Looking at the UK’s Inheritance Tax Amid Calls for Its Abolition

The UK has had some form of inheritance tax since the 17th century, under many names, such as probate duty, legacy duty, and capital transfer tax. IHT was introduced in its current form in 1986 by then Chancellor of the Exchequer Nigel Lawson, creating the concept of an “estate” for IHT purposes.

The Conservative Growth Group has started a campaign to abolish IHT, and its report is expected to be published this month. While we wait for the full details of their campaign, the key arguments focus on the relatively small amount that IHT raises—around £7 billion ($8.9 billion) which is less than 1% of tax revenues—and also that it is a double tax and therefore unfair.

The IHT double tax argument is a long-debated point. Is it double tax if you pay tax on your salary throughout your lifetime and then pay IHT on your death with the funds that you didn’t spend, or that you invested? Many taxes have a similar element of double tax, such as paying tax on your salary and then buying a good or service that is subject to value-added tax—so this argument isn’t unique to IHT.

While it can be argued that IHT doesn’t raise significant amounts, around £7 billion would need to be found from elsewhere, which would need to be considered.

Some countries, such as Sweden and Portugal, have abolished their death taxes, and others such as New Zealand never had such a tax. It is often difficult to compare personal tax regimes internationally, as like-for-like taxes may well differ, but often capital is taxed in different ways, such as an annual wealth tax, property taxes, or tax on gifts. A truly accurate global comparison requires some careful thought.

The UK’s Current Regime

Unlike other countries, in the UK tax on death is levied on the estate of the person who died, rather than the people benefiting from the estate. An individual’s liability to IHT depends on the location of their assets and their domicile status, as well as the availability of allowances, exemptions, and reliefs.

If an individual is UK domiciled, they will be subject to IHT on their worldwide estate irrespective of where the assets are located. If local capital taxes are levied on an individual’s death, then if there is a capital taxes treaty with the UK, relief should be available from double taxation. Where there is no treaty, some relief may still be available.

If an individual is non-UK domiciled, they will only be subject to UK IHT on assets located there, such as real estate in the UK, cash in UK bank accounts, and FTSE100 stocks and shares. Anyone invested in these assets in the UK will be subject to IHT on their death even if they don’t live there.

The current rate of the UK’s IHT is 40%. An IHT liability arises on death but can potentially apply on lifetime gifts to individuals if they don’t survive the gift by seven years. Gifts made to trusts or companies can trigger an immediate IHT liability of 20%. Assets in trust are also subject to IHT (at a maximum of 6%) but generally this is every 10 years or when assets exit the trust, rather than on a death.

All individuals are entitled to a tax-free amount known as the nil rate band. The current rate is £325,000 per person. Married couples can accumulate their nil rate bands together making a total of £650,000. There is an enhanced nil rate band of £1 million per married couple for residential property where the total estate is worth less than £2 million and the residential property is passed to a direct descendant.

For those who are married or in a civil partnership, there is a spouse exemption available. Provided that both individuals have the same domicile, the spouse exemption is limitless, and essentially means that on first death all assets can pass to the surviving spouse free of IHT. If individuals have different domiciles, they should seek advice as their spouse exemption may be limited to £325,000.

There are other exemptions too, such as gifts to UK registered charities, gifts in consideration of marriage, small gifts to the same person, gifts to the nation, and normal expenditure out of income. There is also an annual exemption available of £3,000 for all gifts, that can be carried forward for one year only.

Relief is also available if an estate owns particular assets such as agricultural property, woodlands and business property, and provided that an individual qualifies at the time of their death relief from IHT can be up to 100%. Examples of assets that qualify for business property relief are shares in unquoted trading companies (including Alternative Investment Market listed shares), an interest in a trading partnership, and an interest in a trade (self-employment).

On death, all assets are valued at their market value and are reduced by qualifying deductions such as mortgages, loans, and other liabilities, to arrive at the estate for IHT purposes. Exemptions and reliefs are then applied to give the value of the chargeable estate for IHT purposes, that is taxed at 40% after deducting any unused nil rate band.

IHT is due to be paid within six months, although it is possible to apply to pay by installments for certain assets such as land. All estates where there is IHT due or that are worth more than £3 million, even if there is no IHT due, will need to complete inheritance tax forms and submit them to the UK tax authority, HM Revenue & Customs.

In Brief

The UK has an inheritance tax (tax on death) as well as a capital gains tax (tax on disposals), whereas other countries have a wealth tax (an annual tax on the value of an individual’s estate).

There is discussion in the media about potential reform, or perhaps even abolition, of IHT in the UK, but in my view this would need to be considered alongside other capital taxes to ensure that the UK remains a competitive place to risk capital.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jo Bateson is a partner, family office and private client, with KPMG.

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