Inheritance Tax: Time for a rethink 

by | Jun 11, 2024

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Written by Tom Adcock, Tax partner at Gravita

Inheritance Tax (IHT) has long been a fixture in the UK’s tax landscape and its steep rate of 40% can come as a shock to those unfamiliar with it. It is a tax that has endured through the ages, but it has become increasingly complex and the misconceptions that surround it call for a serious discussion on its reform. 

A recent poll revealed that around 40% of UK residents believe they will have to pay IHT, yet in reality, only about 3.5% of estates are subject to this tax, which just goes to highlight how misunderstood IHT really is. It’s not just the rate that worries people, but also the labyrinthine rules and regulations that govern it. The tax’s foundation lies in old legislation that has been continuously amended, creating a convoluted system that ensnares both UK residents and non-residents who might own property here. 


One of the major flaws of IHT is that it doesn’t function as intended. Its rate and complexity, combined with the fact that so few are actually affected by it, underscore the need for a shake-up. During the Spring budget announcement, the Government mentioned the possibility of abolishing IHT, causing quite a stir among my colleagues who specialise in this area. Since then, it seems this idea has been shelved, as no significant steps towards reform have been taken since. 

In my view, replacing parts of IHT with Capital Gains Tax (CGT) could be a more rational approach. While CGT is also complex, it’s better understood by both tax professionals and investors. IHT is based on the net value of an estate, which doesn’t always accurately reflect the growth and value of assets. For instance, if you purchase a property for £1 million and it appreciates to £2 million, it makes more sense to tax the £1 million gain rather than the entire £2 million estate. This method is much fairer and aligns better with the principle of taxing economic gains. 

Reforming IHT to incorporate elements of CGT would not only simplify the system, but it would also bring a sense of justice to how estates are taxed upon death. It’s a change that could address both the technical issues and the public’s perception of the tax. 


Fallout from the budget 

One notable change following the Chancellor’s Spring budget announcement was the reduction in National Insurance by 4% for workers, providing some relief for the public. Additionally, the continuation of full expensing for capital expenditures is great for businesses with high capital costs, allowing them to claim unlimited tax relief, although it’s not a game changer for the majority. 

However, one of the worst things that came out of the budget affected those with furnished holiday lets (FHLs). Previously, FHLs enjoyed several tax reliefs unavailable to standard rental businesses and the government’s decision to remove these reliefs in the name of fairness is debatable. This means FHLs as a concept have vanished entirely and now, they’re treated exactly the same as normal letting businesses. Some people might argue that this is fair, others may not. 


FHLs don’t have the same stability of income, they have a different cost base and they advertise differently to traditional lettings companies who are in it for the long haul. Although ultimately, they are still an operating business. Whether it gets the outcome that the government is looking to achieve is another matter. 

Another notable change is the removal of certain Stamp Duty Land Tax (SDLT) reliefs. Previously, property buyers could split purchases into separate dwellings to lower their tax liability. The government’s move to close this loophole adds complexity for those buying residential or commercial 

properties. While it aims to curb tax avoidance, it could also hinder efforts to increase housing availability. 


Non-doms and future changes 

With an election on the horizon, the tax treatment of non-domiciled individuals (non-doms) is under scrutiny. Labour has long criticised the advantages enjoyed by non-doms, who can protect their overseas income and gains from UK tax by using offshore trusts. Recent changes mean that new UK residents will benefit from tax exemptions on overseas income for only four years. From April 2025, non-doms will face a phased introduction of UK tax on their overseas income, potentially transforming the landscape for globally mobile individuals. 

Labour has indicated that these changes would remain in place if they win the election, as well as targeting offshore trusts that shelter wealth from UK taxes. While these reforms do aim to increase fairness, their implementation will be complex and subject to intense political negotiation. 


Navigating a change of government 

The UK’s tax system is intricate and constantly evolving. Any significant reforms will require careful consideration to balance fairness with efficiency. At Gravita, we tend to look past the politics and focus on the policies themselves and how it would work for our clients. That said, it is impossible to ignore the fact that the country is in a financial mess and the last few years have cost taxpayers a fortune. Taxpayers are wiser than ever before and the government, whoever it is, will be under greater scrutiny. 

I would urge everyone to wait and ensure they understand what assets they have in the UK and abroad. As the political landscape shifts, staying informed and prepared for upcoming changes will be crucial for taxpayers and professionals alike. The devil is in the detail, and it will only be once we have real clarity that plans can be set in motion.


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