OECD report on inheritance tax

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The OECD has published a report on inheritance taxation in OECD countries that explores the role the tax could play in increasing income (given the Covid-19 crisis) and in combating wealth inequalities and improve efficiency in the future.

Based on a comparative assessment of 36 of the member countries, the report identifies reform options that governments could consider to improve the design and operation of wealth transfer taxes. The reason is that over the past two decades, wealth inequalities have greatly increased. Additionally, if trends continue and as baby boomers age, inheritances are expected to increase in both size and number.

The report concludes that greater use of inheritance tax is justified for reasons of equity, efficiency and administration and makes several recommendations for reform, subject to the specific circumstances of each country. We highlight the following findings and note the similarities with recent UK recommendations from the Office of Tax Simplification’s (OTS) and the All-Party Parliamentary Group for Inheritance & Intergenerational Fairness (APPG):

  • A beneficiary-based inheritance tax (IHT) may be fairer than an inheritance tax on the total wealth transferred by donors. This would allow progressive taxes to be levied on the amount of wealth received by beneficiaries. This encourages division of the estate and reduces concentrations of wealth. However, the OECD recognizes that it is administratively more difficult and costly to collect tax from a number of beneficiaries rather than a single estate.
  • A fair and effective approach would be to tax beneficiaries on donations they receive during their lifetime in excess of a certain (modest) tax-free amount. This would imply a reduction in revolving thresholds such as the UK zero rate band which can be replenished every seven years.
  • Exemptions or reliefs for business assets should be carefully designed and alternatives considered. The report finds that family businesses tend to benefit from generous concessions. He cites the OTS report to find that business ownership tends to be concentrated among the wealthiest households, who benefit most from this type of relief. Their recommendations include that any relief should be subject to strict eligibility criteria, such as a minimum ownership period and a continuation condition (i.e. the business must continue after its transfer and, if not, l relief would be subject to clawback). Countries might consider capping the amount of relief available or introducing some form of resource control. An alternative reform consists in having a relatively low IHT rate and in allowing the payment of the tax in installments (echoing the recommendations of the APPG).
  • Other recommendations include reducing exemptions for which there is no strong justification (the OECD identifies private life insurance and retirement savings products, which may escape inheritance tax).
  • Another recommendation is to consider the position on unrealized capital gains on death. The report states that “there are strong arguments in favor of removing the gross-up basis for unrealized capital gains on death, especially when inheritance tax is not levied”(Page 128 of the report). This change was also advocated by the OTS. The reason given is that unrealized capital gains constitute an important part of the wealth of the richest taxpayers. The report considers two tax bases: (i) the gross-up base (this is what we currently have in the UK) when an asset is increased to market value upon transfer on death and (ii) the deferral basis, where an heir takes the capital gain but the capital gain is taxed when the asset is sold (deduction from the total capital gain). The report considers two disadvantages of deferral: (i) it forces beneficiaries to follow the cost base of the asset and (ii) the capital gain may become disproportionate for the business and create an incentive to hold the asset for the long term. . One potential reform is to tax unrealized gains on death, but allow flexible payment terms such as deferral if necessary (but probably not in addition to the IHT!).
  • More broadly, the report identifies stronger reporting requirements and notes that governments will be able to track wealth transfers as the tax system digitizes.

Recent reports suggest that Chancellor Rishi Sunak may consider raising IHT rates, although the timing and precise nature of any changes remain uncertain. Many of the OECD’s proposals would represent a radical departure from the UK’s current IHT system. In addition, there is little evidence that a beneficiary-based tax generates much more income. In addition, this system is not ideally suited to jurisdictions like England and Wales, which do not have forced inheritance provisions and make extensive use of trusts.

It remains to be seen whether there is an appetite for such a fundamental reform of the IHT in the UK, but with the intervention of the OECD, in addition to the OTS, the APPG and the wealth tax, some kind of change could be approaching.

This article first appeared in our spring 2021 edition of our Private Clients and Taxation Newsletter.


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