Key think tank recommends new progressive rate structure for IHT

A prominent economic think tank has urged the government to move from a flat rate of inheritance tax (IHT) towards a progressive rate structure.

The Resolution Foundation – which also suggested that IHT should be tightened so that it cannot be avoided by the “wealthy and well-advised” – pointed out that the UK’s estate taxes pre-1988 did in fact have progressive rate structures, and that such formats are more common in other jurisdictions than flat rates.

Specifically, they suggest a 20% band for value between £650,000 and £1 million (for couples), as well as a 30% band up to £1.5 million. Even at £1.5 million, the effective tax rate would be only 15% – something the Resolution Foundation argues would assure voters.

Their report, Tax Planning: How to match higher taxes with better taxes, also suggested that business and agricultural property reliefs “should be scrapped or heavily restricted”, which they say are concentrated among a small number of estates and are a key cause of the fact that the effective rate paid on estates worth over £10 million is, at 10%, far lower than the rate paid by smaller estates.

The Resolution Foundation also recommends taxing inherited pension pots, which it says “if not used to purchase an annuity, are not fundamentally different from any other savings pot”.

Importantly, they also recommend scrapping the residence nil-rate band (RNRB):

“The RNRB does significantly reduce how many estates pay any IHT.147 And it is not as topheavy as Business Relief is, for example, in part because it is at least partially withdrawn from estates worth over £2 million.

It is hard to argue why main homes should be favoured over other assets among the small proportion of the population that pay IHT – particularly given that these also benefit from an exemption from Capital Gains Tax. And it is hard to argue why transfers to siblings or niblings, for example, should be taxed very differently from transfers to children or grandchildren

The RNRB is also complicated, for example due to the well-intentioned downsizing provisions that mean that the relief can apply to non-housing wealth so long as the deceased previously owned a home.”

Another policy put forward in the report is the replacement of IHT with a lifetime tax on recipients, the main features of this being an annual allowance for small gifts (e.g. £3,000), a lifetime tax-free allowance (e.g. £125,000) and a progressive rate structure beyond this.

“This approach would have a number of advantages. First, while IHT may only apply to transfers made within seven years of death, a broader tax would potentially include all gifts and therefore could not be avoided simply through giving earlier in one’s life.

Second, taxing recipients rather than estates would bring practical benefits such as removing the current need for policy to transfer tax allowances within marriages and civil partnerships, which is complicated and unfair on cohabiting couples; and reporting transfers when they are received rather than retrospectively at death.

But, third, it could also change perceptions of inheritance taxation. The charge levelled against IHT that it is a double taxation of savings would hold less weight if it was explicitly a tax on the income of recipients.156 And there is greater public support for applying inheritance taxes to people who have previously received inheritances (or otherwise have higher incomes and/or wealth) than for others. Indeed, such an approach would also encourage donors to spread their bequests more widely (to take advantage of per-person tax allowances and tax rates).”

They suggest a good example of this is Ireland’s Capital Acquisitions Tax, which has existed since 1974:

“Given the scale of reforms that are warranted within the existing IHT system – including but not limited to the questions of scope, reliefs and rates we have discussed above – it may well be worth ripping up existing IHT legislation and starting again with a new system that delivers all of these desirable changes at once and is fit for the coming decades and the increased flow of inheritances that they will bring.”

However, they stopped short of recommending abolition of IHT, which they say are “fundamentally […] good for the UK”:

“Inheritances are a form of income, yet one that is not a function of personal effort or output, and every pound raised via inheritance taxation is a pound that does not need to be raised via taxing earned income…

…The current system of IHT is in no way a significant burden on households in aggregate, with only around 1 in 17 deaths leading to an IHT bill.”