Opinion: Inheritance Tax inconsistencies prove it's time for wholesale reform

The richest aren’t paying their fair share of Inheritance Tax. It’s time to start again on this hated charge.

It’s no secret that Inheritance Tax is one of the least popular levies around.

A study by YouGov a few years ago found that 59% of people found it unfair, while it’s a subject guaranteed to lead to frayed tempers over the dinner table at many homes across the nation, mine included.

But it’s also a big earner for the Government. According to data from the taxman, the Government pocketed around £5.2 billion in Inheritance Tax receipts in the 12 months to January 2019.

In theory, the rate that you pay seems pretty simple – 40% on the value of your estate, above the Inheritance Tax threshold, which currently stands at £325,000.

But the actual effective tax rates people pay can be significantly different.

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How the super-rich are sidestepping Inheritance Tax

Canada Life has analysed data from HM Revenue & Customs to break down the effective Inheritance Tax rates paid by estates of different sizes, and it makes for some shocking reading.

The firm claims that estates worth more than £10 million end up paying an effective Inheritance Tax rate of just 10%.

That’s just half of the 20% effective rate paid by estates worth between £2 million and £3 million, while even estates worth £1 million to £2 million pay around 17%, significantly more than the richest.

Canada Life argues that this is down to the different assets likely to be seen in larger estates.

For example, the wealthiest estates are less likely to have a significant portion of that wealth tied up in residential property, but more likely to have significant amounts in securities, which can benefit from 100% tax relief.

In other words, the actual make-up of the estate becomes as important as the actual value when working out what you are likely to end up paying in Inheritance Tax.

Fail to prepare, prepare to fail

As Neil Jones, market development manager at Canada Life, puts it a “willingness to plan” will make a big difference to the effective tax rate your estate pays after you pass away.

As the tremendous, and comprehensive, loveMONEY guide to Inheritance Tax points out, there are a whole host of measures you can take to reduce the amount your estate has to hand over to the taxman before it gets divided between your loved ones.

By doing your homework in advance and making use of things like gift allowances – as well as moving your money into assets that are more likely to benefit from tax relief – you can make a significant difference to your eventual bill.

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What do we want from Inheritance Tax?

But this raises the question of what we want Inheritance Tax to be.

On the face of it, it seems a simple tax – if you leave an enormously valuable estate when you die, then you pay a flat rate of tax on a portion of it.

It seems like a progressive tax too, since only the richest estates pay it – currently just 5% of estates in the UK are subject to Inheritance Tax.

However, this clearly isn’t the reality of it, with the wildly inconsistent way that different assets can benefit from tax relief, to the various loopholes and potential tax breaks open to you if you start planning how to divide your estate up well before you actually die.

If you’re wealthy and have a decent financial adviser, you will end up paying less than people who are far less well off but who happened to purchase a home in the south before the house price boom.

That’s a ridiculous situation to end up in, and the only way to fix it is to strip the tax back to its fundamentals.

Last year the Office of Tax Simplification published its first report on Inheritance Tax, though this very much focused on the process side of things – the difficulties people face in filling in forms, the complicated nature of the guidance from the taxman, and the fact that the entire system is not online.

The body’s second report is due out this year, and should look in more detail on the actual make-up of the tax itself.

The current system is so complicated because, for years, the authorities have fiddled around at the edges rather than have the guts to carry out a wholesale reform.

It’s time to start again, removing all of the well-intentioned but unnecessarily complicated additions that have turned Inheritance Tax into a mess.

It may be bad news for the super-rich and their financial advisers, but that’s a price worth paying for a tax system that is fair.