Unlock the Editor’s Digest for free
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Chancellor Rachel Reeves is looking to make sweeping changes to UK inheritance tax in her Budget, drawing on proposals from a five-year-old blueprint for reforming the levy.
Reeves, who is aiming to close a £40bn government funding gap, has been studying a 2019 report by the now-defunct Office of Tax Simplification, according to people briefed on the chancellor’s Budget preparations.
The chancellor has looked at extending the “seven-year rule” — a bedrock of UK inheritance tax planning governing gift giving — from seven years to 10 years, people briefed on her thinking told the Financial Times.
Currently, assets given away during an individual’s lifetime are exempt from IHT if the person lives for at least seven years after making the gift. Gifts made three to seven years before your death are taxed on a sliding scale known as taper relief.
Extending the rule to 10 years would make it harder for wealthy people to pass on assets without paying inheritance tax as they would need to live longer to do so.
The OTS, an independent body set up to advise the chancellor that was abolished last year, recommended reducing the rule to five years and scrapping taper relief.
IHT currently raises about £7.5bn each year. Rising house prices and frozen tax thresholds mean more middle class families have been dragged into paying IHT, yet the very wealthy often make use of a complex web of reliefs and exemptions to avoid or reduce it.
The OTS report also questioned the IHT exemption for Aim shares, with its then director telling the FT: “We think Aim is the only market in the world where investors can receive an inheritance tax benefit.”
The IHT exemption on Aim shares has also been highlighted by the Institute for Fiscal Studies and Demos think-tanks as something the chancellor should scrap. However, the suggestions have sparked warnings that this could lead to the collapse of the market.
The chancellor has been a long-standing critic of what she regards as wealthy people using loopholes to avoid IHT and her team has been looking at ways to raise taxes on those with “the broadest shoulders”.
Writing in her 2018 book The Everyday Economy, Reeves criticised loopholes left by the Conservatives through which the “healthy, wealthy and well-advised” can avoid paying tax.
The tax, she said, needs to be either reset or “shifted wholesale” to a tax on the receipt of any gifts throughout a lifetime. Under this idea, tax on all gifts would be made equal, thus making it harder to avoid tax.
Labour officials have for weeks said that Reeves was looking to raise more from inheritance tax. The Treasury declined to comment on Budget “speculation”.
The 2019 OTS report made a number of recommendations on gifting that were not acted upon. At present, wealthy individuals can make unlimited “gifts from existing income” free of IHT if these are made on a regular basis and do not affect the giver’s standard of living.
The report recommended introducing a fixed percentage of income that people were allowed to gift and remove the need for this to be regular, or scrap the exemption rule altogether and replace it with a higher annual personal gift allowance. This allowance could in turn be used to make gifts either from capital or income.
Among the potential reforms are a push to bring defined contribution scheme pension pots within IHT, instead of exempting them on death. Ending this loophole would raise about £400mn in 2029-30, according to research by the Institute for Fiscal Studies.
Among the other loopholes that could be addressed are relief from IHT for business assets and agricultural land. Removing these wholesale would raise another £2bn by the end of the forecast period.
The plethora of loopholes in the IHT system means that large estates tend to pay a lower marginal rate. Despite a headline rate of 40 per cent, the effective rate of inheritance tax peaks at 25 per cent for estates worth between £3mn and £7.5mn, before declining to 17 per cent on estates worth at least £10mn, according to the IFS.
The OTS also recommended the removal of the capital gains uplift that currently applies when someone inherits assets.
The measure, which has been a part of the UK tax system since the 1970s, allows the person inheriting an asset to acquire it at the market value on the date of death, rather than the amount originally paid for it.
