Death and other taxes: there may be a better way - Opinion
Last year Inheritance Tax (IHT) produced a record £5.4bn. The fact that the personal tax-free allowance has remained at £325,000 for 10 years and property prices have escalated are the chief culprits in this tax bonanza
When the consensus among political parties of all stripes, economic commentators and advisers is that IHT needs reform, then it probably does. What they do not agree on, of course, is what reform looks like and how the revenues thus surrendered should be replaced.
There have been suggestions that the UK might follow Australia, where death taxes were abolished decades ago. There would of course be a price to pay for what would be a wildly popular measure in the Home Counties.
The Australian Government may not impose a death tax, but it does charge any subsequent asset disposals to capital gains tax unless an exemption applies. To explain: where the asset is bequeathed to someone there is no tax on that transfer, if that asset is later sold it is subject to capital gains tax – using the cost at original acquisition rather than any uplifted value at the date of death to calculate any gain on disposal.
Similarly, if an Australian executor sells assets with the intention of distributing cash to beneficiaries instead of distributing the asset, there will be a potential capital gains tax charge on that sale. The intention is to encourage asset retention within families without a tax charge at death, which is something for which those lobbying against IHT have argued. As there is no tax charge at the time of death there is no equivalent probate value of those assets, which is a disincentive to disposal and the generation of a capital gain.
In France and elsewhere the tax authorities impose an annual wealth tax. This is based on net wealth and usually has an exempt threshold. The problem with this variety of tax is that savvy taxpayers can manipulate the value of their net wealth with a combination of structuring how assets are acquired and debt. And France still charges tax on death as well as on lifetime gifts. Levying a lifetime wealth tax does not seem to be a viable alternative to IHT, and there are also issues where the assets do not generate income to cover the tax.
In the US, the IRS imposes lifetime gift taxes and death taxes. While the thresholds for administration and payment of these US taxes may be relatively generous, (e.g an estate must be greater than $10m before a return is required) the tax system is ferociously complicated. If the UK is seeking to adopt a system that is simpler than the current one, the US is not a good role model.
Countries such as Israel, Portugal and Italy have introduced tax incentives that include reduced or no IHT to attract wealthy foreigners, and they are succeeding in these reforms.
Portugal for example, has introduced the concept of non-habitual residence (NHR) which applies for the first 10-years of residence. The flat rate of income tax is charged at 20% irrespective of level of income and there is either preferential or no tax levied on dividends or other investment income. The main encouragement for wealthy UK retirees to the sunny Algarve seems to be no inheritance tax, gift or wealth tax if you are NHR. The usual rate of income tax may be 48% once the NHR period has ended, but IHT is then levied at 10%; a huge difference to the 40% charged in the UK.
While the abolition of IHT may be a popular headline, it does come with a warning that alternatives may be simpler to understand, but more draconian and costly in their impact. Countries that seek to attract wealthy residents with reduced or no IHT being levied on death usually have a limitation on the period that incentive applies. In many cases an individual remains subject to UK IHT as they have failed to shed their links to the UK as far as the taxman is concerned.
Taxation is required to support Government spending, and abolishing IHT without reform of other taxes is unrealistic. IHT in its current guise is unpopular, complicated and requires onerous record keeping. The Australian model does seem to work on many levels, but anyone thinking that abolishing IHT will reduce the overall tax take will be disappointed.
Lynne Rowland is a tax Partner at Moore Kingston Smith
Originally published in Economia on 24 October 2019.