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Playing the long game with inheritance tax

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Despite affecting a comparative few, inheritance tax has become a topic of much debate as a general election approaches. Helen Thornley looks at its history and possible reform.

19th Oct 2023
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For a tax that only affects a small proportion of the public – and makes a modest contribution to UK tax receipts – inheritance tax (IHT) is perhaps an odd choice of political football. But earlier this year The Telegraph, backed by a reported 50 Conservative MPs, launched a campaign to abolish the tax, claiming it was inherently unfair. 

More recently, media attention has focused on whether Labour, if elected, would rein in some of the more favourable reliefs for business and agriculture – again in the name of fairness. 

Potted history of death duties 

Despite being paid by only 4% of estates, IHT is a particularly emotive tax. It’s taken 300 years to get from a basic flat rate to our comprehensive – and complex – system, with opposition at every stage. 

The first instance of a death duty was probate duty, first introduced in 1694. Set as a fixed fee of five shillings on estates of over £20, it was one of a number of “stamp taxes” on legal transactions introduced to fund the war against France. 

In 1780, with funds needed for the American Revolutionary War, an element of graduation was introduced to probate duty, along with a new tax – legacy duty. This was charged on the receipts given for legacies, with the rate dependent on the value of the legacy. Since there was no law requiring receipts to be given or received for legacies, this was fairly easy to avoid – until William Pitt fixed the problem in 1795 by requiring executors to issue them.

The following year, Pitt changed legacy duty again, shifting rates so they depended on how closely the recipient was related to the deceased. At first, wives and children were exempt, but as rates increased, within 20 years only transfers to a widow remained untaxed and had reached 10% for those not closely related to the deceased.

Both taxes were limited – they only applied to moveable assets passing on death, and generally omitted to tax interests in land, settled property or gifts. To try to broaden the tax base William Gladstone introduced succession duty in 1853. This taxed freehold, leasehold and heritable property – although not at the full market value, and with lower rates if passed to close descendants. As a consequence, the new tax raised much less than expected. 

Estate duty

Further revisions and rate increases followed over the next 40 years, but the first comprehensive regime of death duties was estate duty, introduced for deaths from 1 August 1894. This replaced probate and account duty, and reduced the rates and scope of legacy and succession duty. Introduced by Sir William Harcourt, there was sustained opposition to the measures, and substantial parliamentary time spent on the issue. estate duty was even dubbed the “second son’s revenge” as Sir William’s father’s estate was expected to pass to his elder brother.

There’s a lot we would recognise from estate duty. Property was valued at the market value at the time of death, and the estate included land and property outside the UK as well as gifts made within three years of death. 

The rates for estate duty were modest to begin with, ranging from 1% for estates over £100 (around £10,700 now) to 8%. Inevitably, they increased over the following decades. The 40% rate we have now in IHT first appeared in 1919, for estates of over £2m, with the rates peaking at 85% in 1969 for amounts over £750,000. 

Estate duty lasted until the 1970s, when it was replaced by capital transfer tax by Labour Chancellor Harold Wilson. This sought to tax transfers of value in life as comprehensively as those in death. The regime lasted for around a decade, before Conservative Nigel Lawson reframed it as inheritance tax in 1986. He reduced the taxes on lifetime gifting, believing this would encourage enterprise. Bringing back some of the rules from estate duty, gifts made more than seven years before death could now potentially escape a tax charge altogether. 

Where are we now?

In 2022/23, receipts from inheritance tax amounted to around £7bn – just under 1% of total tax receipts for that year. IHT is dwarfed by the “big three” revenue generators – income tax (first introduced in 1798), national insurance (1911) and VAT (1973). 

IHT is not generally considered to be terribly popular. A recent YouGov survey suggests that 54% of people consider it either unfair or very unfair. But it does appear that views on this issue can be affected by how the question is framed. 

A study by Demos in July 2023 found that while half of those surveyed thought that inheritances in general should always be tax free, this view shifted when presented with more concrete examples of specific inheritances. Only 17% of those surveyed thought that the inheritance of a second home that had increased in value should always be tax free, with the majority thinking that some tax should apply in these circumstances.

Interaction with capital gains tax 

If IHT were abolished, it would represent a massive break in 300 years of evolving death duties. It would also have knock-on consequences for capital gains tax (CGT). Despite the latter’s relatively late arrival in 1965 – and in theory quite different policy intent – it’s generally impossible to advise without considering both.   

As a rule of thumb, gifts in life are subject to CGT, while gifts on death are subject to IHT, unless business or agricultural property is involved. CGT is eliminated on death because assets are given a tax-free uplift to the IHT value. 

When the Office of Tax Simplification (OTS) considered IHT in a 2019 report on Simplifying the design of the tax, they identified the uplift on death as distorting decision-making. Contributors to the report said that it encouraged people to hold onto assets that benefit from IHT exemptions. On this basis, there’s an argument that abolishing IHT entirely without any compensatory changes to CGT could curtail enthusiasm for lifetime gifting even further. Why incur CGT in life, or rely on holdover, when you could pass it over after your death with a CGT-free uplift? 

The OTS recommendation was to consider removing the capital gains uplift and provide for the individual to acquire assets at the historic cost to the donor. While I can see the logic in this suggestion, my personal view is that this would be incredibly difficult in practice. It’s bad enough finding out base costs when the donor is alive, let alone when they are deceased. 

Pressure for change

It’s difficult to imagine that we will ever return to a pre-1694 era of tax-free wealth transfers on death, but it is likely that pressures for some form of change will build. The latest Institute for Fiscal Studies report on reforming inheritance tax suggests that in ten years’ time 1 in 8 estates will be in scope – three times the current number. Combined with an election deadline of December 2024, we can probably expect to hear a lot more about what the different parties consider fair over the coming months. 

Replies (7)

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By WhiteRose
19th Oct 2023 11:17

Thank you for an interesting precis.
Another problem is that the amount charged on an estate will vary depending on whether or not you have 'direct descendants', which seems a little unfair.

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Replying to WhiteRose:
Helen Thornley Profile picture
By Helen Thornley
24th Oct 2023 10:11

Thanks, yes good point and it feels unfair to me too.

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By philrob
19th Oct 2023 19:16

IHT is a wealth tax. With certain exceptions and allowances the government takes 40% of your wealth when you die. Is it fair to tax again something that has already been taxed? No, but the country needs either to increase tax or spend less and the IHT wealth tax makes a contribution to the coffers.

I think there is an argument for reform coupled with increased allowances and a far faster process for probate.

Looking at the key reliefs first. Shares in private businesses and agricultural land fall outside of IHT. This is to prevent the forced sale/closure of businesses to pay IHT and is the correct decision. I would however argue (as mentioned in the article) that the rebasing of value on death should be removed and the original capital cost carried forward. Companies are required to have registers of share allocations, transfers etc. and the Land Registry (mostly) has records of property values so the data (mostly) should exist.

As an aside, Capital gains tax has become a real issue. Get rid of the 'allowance' and re-introduce indexation - to do anything else is unfair even with the lower CGT rates compared to income tax.

To make life simple for the taxman I would suggest that the capital base cost of inherited shares and land is zero unless the shareholder can demonstrate the actual capital base cost. That will eliminate all delays on probate related to private businesses.

Business Property Relief on AIM shares should be limited to IPO shares only. That is money purportedly raised to grow the business. Buying and selling shares after that is no different to the main exchange. I recognise that the share price of aim shares will drop by circa 40% if this is adopted.

In terms of probate valuations we are left with chattels and property - the systems more or less work for those - they aren't great but there isn't a real alternative.

Using the money gained from including AIM shares and (eventual) capital gains when the family business/land is sold we should raise the threshold to (say) 1.5m per person. That will take a chunk of people out of the system and allow HMRC to have their 3 day weeks without affecting service.

The Tories get out of the hole they have created for themselves through fiscal drag, Labour get to 'sock it to the rich' and 'redistribute wealth'.

Everyone is equally unhappy, but probate can be far faster.

There probably are lots of reasons why the suggestions above won't work but it is time we had national debate about tax, how it is raised, how much is 'right' and what it is spent on.

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Replying to philrob:
paddle steamer
By DJKL
23rd Oct 2023 17:50

AIM will possibly cease to exist as a market and your 40% drop might well be conservative.

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paddle steamer
By DJKL
23rd Oct 2023 17:47

Have always thought IHT ought to go but CGT be brought in on second death ,including one's Private Residence.

1. It spreads the tax, taxes that only hurt a few are easy for everyone else to vote for but players ought to have a stake on the table, broaden it and drop the rates.

2. Appreciate more difficult to compute but anyone holding assets with pregnant gains ought to keep a record of costs anyway and property these days gets added to Land registry leaving an audit trail for executors to use re base prices. (If they do not record improvements then tough, they lose out)

It is to me exceptionally unfair that the total return from say a bank deposit gets taxed as interest whereas with a share investment only the dividend gets taxed if held until death, so the prudent who are risk averse receive a worse deal than the speculators and those less risk averse.

If you want business relief to keep a business in same family introduce deathbed holdover relief of some sorts.

If need be report house improvements annually on tax return (Sweden has boxes for significant additions but of course their returns cover "Council Tax", "Income Tax" and "Capital Gains tax "(CGT taxed broadly at same rate as investment income , 30%, reduction to 22% re residential property and having holdover relief re same if reinvested in another family home)

Holdover gains up the property chain if proceeds invested again in private residence but charge when downsizing releasing cash. (As done by the Swedes, and they have NO death taxes or wealth taxes)

All unlikely to happen, too many people would scream blue murder if you touch their tax free house gains, but untaxed gains on a PR are imho actually not that good for society.

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By FrankTax
24th Oct 2023 12:19

IHT, in theory, taxes the wealthiest. I'm surprised it's so broadly unpopular; for so many it will never be an issue.

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By peterplucker
01st Nov 2023 14:16

Is it true that most of the people who will currently pay IHT are in the South of England (including London) where house / Estate values and costs are much higher than most of the UK? If so, this tax bias is inherently unfair (pun!) especially when recognising that the property owners have often paid more tax in their lifetimes than people outside the South of England because their job incomes more quickly exceed the National Allowance and Tax thresholds. Quoting the % of the UK paying IHT is thus misleading, as a much higher % of people in the South will be paying it. What % of South of England people are paying IHT now, and what % elsewhere in England, Scotland, NI, Wales?

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