Few things divide FT Money readers more than inheritance tax. For some the levy is unfair — a penalty on hard-working parents wanting to pass their wealth to their children. For others, the tax is ineffective as the wealthy avoid it and gain an unfair opportunity to give their descendants a huge advantage in life.
The arguments have been given new force by the Covid-19 pandemic and the need to raise more tax to shore up the public finances once the recovery is secure. For now, chancellor Rishi Sunak is playing his cards close to his chest on where any such levies could fall, but there are plenty of experts who recommend looking at wealth taxes, including IHT.
Among the latest to give a view is the OECD, the rich countries’ club. While it has no direct standing in the UK debate, it provides an international reference point that finance ministers take into account, and sometimes points the way to global change, as with ongoing efforts to reform corporate taxes.
So its view on IHT matters. Especially as its experts in their report this month have not held back from pointing out the UK’s many quirks. These range from special exemptions for farmers and country landowners, to the system of taxing the estates of the deceased rather than the people who receive inheritances.
The OECD suggests governments, including the UK, make more use of IHT to increase equality and raise tax revenue to restore their pandemic-battered finances.
FT Money looks at how the UK system compares with other countries, the key OECD proposals, and whether this latest intervention into inheritance tax signals coming change.
The UK stands out from the pack
Of the 36 OECD countries analysed in the report, 24 levy tax on wealth transfers, including the UK. The rest, including Australia, Canada, Israel, and New Zealand, don’t.
The UK is among only three countries (along with Denmark and the US) that apply taxes to the estate of deceased donors. Other countries tax the recipients.
The UK is also in the minority of countries applying flat rates to inheritance taxes. Fifteen countries apply progressive rates — where the tax rate rises with the value of the inheritance — up to 80 per cent in the case of Belgium.
In contrast, seven countries, including the UK, levy flat rates. The UK had the joint highest flat rate of tax of 40 per cent, shared with the US. In contrast, the Irish rate is 33 per cent and the Portuguese just 10 per cent.
A couple of countries apply flat rates that depend on the relationship between the donor and the recipient. It ranges from 4 per cent for the closest family members to 8 per cent for other beneficiaries in Italy, and from 15 per cent to 36.25 per cent in Denmark.
Most OECD countries have some form of forced heirship where certain people, usually spouses and children, are automatically entitled to a share of the estate.
The UK, along with the US and Latvia, stands out in allowing donors to decide to whom they leave their wealth. There is a twist in Scotland, where moveable assets (including cash), are subject to forced heirship rules but not land.
Taxing recipients not estates
The pandemic has increased economic divisions between the haves and have-nots, heightening concerns about the role of inheritance in deepening social rifts. Or, as the OECD puts it: “The Covid-19 crisis, which has affected different demographic groups differently, may exacerbate difficulties for some households and increase the divide between older asset-owning households and younger households.”
This is especially the case as richer households are more likely to have received an inheritance or a lifetime gift, the research finds. Among households in the top fifth by wealth, the portion who received an inheritance or lifetime gift ranged from 39 per cent in Canada to 66 per cent in Finland.
These trends are getting worse in many OECD countries and likely to worsen, the authors say. They predict inheritances will increase in value, if asset prices continue to rise, and in number as the baby-boomer generation gets older. Meanwhile, younger generations may find it harder to build up wealth on their own as many struggle to buy a home due to high prices.
To “promote equality of opportunity” the report advocates taxing the recipients of gifts and inheritances rather than the estates of donors, as currently happens in the UK.
The OECD’s logic is widely accepted among British experts but many warn the political opposition to such a change would make it impracticable as, generally, better-off people feel they should pass assets to their children with as little tax as possible.
These sentiments seem deeply rooted in the British elite’s centuries-old attachment to landed property. Edward Troup, former first permanent secretary at HM Revenue & Customs, puts it this way: “The depressing fact is because we’re obsessed with housing wealth in this country, we’re also obsessed with not paying IHT.”
Troup believes “taxing [IHT] on a recipient basis has always felt more sensible” than taxing the donors. “If you get an inheritance, you’ve got something from doing absolutely nothing except occasionally being a good child,” he says. “Why on earth, if you’re receiving over £100,000 say, shouldn’t you pay tax on it?”
Lynne Rowland, a tax partner with accountancy firm Moore Kingston Smith. adds that the equality of opportunity arguments might appeal to a government that has pledged to “level-up” the country.
But Troup says that, despite the measure making sense, there would still be big political difficulties in pushing it through.
The financial case for moving to a recipient-based system is weak. The OECD statistics show countries that tax recipients rather than donors do not currently make much more money from it than the UK. “Any reform will have no political traction. In government you should only embark on serious tax reform if you can raise serious money,” Troup says.
A tax on lifetime gifts
In the UK, individuals giving away assets during their lifetime can benefit from the “potentially exempt transfer” system — more commonly called the seven-year rule. Under this rule, assets given away during an individual’s lifetime are excluded from IHT if the donor lives at least seven years after making the gift. If the person bequeathed these assets to their children on death, inheritance tax would be due (above the £325,000 threshold).
The rule effectively “allows the very rich and those with easily transferable assets to make substantial tax-free gifts over several years”, according to Elaine Shiels and Sarah Saunders of RSM, an accountancy firm.
The OECD agrees. Speaking specifically about the UK rule, it says the “avoidance opportunity” created by tax breaks on lifetime giving could be eliminated.
It suggests “a lifetime wealth transfer tax” on gift recipients. There would be a lifetime allowance for receiving wealth tax-free, with tax applied above this threshold.
This is not the first time taxing lifetime gifts has been recommended. Changes to UK gift taxes have been suggested by both the statutory Office of Tax Simplification and by MPs on the all-party parliamentary group on inheritance and intergenerational fairness.
The OTS suggested a myriad of gift allowances be replaced with one allowance per person. The MPs, in January 2020, proposed scrapping the seven-year rule alongside all IHT exemptions, lowering the rate from 40 to 10 per cent and applying it to gifts made during life and on death.
Arun Advani, assistant professor at the University of Warwick, and a member of an independent wealth tax commission that reported last year, says a lifetime gift tax on recipients is “in principle, the way to go”.
However, he warns it would involve more administration for both HMRC and taxpayers. He says there are other ways to “raise more money for less political pain. I’d be surprised if [reforming IHT] is really where politicians go first.”
Tightening and scrapping IHT exemptions
Though tax experts think it’s unlikely the UK would follow OECD advice in taxing heirs or seriously tightening up on lifetime gifts, they see more chance of the country accepting its recommendations on reducing exemptions. “Countries should consider scaling back tax exemptions and reliefs for which there is no strong rationale and which tend to be regressive,” says the OECD.
It refers to British research from the OTS showing that two key IHT reliefs — for business and agricultural assets — predominantly benefit the wealthiest households.
Zena Hanks, partner at accountancy firm Saffery Champness, said her clients were at times concerned about the “increased chatter” about changes to these reliefs.
Scrapping or greatly tightening them would lead to complicated issues for many businesses and farmers she warns. “People want to be able to budget, they don’t want surprises,” she says.
Troup argues the “massive reliefs” for business and agriculture “do not have any credible economic argument” — citing analysis in the report which found heirs managing businesses underperform.
Abolishing IHT reliefs “would get squeals” from those affected, says Troup. He is “gloomy” at the prospect of the current government doing so but he says the time for reform will come.
Rowland thinks the pandemic is likely to bring that moment forward sooner. She says: “A door is swinging open for the government, but it depends whether they are brave enough to go through it.”