Rishi Sunak’s government is exploring major changes to inheritance tax in a bid to boost the Conservative party’s standing ahead of the UK general election expected next year.
The potential changes include cutting the rate at which the highly divisive tax is levied — at present 40 per cent — or abolishing it altogether. Asked about discussions inside government on the issue, the prime minister said he did not “comment on tax speculation”.
“The most important tax cut I can deliver for the British people is to halve inflation,” added Sunak, a reference to one of the five “people’s priorities” he has vowed to deliver before the next national poll.
Lowering inheritance tax or scrapping it are both options that have been debated by Downing Street aides, according to government insiders, but no decision is expected until 2024.
Chancellor Jeremy Hunt said last week that tax cuts would be “virtually impossible” in his Autumn Statement on November 22. Any move on inheritance tax would be expected to come in next spring’s Budget or as a pledge in the Tory election manifesto.
What is inheritance tax?
Inheritance tax (IHT) is applied by HM Revenue & Customs to the estate of someone who has died, including all their property, money and possessions. It is charged at a headline rate of 40 per cent on estates that are worth more than £325,000.
Under the “residence nil-rate band”, people can pass on a main home to their children or grandchildren, raising the tax-free allowance by £175,000 and enabling them to pass on a total of £500,000 before IHT is applied. For a couple, the figure rises to £1mn.
How much does inheritance tax raise?
The amount of money paid in IHT has steadily increased in recent years, hitting an all-time high of £5.76bn in 2020-21, the latest full year of data, according to HMRC. However, it still accounts for less than 1 per cent of total tax revenues. By contrast, income tax raised around a third of tax collected and VAT generated a fifth of total tax revenues in 2020-21.
More up-to-date monthly estimates published by the tax authority have shown a continued surge in IHT receipts. In the current tax year, the Office for Budget Responsibility, the independent fiscal watchdog, has forecast that IHT will raise £7.2bn.
Who pays inheritance tax?
A very small proportion of the population is affected by IHT. HMRC’s latest figures show that of the 722,000 deaths recorded in the UK in 2020-21, just 27,000 estates paid IHT — representing a charge for less than 4 per cent of deaths.
However, the number of estates that are liable for IHT has risen in recent years, jumping by 17 per cent in 2020-21 compared with 2019-20. HMRC has attributed the increase in 2020-21 to the rise in mortality at the height of the Covid-19 pandemic, but tax experts also pointed to more people being dragged into its net by rising asset values and frozen IHT thresholds.
Rachael Griffin, tax and financial planning expert at wealth manager Quilter, said “many more middle-income earners, particularly in the south-east of England” were being affected by IHT in part because of “property price growth”.
The housing market plays a big role in the location of estates paying inheritance tax, according to official data. London and the South East were home to the most of the estates that incurred IHT charges on death in 2020-21 — 4,800 and 5,650, respectively.
The two regions each accounted for £1.3bn of the total IHT tax liability in 2020-201, or 45 per cent of the IHT liability across the whole UK. The average tax bill in London was £279,200.
By contrast, HMRC said the lowest number of IHT-paying estates were in the north-east of England, Northern Ireland and Wales owing to “lower house prices” and therefore “lower values of wealth transfers”.
Why would Sunak think abolishing or cutting IHT would boost his election chances?
Many parts of the UK with high concentrations of estates paying IHT are home to constituencies held by Conservative MPs, and the party is hoping a shake-up could win votes.
Sunak and his advisers may calculate that changing IHT will not alienate voters who are unlikely to pay it. Even though the proportion of UK estates that pay IHT is in the single digits, it has been described as “unpopular”, “unfair” and “Britain’s most hated” tax, and does not poll well with voters.
One of the reasons behind that perception, according to Dan Neidle, a tax lawyer and founder of Tax Policy Associates, is that IHT is riddled with exemptions and reliefs so that the wealthiest have “lots of opportunities to avoid [paying] it” in practice.
Nimesh Shah, chief executive of accountancy firm Blick Rothenberg, said history suggested a move by Sunak “may be a vote winner”.
He cited the promise to cut IHT that was made in 2007 by then shadow chancellor George Osborne, at a time the Tories feared annihilation in a rumoured snap general election.
The policy announcement proved immediately popular and was later deemed one reason why Gordon Brown, then prime minister, decided against going to the polls.
Will abolishing IHT be popular?
Tax advisers said their clients had already reacted positively to reports that the government was exploring cutting or scrapping IHT. But some cautioned that any tax giveaway would probably need to be filled by tax rises elsewhere or by spending cuts.
Lucy Woodward, partner at accountancy firm Saffery, said: “Any future government looking to abolish IHT would need to tread a political tightrope — balancing any voter goodwill gained with an almost £6bn hit to the Treasury.”
Neidle warned that politicians could fall into the “trap” of thinking that a tax policy well received in focus groups or opinion polls would be popular if enacted.
“IHT is an unpopular tax. It doesn’t follow that its repeal would be popular,” he said.
Meanwhile, the Tories will need to beware of the perception that they are giving a tax break to the wealthy. Labour, which is well ahead in opinion polls, has sought to draw a link between Liz Truss’s ill-fated “mini” Budget when she was prime minister last year and with the latest discussions in Number 10.
Darren Jones, shadow chief secretary to the Treasury, said: “A year ago Liz Truss trashed the economy with unfunded tax cuts. Now Rishi Sunak is doing what Liz Truss wants.
“Abolishing inheritance tax — which 96 per cent of people never pay — is an unfunded tax cut of £7.2bn per year. The biggest threat to the economy is the Conservative party.”
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