OVERVIEW: Understanding the UK Inheritance Tax System
As part of the 2019 Conservative Party Conference in early October 2019, UK Chancellor Sajid Javid openly pointed out that UK Inheritance Tax (IHT) law was in need of long overdue reform. Acknowledging what he perceived to be general public opposition to the IHT, the Chancellor even went so far as to suggest that the government could scrap the so-called death tax altogether.
IHT in the UK
IHT regimes vary by national jurisdiction. If we take the example of Germany, small inheritance legacies are exempt from tax, while a progressive scale is used which takes into account the relationship and the value of the inherited assets, before a final invoice is issued.
In countries like Australia, Israel and India, inheritance tax systems were completely abolished, while in other places like the Cayman Islands and Guernsey, the tax was never put in place. in place.
In the UK, the history of the tax is long and complex, dating back to 1694, when a probate tax was introduced on personal property in wills. A land tax was then added in 1796 to help the government fund the Napoleonic Wars. Something akin to the IHT as we generally recognize it today was announced in 1894 when a land capital value duty began.
In 1986, the IHT was introduced to replace a similar levy on capital transfers by then-Chancellor Nigel Lawson, who considered the latter to be a hindrance to small businesses by discouraging liquidation and transfer of assets. Interestingly, and reflecting its complicated history, is the fact that the tax is technically an inheritance tax rather than a transfer tax: assets are taxed by the UK government before being transferred to the specified beneficiaries. in the will.
A controversial tax
IHT has long been a controversial issue in the UK. Public opinion polls have consistently shown it to be one of the least popular forms of taxation in the country, with 59% supporting its removal.
While few taxes are popular with those who pay them, the IHT has been particularly reviled since its inception. The question is, why are so many opposed to the IHT in the UK?
I believe there are two reasons for this. First, as a matter of principle, there seems to be a general objection to double taxation. In other words, it is apparently unfair to pay taxes on assets that have already been purchased with taxed income. Second, IHT can cause undue stress for parents trying to ensure their children and grandchildren have the financial security they need in life.
Additionally, navigating the regulations governing IHT in the UK can also be a complex task. At Market Financial Solutions, we commissioned an independent survey of 800 UK homeowners this year, which found that 28% do not understand recent inheritance tax reforms. Specifically, there was confusion about the non-taxable allowance for inherited properties.
Considering all these factors, one could understand why there is general opposition to the IHT. Nonetheless, understanding the basic regulations governing the tax regime can ensure that people with assets in the UK are able to put in place effective and IHT-compliant estate plans. This is especially true for UK expats, immigrants and emigrants, where the IHT rules are not as clear as for residents.
Of course, there are interesting arguments in favor of the tax that should not be forgotten.
The goal of the IHT, to break the cycle of accumulated wealth and redistribute it to the less fortunate, seems noble. In the UK there are a number of valid exemptions, including cases involving serving members of the military who die while serving. Additionally, it operates on a sliding scale and is not a flat tax, meaning those who inherit a larger estate have to pay more.
How does the IHT work?
In the UK, the tax is calculated at 40% of the deceased person’s estate, with any gifts given in the seven years prior to death also liable to be charged, although less and less as they are given earlier.
The first £325,000 ($420,575) of each estate is exempt under the “zero-rate bracket”, and it’s transferable between partners if unused, meaning that together a married couple could be entitled to transmit 650,000 pounds without having to pay tax. On top of this, new exemptions were introduced in 2017 for passing on family homes, so those who inherit family property are less likely to be forced to sell the asset in order to pay the tax. For the 2019-2020 tax year, an additional allowance of £150,000 has been added, meaning a potential total exemption of up to £800,000 for married couples.
Manage IHT effectively
As with all taxes, governments regularly change the tax brackets, rates and exemptions. Of course, there are common practices used as part of a tax-efficient investment strategy.
People who plan to pass their assets to a family member can often gift items to those to whom they plan to pass their wealth. This reduces the actual amount of capital that will remain in the will.
What about the actual exemptions that apply to the IHT? In short, individuals can dispose of up to £3,000 of their estate each tax year before it becomes subject to IHT. Additionally, up to 250 books can be donated to any number of people per year. Similarly, parents can give 5,000 pounds to each of their children if they marry, while grandparents can give 2,500 pounds and anyone else can give 1,000 pounds. The UK government also encourages charitable giving, meaning if you bequeath 10% of your estate to charity, you’ll only be charged 36% of the rest, 4% less than the standard rate.
There are also slightly more sophisticated options. By putting money into repos, you can potentially reduce your IHT bill. If someone dies before reaching age 75, the benefits remaining in a defined contribution pension can be paid out as a lump sum to a beneficiary without any tax liability. As long as the fund remains in drawdown, it will be IHT-free, allowing each generation to pass on the account tax-free.
What about those outside the UK?
The UK administrative process of collecting an estate, paying IHT and passing assets to beneficiaries is known as ‘probate’. Cross-border registration follows the same process; however, the rules are different for foreign nationals with assets in the UK, UK nationals with assets overseas, expats with assets in the UK and those living in the UK whose official domicile for tax purposes is abroad (non-domiciled residents).
The cross-jurisdictional nature of international probate makes it a much more complicated process and it is always a good idea to seek professional advice before making any major decisions.
For foreign nationals with assets in the UK, including those in the US, it is important that HM Revenue & Customs understands your non-domiciled status, otherwise you could be liable for the 40% duty on your assets in worldwide, not just those in the UK.
As of April 2017, all UK properties, whether directly or indirectly owned, have become subject to IHT, meaning property investors will be subject to IHT to the extent the value of their shares is attributable to British ownership. In this way, offshore corporate and trust structures no longer offer tax protection.
It is difficult to say in which direction the IHT may be taken by the governments of the future. It is neither widely popular with the public nor does it generate a significant amount of revenue for the government, so cuts (or even abolition) may be more likely than one might think.
What is clear, however, is that for those who take the time to comb through the details and seek professional advice, it is possible to effectively comply with applicable rules and regulations without suddenly being faced with an unexpected tax bill.
For those living abroad, including in the United States, this is all the more crucial as recent reforms have added further complexity.
Paresh Raja is the CEO of Market Financial Solutions.
The author can be contacted at: [email protected]
Market Financial Solutions is not a tax specialist. MFS advises seeking the advice of an independent professional in all matters relating to inheritance tax.
This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.