Could gift allowance replace Inheritance Tax in the UK?

MPs have proposed that the UK abolishes inheritance tax and replaces it with a gift allowance system. Andrew Welch of Stephensons Solicitors LLP explains the proposals and the likelihood of reform.

Gift Allowance UK

Why might there be a change to Inheritance Tax in the UK?

In January 2020, the All Party Parliamentary Group on Inheritance Tax and Intergenerational Fairness (APPG) reported to discuss extensive proposals for reform of the UK’s Inheritance Tax (IHT) system. As it identified in its report, IHT “is often criticized as complex, ineffective, riddled with anomalies, distortionary and unfair. It is unpopular and ripe for reform”.

The report identified that out of about 588,000 deaths a year, only 24,500 (less than 5 per cent) result in payment of IHT and, although IHT only raises less than 1 per cent of the total government tax take, it encourages wealth to be concentrated rather than spread through wider society and the economy during people’s lifetimes.

What are the UK gift allowance proposals?

The APPG had two major proposals:

  1. Replacing IHT with a tax on lifetime and death transfers of wealth, with very few reliefs and a low flat rate, between 10 per cent and 20 per cent, with the Capital Gains Tax (CGT) tax free death uplift being scrapped.
  2. HMRC and HM Treasury to be given greater powers to collect data through compulsory reporting of lifetime gifts – this would allow the government to redesign wealth taxes using data that it currently does not have.

Within these proposals, particularly the first, there was lots of further detail relating to matters such as Trusts and Foreign Domiciles. However, some the key additional points were:

  • People should be able to make tax free lifetime gifts of up to £30,000 per annum, which would encourage lifetime distribution of wealth to other generations more effectively than the current £3,000 gift exemption, and cover all but the very wealthy.
  • The £325,000 Nil Rate Band would remain, but only on death, and the Residence Nil Rate Band would be abolished.
  • The tax rate would be dropped to 10 per cent on most estates because it was felt that that was a level which would not make incentives to plan around it worthwhile. It is said that for most estates this arrangement would not increase the overall tax bill, but it would be simpler and encourage lifetime distribution of wealth.

What are the controversies to the UK gift allowance proposals?

However, there are some recommendations which would not be popular for some taxpayers. For example, to simplify and remove the complex reliefs, APPG recommended abolishing Business Property Relief (BPR) and Agricultural Property Relief (APR). They recognise the hardship that that may cause to some family businesses and farms but say that that is reduced by the lower tax rate and possibly payment over 10 years. They point out that now beneficiaries could inherit a BPR qualifying business free of IHT then go on to sell it shortly afterwards and pay no Capital Gains Tax (CGT) either.

Another detail in the proposals which may prove controversial is the abolishing of the CGT tax free death uplift. At present beneficiaries inherit assets at the value on death, which means that often no CGT is payable if they are disposed of shortly after. APPG propose no CGT being payable on the death of the donor but the recipient inherits at the donors cost base:

  • So, for example, children could inherit the family home but at the costs base applicable years ago when parents bought it. When those children come to sell there could be a substantial CGT bill to pay, assuming they don’t live in it and qualify for main residence exemption. APPG suggest that could be reduced by allowing a principal residence relief for the period when the donor was in residence. However, it does illustrate that under these proposals CGT would become a more significant feature of death tax planning.

Will the gift allowance proposals come into effect and when?

Realistically, the gift allowance proposals aren’t likely to come into effect anytime soon. APPG is an informal group of members of both Houses of Parliament that have a common interest in these issues. It does not play any part in the legislative process and ministers are free to take or leave its suggestions.

The Office for Tax Simplification (OTS) also reported to the then Chancellor on wealth taxes in 2019, although its remit was to suggest reform rather than replacement of IHT. However, the present Chancellor in his March 2020 budget did not take up either the APPG or the OTS suggestions or give an indication that he was likely to do so.

Coronavirus and the likely need to raise taxes as a result may prompt a revisiting of wealth taxes but what is raised by IHT now is a modest proportion of government tax take and some very major changes would be needed to increase that substantially. The APPG suggestions are not aimed primarily at increasing the tax take but at making it fairer and easier to process.

It should also be noted that the political appetite to make major changes to IHT is unlikely to be there. The OTS described IHT as “almost uniquely unpopular”. Politicians have sought to avoid becoming mired in the reform of IHT for decades and, if anything, the trend in recent times has been mitigate it for many estates with the increasing Residence Nil Rate Band.

Therefore, it seems unlikely that IHT reform will be top of the present governments’ list of priorities for change. But we live in uncertain times and only the very brave would rule anything out, especially given the amount of wealth tied up in assets and the likelihood of future governments need to raise the tax take.

About the author

Andrew Welch is a Partner at Stephensons Solicitors LLP.

See also

HMRC announce changes to Inheritance Tax processes during lockdown

How to make or amend a will during the Coronavirus (COVID-19) lockdown

Find out more

Inheritance Tax (GOV.UK)

Image: Getty Images

Publication date: 7 May 2020

Any opinion expressed in this article is that of the author and the author alone, and does not necessarily represent that of The Gazette.