Should a Gift Tax replace Inheritance Tax
Inheritance tax raises less that 1% of total tax revenues in the UK and yet is one of the most emotive and controversial taxes on the statute books. For many people such a tax penalises families who have saved their whole life and wish to pass those savings on to the next generation. They feel inheritance tax is a form of ‘double taxation’, a tax on monies already taxed through income or capital gains tax.
There are many issues surrounding the perception and practical implementation of inheritance tax which makes it ripe for reform, possibly replacing it with a Capital Acquisitions Tax as adopted in Ireland.
Looking at some of the current issues with the tax:
One of the fundamental issues is the name of the tax. Introduced in 1986, inheritance tax replaced the Capital Transfer tax, a name which more accurately reflects the nature of the tax burden being levied upon wealth transfers either during lifetime (within seven years of death) or upon death. There is an automatic reluctance to accept a tax which is deemed to be a ‘death tax’. There is also a fear by many families/individuals that all of their estate would be eaten up by tax but many people are not aware of the £325,000 nil rate band, with only 7% of estates paying inheritance tax.
Double taxation is seen as inherently unfair but actually occurs far more often than is realised. Any consumption tax (i.e. VAT) is paid on goods or services by individuals out of their post-tax income, effectively creating double taxation. However, much of the wealth in most estates has not already been taxed, those estates comprising property or assets only taxed on sale and these assets benefiting from a ‘free’ capital gains tax uplift on death.
There are several exemptions from the tax principally under the business property relief and agricultural property relief rules. These were introduced to allow businesses to be continued following succession without being damaged or having to sell the businesses to pay the tax. There are, however, significant loopholes whereby these businesses can be sold immediately after death by the recipient without any tax payable.
Residential Property/the ‘£1 million’ threshold
In response to a proposal by Gordon Brown for Labour to potentially lift the zero-band threshold to £1m, George Osborne introduced the unnecessarily complicated Residence Nil Rate Band (RNRD). This exemption allows for residential properties passed down to lineal descendants to have an additional exemption (£175,000 by 2020/21) from inheritance tax. This amount, when added to the £325,000 nil rate band and when doubled through the transferable nil rate band between husband and wife, achieves the magic £1m figure. This political contrivance has no place in today’s statute when we are looking to simplify the tax system.
‘Voluntary in nature’
As the tax only applies upon death or on gifts within seven years of death, it is relatively simple (for wealthy individuals at least) to pass on their assets outside of this period thus avoiding the tax.
An Alternative Idea
As suggested above, one potential solution is to tax the recipient of the transfer rather than the donor – a gift tax. A resident individual would receive a lifetime allowance and only pay tax on receipts above this level. The rate of the tax would need to be determined but should be set at a level equivalent to that derived from earned income to avoid the incentive for the creation of avoidance schemes. There would likely be more of an acceptance of this tax simply by not being called or considered a ‘death tax’.
One of the major advantages of such a scheme would be to reduce wealth inequality. With each recipient receiving the lifetime allowance there is an incentive to spread the gifts across a number of beneficiaries thus allowing for greater tax saving by the recipients. Taxing at marginal rates would also benefit lower rate taxpayer recipients and penalise higher rate taxpayers generating a more progressive outcome.
The need for exemptions would also be reduced, specifically the ‘seven-year rule’ thus reducing the avoidance of the tax through tax planning by wealthy individuals. In addition, the BPR and APR could have conditional exemptions allowing the recipient to retain these assets/businesses without paying tax immediately but requiring the tax to be paid when the businesses are sold.
This scheme has operated in Ireland since 1976 and there appears to be no sign of this changing. It generated 0.88% of the total tax yield in 2017, a very similar level to the 0.7% of tax yield generated in the UK from inheritance tax in the same period. Similarly, around 20,000 people per annum pay this tax in Ireland, just 0.8% of the population.