The last tax year has proven to be yet another record year for UK inheritance tax (IHT) receipts. HM Revenue & Customs (HMRC) announced it received an extra £200 million in 2018/19, generating a total of £5.4 billion. This burden was shared between 27,000 families, paying an average tax bill of £200,000 each.
Usually, higher tax receipts can be explained through government measures to increase tax rates and widen the scope for liability. However, the 40% rate has been unchanged since IHT’s inception in 1986, and an additional main home relief has been in place since April 2017.
So why is IHT revenue increasing and even forecasted to reach £10 billion by 2030?
Frozen reliefs and rising property prices
It is not just the tax rate that has been unchanged over the years. The ‘nil-rate band’ – an individual’s tax-free allowance – has stayed at £325,000 for the last decade and the annual exemption for lifetime gifts has been frozen at £3,000 since 1981.
Being static, these bands have not kept up with inflation over the years, and have been eradicated further by rising property values. As house prices have continued to grow, so has the number of estates being pushed over the IHT threshold and the amount of tax payable. Over the past five years, it is estimated that 50% more properties have fallen into the IHT net.
The residential nil-rate band (RNRB)
Since April 2017, the RNRB has provided extra inheritance tax relief when passing on a main home, including overseas homes owned by UK domiciles. Starting at £100,000 per person, the allowance increased by £25,000 in 2018 and by the same amount this April to reach its current level of £150,000. It will peak at £175,000 in 2020/21 before it starts tracking the Consumer Price Index each year.
Any unused relief is transferable to a spouse on death. When combined with the standard allowance, this means couples today can potentially pass on up to £950,000 tax-free, or £475,000 for individuals (increasing to £1 million/£500,000 in April 2020/21).
While this sounds high, remember all owned assets may be considered for IHT purposes, including savings, investments, vehicles, businesses, life insurance policies and other properties.
Limitations of the home allowance
Despite being introduced to reduce the number of liable home-owners, the RNRB has failed to do so in part by underestimating the housing market, particularly in certain regions. While official statistics put the average UK house price in August 2018 at around £232,000, it was more than double that in London at £479,991 and £328,287 in the South East.
Furthermore, eligibility for the RNRB is quite restrictive. The full tax-free allowance only applies to a main residential home that is directly passed to children and grandchildren, valued under £2 million. Higher value properties are subject to a tapering system that eliminates the allowance entirely when a home exceeds £2.3 million (in 2019/20). Regardless of value, heirs other than direct descendants and second homes or investment properties do not qualify.
There are also concerns that many people are not taking advantage of the RNRB because they are simply not aware it exists or cannot understand how it works.
By commissioning the Office of Tax Simplification to review the “particularly complex” IHT regime in February 2018, UK Chancellor Philip Hammond admitted how confusing the system can be. So far, there have been no changes to the rules, but it will be interesting to see what develops.
In the meantime, with such a complex, limited framework within a still-buoyant housing market, the relief system looks unlikely to reverse the trend for ever-increasing inheritance tax revenue.
Changes to non-domicile rules
Reforms to non-domicile rules could have also helped increase IHT earnings. As it is domicile that determines liability, not where you are resident, many expatriates remain subject to UK IHT, often without realising it.
Changes from April 2017 mean it can take up to four years to lose a UK domicile of origin after relocating and acquiring a domicile of choice in your new country.
Foreign-born UK residents are also now deemed to be UK domiciled after living in the UK for 15 (previously 17) out of the last 20 tax years.
Regardless of domicile, UK-based assets always attract UK inheritance tax. Before 2017, however, this did not include UK residential properties that were indirectly-owned (‘enveloped’) through a trust or corporate structure. Now, all UK residential property is within IHT firing range.
Cross-border estate planning can be a minefield – you could even be subject to inheritance taxes in more than one country – so take specialist advice to get it right and take advantage of the planning opportunities available.
The tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.
By Adrian Hook
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Adrian Hook is a Partner of Blevins Franks and has been providing holistic financial planning advice to UK nationals in the Algarve since 2007. Adrian is professionally qualified, holding the Diploma for Financial Advisers.