The government is set to increase the amount of money it raises through inheritance tax in what is predicted to be the biggest tax raising Budget on record.
A number of exemptions and loopholes may be in the sights of the Chancellor in order to bring in billions of pounds from the estates of the dead, that will reduce how much people can pass on to loved ones.
Currently, inheritance tax is paid at a rate of 40 percent on estates worth more than £325,000, However, the reality is that various exemptions, including around the family home, means most people can pass on £1 million without paying the tax.
The net effect is that less than 4 percent of all estates end up being liable to inheritance tax while the wealthy, those with estates worth over £10 million, are generally able to slash the amount paid by taking advantage of various exemptions.
Details of exactly where the rules will change will be kept under wraps until the Budget on October 30, however think-tanks have identified some areas where inheritance tax loopholes could be axed.
The Demos think tank suggested that the UK could copy the inheritance tax rules that apply in South Korea in a way that would see the proportion of estates hit by the tax rise from the current figure of around 3.7 percent to 6.4 percent.
It said this would involve blocking the wealthy from using exemptions and loopholes to avoid paying the tax and so boost government income by as much as £9 billion a year.
Demos said: “We could make our system fairer. In the UK, the wealthiest estates tend to pay lower effective rates (the percentage of all inheritance paid in tax).
“Those worth between £2m and £7.5m paid 25 percent in 2020-21, while those over £10m only paid 17 percent. In South Korea, meanwhile, the effective rate reached 33 percent for estates between £6m and £30m, and 44 percent for those over £30m in 2022.”
Inheritance tax exemptions and loopholes that could be abolished include:
Pensions
Currently people can pass on a pension pot, which could be worth more than £1 million, free of inheritance tax if they die before the age of 75. It is likely this exemption will be removed so anyone receiving a pension pot in these circumstances will be taxed on the windfall.
Gifts
Currently, people can avoid inheritance tax if they give away their cash and assets at least seven years before their death. People can also give away up to £3,000 a year to loved ones without being liable for the tax.
The Chancellor could change the rules to, for example, require people to give away wealth at least 10 years before death to avoid IHT. At the same the £3,000 gift allowance could be reduced.
Any shift to encourage people to give away their wealth earlier in life could have positive effects for the economy by boosting consumer spending. A number of elderly people might choose to downsize and pass on large lump sums to help adult children on to the property market.
Investments
Currently, people can buy shares in businesses that are not listed on stock markets and the value of these shares is not subject to inheritance tax. Many wealthy people pour money into these shares to avoid paying IHT. This exemption could be removed, or the value of shares held in such investments could be capped.
Farmland and family businesses
Currently, it is possible to pass on farmland and stakes in family businesses free of IHT. As a result, certain wealthy families have bought up large swathes of farmland without doing anything with it in order to avoid IHT. This tactic could be outlawed.
Rachael Griffin, tax and financial planning expert at Quilter, said: “”Inheritance tax (IHT) is one of the most hated taxes in Britain, often viewed as unfair. The super-rich tend to avoid it by hiring tax advisers to navigate the complex web of reliefs and exemptions.
“Consequently, the majority of the annual £7bn revenue comes from those who are well-off, but largely because they have worked hard, saved, and invested diligently throughout their lives.
“For many, IHT is an emotive issue. Frozen thresholds mean that a growing number of taxpayers have found themselves caught in a whirlpool of ever-evolving tax codes and regulations. In reality, IHT has been ripe for reform and simplification for years, as it is full of impenetrable and irrelevant details that need to be reviewed.”
She added: “The Conservative Party, under Rishi Sunak, flirted with the idea of reducing, if not abolishing, IHT to woo voters. If Labour’s reforms are perceived as a hasty tax grab, they are likely to receive significant backlash. Policymakers should tackle IHT reform seriously instead of using it as a political tool and revenue generator.
“For some time, the Labour Party has eyed the reform or even closure of several tax reliefs, such as agricultural and business property relief with a view to potentially removing, capping, or redefining these benefits, which could have the knock-on effect of AIM share losing their inheritance tax break. A move that would seem odd for a government looking to drive growth and investment in UK assets.
“If reports are true and Labour opts to make IHT more punitive, it could choose to balance this by modernising gifting laws. Simplifying the IHT regime and increasing the annual gifting exemption could ease the complexity of transferring assets and help families pass wealth on during their lifetime.
“ Raising the gifting threshold would encourage earlier wealth transfer, reducing future IHT liabilities, and potentially boosting consumer spending.”
