed of or sold.
If IHT is abolished, could this lead to a significant reduction in lifetime gifting? There would be no IHT benefits coupled with a lifetime gift, which unless made into trust, would trigger an immediate CGT liability (which would otherwise be wiped out if the donor retained the assets until death), so the idea becomes much less attractive. Could this, therefore, lead to an increase of wealth accumulation in the older generations?
- Charities
Full IHT relief is also available on any legacy to a UK-registered charity. For those that leave a minimum of 10% of their estate to charity, a reduced rate of IHT is applied to the wider estate, reducing the IHT rate from 40% to 36%. It is possible that the abolition of IHT could have the unintended consequence of reducing charitable giving on death.
- Business and farming assets
For those with family-owned businesses or family farms, the availability of IHT relief is a key issue when families look to hand on their business or farm to the next generation. Sole trader businesses, shares in privately owned companies and AIM-listed companies qualify for 100% Business Property Relief from IHT when held for two years and provided the business is not carried on for investment. Similarly, generally speaking, Agricultural Property Relief (APR) is available on "true" agricultural land and will attract 100% relief after two years, or seven years if it is let.
These IHT reliefs are, for many, a key incentive to retain (and invest in) their business or farm.
The Birketts View
Given the Government has recently closed its most recent consultation on IHT and called for evidence in relation to APR, we consider reform, particularly around CGT and the availability of rebasing on death, a more likely outcome than the total abolition of IHT, not least because a viable alternative would be needed to plug the gap in the Government's spending plans.
Historically, the rates of both IHT and CGT are low and, given the uncertainty about the future of reliefs and whether they will survive in their current form, it may be a timely opportunity to capitalise on the currently available reliefs to secure the future of the transfer of wealth to the next generation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
