The future of inheritance tax in the UK – lessons from other countries

Few things divide FT Money readers more than inheritance tax. For some, the levy is unfair – a penalty for hard-working parents who wish to pass their wealth on to their children. For others, the tax is inefficient because the rich avoid it and get an unfair opportunity to give their descendants a huge advantage in life.

The arguments were reinforced by the Covid-19 pandemic and the need to raise more taxes to consolidate public finances once the recovery is assured. For now, Chancellor Rishi Sunak is playing his cards close to his chest on where such levies could fall, but many experts recommend looking at wealth taxes, including the IHT.

Among the last to give its opinion, the OECD, the club of rich countries. While he has no direct position in the UK debate, he provides an international benchmark for finance ministers to take into account, and sometimes points the way to global change, such as ongoing efforts to reform the UK. Business Taxation.

His point of view on the IHT is therefore important. Especially since its experts in their report this month did not hesitate to point out the many quirks of the United Kingdom. These range from special exemptions for farmers and landowners to the system of taxation of estates of the deceased rather than of people receiving inheritances.

The OECD suggests that governments, including the UK, make more use of the IHT to increase equality and raise tax revenues to restore their pandemic-ravaged finances.

FT Money examines how the UK system compares to that of other countries, the main OECD proposals and whether this latest intervention in inheritance tax signals a change to come.

UK stands out

Of the 36 OECD countries analyzed in the report, 24 levy taxes on wealth transfers, including the United Kingdom. The others, including Australia, Canada, Israel and New Zealand, do not.

The UK is one of only three countries (along with Denmark and the US) that apply estate taxes to deceased donors. Other countries tax recipients.

The UK is also among the minority of countries that apply flat rates to inheritance tax. Fifteen countries apply progressive rates – where the tax rate increases with the value of the estate – up to 80% in the case of Belgium.

In contrast, seven countries, including the United Kingdom, apply flat rates. The UK had the highest flat tax rate of 40 percent, shared with the US. On the other hand, the Irish rate is 33% and that of the Portuguese only 10%.

A few countries apply flat rates which depend on the relationship between the donor and the recipient. It ranges from 4 percent for closest family members to 8 percent for other beneficiaries in Italy, and from 15 percent to 36.25 percent in Denmark.

Most OECD countries have some form of forced inheritance where certain people, usually spouses and children, are automatically entitled to a share of the estate.

The UK, along with the US and Latvia, sets itself apart by allowing donors to decide who they leave their wealth to. There is a twist in Scotland, where movable assets (including cash) are subject to the rules of forced inheritance, but land is not.

Tax beneficiaries and not inheritances

The pandemic has increased economic divisions between the haves and have-nots, heightening concerns about the role of inheritance in deepening social divisions. Or, as the OECD says: “The Covid-19 crisis, which has affected different demographic groups differently, may exacerbate the difficulties of some households and widen the gap between households with older assets and younger households. . “

This is all the more the case as wealthier households are more likely to have received an inheritance or a lifetime gift, according to research. Among households in the top fifth by wealth, the proportion that received an inheritance or a lifetime gift ranged from 39 percent in Canada to 66 percent in Finland.

These trends are worsening in many OECD countries and are likely to worsen, according to the authors. They predict that inheritances will increase in value, if asset prices continue to rise, and in number as the baby boom generation ages. Meanwhile, younger generations may find it more difficult to build wealth on their own, as many find it difficult to buy homes due to the high prices.

To “promote equality of opportunity” the report advocates taxing recipients of gifts and inheritances rather than donor estates, as is currently happening in the UK.

Income from inheritance, inheritance and gift taxes

The OECD logic is widely accepted among British experts, but many warn that political opposition to such a change would make it impractical because, in general, the well-to-do feel that they should pass on assets to their children with the less tax possible.

These feelings seem to be deeply rooted in the age-old attachment of the British elite to land ownership. Edward Troup, former First Permanent Secretary of HM Revenue & Customs, puts it this way: “The depressing fact is that because we are obsessed with real estate wealth in this country, we are also obsessed with not paying the IHT. . “

Troup believes that “tax [IHT] recipient-based has always seemed more reasonable “than taxing donors. “If you get an inheritance, you’ve got something to do by doing absolutely nothing except being a good kid every now and then,” he says. “Why the hell, if you get over £ 100,000, say, shouldn’t you pay tax on it?” “

Lynne Rowland, tax partner at the accounting firm Moore Kingston Smith. adds that equal opportunities arguments might appeal to a government that is committed to “raising the bar” of the country.

But Troup says that while the measure makes sense, there would still be great political difficulties in pushing it through.

The financial arguments for moving to a beneficiary-based system are weak. OECD statistics show countries that taxpayers rather than donors currently do not get much more money from it than the UK. “Any reform will have no political force. In government, you should only embark on serious tax reform if you can raise significant funds, ”Troup said.

A tax on lifetime donations

In the UK, individuals who transfer assets during their lifetime can benefit from the “potentially exempt transfer” system – more commonly known as the seven-year rule. Under this rule, property donated during a person’s lifetime is excluded from the IHT if the donor lives at least seven years after making the donation. If the person left these assets to their children on death, inheritance tax would be due (above the threshold of £ 325,000).

The rule in effect “allows the very wealthy and those with easily transferable assets to make substantial non-taxable gifts over several years,” according to Elaine Shiels and Sarah Saunders of RSM, an accounting firm.

The OECD agrees. Speaking specifically of the UK rule, she said the “avoidance possibility” created by tax breaks on lifetime donations could be eliminated.

He suggests “a tax on the transfer of wealth for life” on the recipients of gifts. There would be a lifetime allowance to collect wealth tax-free, with tax being applied above this threshold.

Net wealth held by the richest households

This is not the first time that the taxation of lifetime gifts has been recommended. Changes to gift taxes in the UK have been suggested by both the Statutory Office of Tax Simplification and by Members of the All-Party Parliamentary Group on Inheritance and Intergenerational Equity.

The OTS has suggested that a myriad of gift allowances be replaced with a per capita allowance. MEPs in January 2020 proposed to do away with the seven-year rule alongside all IHT exemptions, lowering the rate from 40% to 10% and applying it to donations made while alive and on death.

Arun Advani, assistant professor at the University of Warwick and member of an independent wealth tax commission that reported last year, says a lifetime gift tax on beneficiaries is ” in principle, the way forward “.

However, he warns it would involve more administration for HMRC and taxpayers. He says there are other ways to “raise more money for less political pain.” I would be surprised if [reforming IHT] this is really where politicians go first.

Tighten and remove IHT exemptions

Although tax experts believe the UK is unlikely to follow OECD advice in taxing heirs or seriously toughening lifetime gifts, they see a greater chance that the country will accept its recommendations on the issue. reduction of exemptions. “Countries should consider reducing exemptions and tax breaks for which there is no strong justification and which tend to be regressive,” says the OECD.

He refers to UK research from the OTS showing that two key IHT reliefs – for business and agricultural assets – mainly benefit richer households.

Cumulative stock of inherited wealth

Zena Hanks, a partner at accounting firm Saffery Champness, said her clients were sometimes concerned about “increased chatter” about changes to these reliefs.

Removing them or tightening them sharply would lead to complicated problems for many businesses and farmers, she warns. “People want to be able to budget, they don’t want surprises,” she says.

Troup argues that the “massive cuts” for business and agriculture “have no credible economic case” – citing an analysis in the report which found that heirs running businesses are underperforming.

Abolishing the IHT reliefs “would cause high-pitched cries” from those affected, Troup said. He is “grim” that the current government is doing it, but he says the time for reform will come.

Rowland believes the pandemic is likely to advance this time sooner. She says, “A door opens for the government, but it depends on whether it is brave enough to walk through it. “

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