Taxes are rarely popular, but Inheritance Tax (IHT) seems to have an especially tough time in public popularity polls. Articles on IHT have been a common sight in the press in recent months, with some mainstream newspapers suggesting the tax should be reformed or even scrapped completely.  

Does IHT deserve this bad press? We take a look at where the tax came from, how it works, what revenue it raises, and why it is so topical at the moment.  

A brief history of IHT 

IHT was introduced in Finance Act 1986, when it replaced Capital Transfer Tax (CTT). CTT imposed a tax levy on most gifts made during lifetime as well as transfers on death, but this was seen by then-Chancellor Nigel Lawson as stifling independent businesses, as it disincentivised passing them (and particularly small family enterprises) down to the next generation.  

IHT did away with the tax on lifetime gifts in most instances, with gifts between individuals normally treated as Potentially Exempt Transfers – meaning no IHT is payable as long as the donor lives for at least seven years from the date of the gift. This ‘seven year rule’ was revived from CTT’s predecessor, Estate Duty, and was intended to prevent people avoiding IHT by giving assets away shortly before they died, a practice often indelicately referred to as death-bed tax planning.  

How much IHT is due when you die? 

IHT is charged on the value of assets held at death. The headline rate is 40%, but due to exemptions and reliefs, the effective rate (i.e. the tax charged as a proportion of the total value of the deceased’s estate) is normally much lower.  

Broadly, the amount chargeable to IHT is the combined value of assets owned less: 

• Liabilities (mortgages, car loans, credit card debt etc) 

• The Nil Rate Band (NRB) – an allowance of £325,000 per person 

• The Residence Nil Rate Band (RNRB) – a further allowance of £175,000 per person, deductible where a home is left to direct descendants, which is progressively tapered to zero if the estate value exceeds £2 million. If a spouse or civil partner has died previously, any unused NRB and RNRB can be claimed on the second death. 

In addition, various exemptions and reliefs which reduce the IHT payable are commonly available, including: 

• Assets left to spouses/civil partners on death are exempt from IHT; 

• Assets left to charity do not suffer IHT, and if enough of the estate is left to charity a lower tax rate of 36% applies to any remaining chargeable estate; 

• Business Property Relief (BPR) can mean businesses or shares in family trading companies do not incur IHT; and 

• Agricultural Property Relief (APR) can exempt the value of farmland and farm buildings from the tax. 

IHT at 40% only applies to the net value after deducting all the above. As reliefs such as the spouse/civil partner exemption, APR and BPR are normally unlimited, the effective tax rate averaged over the whole estate can often be well below 40%.  

According to calculations carried out by the Office of Tax Simplification, the effective IHT rate on death based on 2015/16 data rarely exceeded 20%. The age of that data obviously does not allow for inflation of asset values since 2016, but it also pre-dates the additional IHT relief provided by the Residence Nil Rate Band, which was introduced progressively from April 2017.   

As it stands, a married couple or civil partners with assets of up to two million pounds, who leave a home of sufficient value to children can pass on up to £1,000,000 on death before they start to incur inheritance tax. However, unmarried individuals or those without children can pay more IHT despite having similar net wealth as they cannot access the same exemptions and nil rate bands.  

How much revenue does IHT bring in? 

Whilst the 40% headline rate is among the highest of all UK taxes, IHT makes up a very small proportion of tax revenue for the Government, mainly due to the nil rate bands, exemptions and reliefs outlined above.  

In 2021/22, IHT raised approximately £6bn of tax revenue. Total receipts for HMRC in that year were £715bn, so IHT contributed just 0.8% of all tax revenue.  To put this in context, in that same year IHT brought in just 5% of the £104bn State Pension cost, or approximately half the money needed to fund the £11bn spent on Child Benefit payments.  

In comparison to other taxes, IHT is insignificant. For comparison, receipts in 2021/22 for other common taxes were: 

• Income Tax £220bn  

• VAT £158bn 

• Corporation Tax £64bn 

• Capital Gains Tax £15bn 

IHT’s small role in Government funding is nothing new. A comparison to equivalent data from ten years earlier reveals that in 2011/12 IHT contributed a similarly negligible 0.6% of total tax revenue. The fact this has barely changed in ten years is likely due to the RNRB (introduced from 2017) offsetting inflationary increases in asset values in the interim.  

Do all deaths result in IHT being paid? 

The recent press coverage of IHT tends to create an impression that it affects a lot of taxpayers.  

However, as we’ve seen, the money raised from IHT is insignificant in the scheme of total tax revenue. With that in mind, it is perhaps not surprising that relatively few deaths result in IHT being payable.  

The most recent data available indicates that, at its most widespread, an IHT liability arose in respect of less than 6% of deaths. Since the introduction of the transferable NRB and RNRB, the proportion has fallen to less than 4%, equating to approximately 23,000 deaths resulting in an IHT charge in 2019/20.  

Why is IHT topical now? 

Having established that IHT raises relatively little revenue and affects only a small proportion of the population, how do we explain the recent media interest?  

Firstly, whilst still small in the overall scheme of taxes, IHT receipts are at their highest level ever recorded, both in absolute terms and as a proportion of GDP. This is despite the relaxation to allow the transfer of unused NRB between spouses/civil partners, and the introduction of the RNRB which is similarly transferrable.  

Whilst the RNRB increased progressively from £100,000 at introduction in 2017/18 to £175,000 by 2020/21, it has been frozen at that level ever since. More significantly, the main NRB has been frozen at £325,000 since 2009/10, during which time the Consumer Price Index measure of inflation has increased by over 50% according to the Bank of England.  

Both nil rate bands are set to remain at their current level until at least 5 April 2028. Against a backdrop of continuing high inflation and rising asset values, this means more and more families are likely to have IHT to pay over the coming years.  

For many estates, the most valuable asset is the deceased’s home. A study by Rightmove in 2020 indicated that average UK property prices increased by 41% over the previous decade, during which time available reliefs have been frozen. 

Alongside frozen allowances, another area of media scrutiny is perceived unfairness in IHT. IHT is viewed by some as an optional tax. Given the available reliefs and nil rate bands, with careful planning it is possible to pay no IHT at all on death. Combined with relaxations to pension rules in this year’s Budget, the fact that pension funds are generally outside the scope of IHT also allows even the wealthiest of taxpayers to leave significant amounts of capital to their descendants without any IHT being payable.  

What’s the future for IHT? 

Tax policy rarely stands still and with a General Election expected in early 2025, the potential for major tax changes to IHT in the coming years cannot be ruled out.  

However, calls to scrap the tax are not as simple as might first appear. In a number of situations, IHT and Capital Gains Tax (CGT) are inter-linked, meaning policy makers need to consider the implications on CGT of making changes to IHT. Very broadly, IHT charges transfers on death, but CGT charges gifts or transfers made during lifetime. The two provide a balance – although not a perfect one, as they have different rates and allowances, and some lifetime events can escape both taxes, while others may be subject to both. However, the link means there could be unexpected consequences from removing IHT if changes are not made to CGT.  

For instance, if IHT were scrapped, since CGT is not charged on assets changing hands on death, any increase in value of assets held when someone dies would not be taxed at all. In contrast, gifts during lifetime are usually subject to CGT, so scrapping IHT could discourage individuals from making lifetime gifts and passing wealth on earlier. This would bring us back to the position identified earlier in connection with Capital Transfer Tax discouraging handing down family businesses.  

In the absence of IHT, CGT could be revised to rebalance the life/death tax position and potentially compensate for the lost IHT revenue. For instance, in the absence of an IHT charge on death, any increase in value from purchase to date of death could be made subject to CGT. Alternatively, anyone inheriting an asset might have to take on the original owner’s CGT base cost (which could be tricky to establish), meaning they would pay more CGT when they sell the asset. Under current rules, the CGT base cost for the person inheriting the asset is uplifted to its market or ‘probate’ value at the date of the original owner’s death, meaning any capital gain in the original owner’s lifetime is not subject to CGT. 

An alternative approach is to follow countries like Spain and shift the focus from taxing the deceased’s estate to taxing the recipient. Instead of taxing estates over certain limits, we could look at taxing recipients whose cumulative inheritances exceed certain allowances.  

These examples show how scrapping IHT may solve problems in one area, but risk creating further complexity elsewhere.  

ATT comments 

The ATT is a non-political, educational charity, so we do not have a view on the retention or scrapping of IHT. However, we can and do make representations on unintended consequences of new or existing tax law.  

We have previously called for simplification of a number of aspects of the IHT regime, including the way in which IHT operates for gifts made up to seven years before death, and the valuable but complex exemption for gifts made during lifetime out of excess income. We have also raised concerns about the complexity of the residential nil rate band in discussions with HMT and the (now-disbanded) Office of Tax Simplification (OTS).  These points were addressed in two reports by the OTS  commissioned by then-Chancellor Philip Hammond, in 2018 and in 2019.  

The recommendations by the OTS in those reports included: simplifying the rules for lifetime gifts, removing the CGT base cost uplift for assets which benefit from an IHT relief, and digitalising IHT forms and modernising the payment process. However, these suggestions have been largely ignored, perhaps due to lack of political engagement in the issue at the time, or global events taking priority since the reports were published. Whilst IHT is unlikely to be scrapped completely, it would certainly benefit from targeted reforms to make it simpler and easier to comply with for those who have to.  

In the absence of steps to simplify IHT, we are left with a tax which is misunderstood and unpopular, yet also surprisingly insignificant for the country in a financial sense.