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Comment: How to reform inheritance tax

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The current IHT system is generally regarded as unsatisfactory. Although it yielded a record £5.4bn in 2018/19 IHT now comprises less than 1% of total tax revenues and fewer than 5% of deaths result in payment of IHT. Reform of IHT requires a choice between two alternative wealth transfer tax systems: an estate tax which levies tax on the donor; and an accessions tax which charges the donee on gifts and legacies cumulatively over that donee’s lifetime. A revised IHT must consider the scope of any charge exemptions for spouses and civil partners and special reliefs. Fundamental to the design of a wealth transfer tax is the question of rates; whether rates should be progressive or flat; and the level at which tax should start to be levied. In particular the scope of IHT in relation to gifts from non-residents or to trusts set up...

It is a truth universally known that inheritance tax is unpopular. In its Inheritance tax review: first report (November 2018), the Office of Tax Simplification (OTS) cited a 2015 YouGov poll of UK voters, which found that 59% of respondents felt that inheritance tax was unfair, compared to just 22% who thought it was fair ( In January 2020, the All Party Parliamentary Group (APPG) published a report on the reform of IHT, co-written by the current author, discussing the pros and cons of a wealth transfer tax and looking at some alternatives (

Despite its unpopularity, IHT raises relatively little revenue. In 1895/96, the £14m from death duties represented about 35% of Revenue taxes. By 1968, estate duty produced only about £382m or about 5.8% of total Revenue receipts. The yield in 2018/19 stands at a record £5.4bn but now comprises less than 1% of total tax revenues. Fewer than 5% of deaths actually result in payment of inheritance tax.

The history of wealth transfer taxes in the UK – from estate duty in 1894 to capital transfer tax in 1974 and inheritance tax in 1986 – is essentially one of failure. Little money is raised overall, lifetime transfers of wealth remain largely untaxed, the system is immensely complicated and the incidence of IHT is currently regressive at the higher levels. As the Office of Tax Simplification (OTS) pointed out in its first report, the average rate of tax is 5% for estates with a net value of under £1m, and up to 20% for estates valued at £6m to £7m. It then falls to 10% for estates with a value of £10m or more. This does not take account of lifetime giving, which probably increases the distortion still further, as people whose main asset is the family home cannot easily give it away during their lifetime. (See, for example, the recent case of Shelford (Executors of J Herbert) v HMRC [2020] UKFTT 53, where an attempt to do so failed.)

In the light of such unpopularity, should the UK now follow Commonwealth countries such as Australia, New Zealand, Canada, India and Pakistan, which have abolished estate duty, and perhaps replace it with CGT on death? Or should the UK follow the Irish model and opt for a form of accessions tax? Russia, China, Israel, Sweden, Norway and Austria have no death taxes. Do we actually need any wealth transfer taxes?

This article rejects piecemeal reform: IHT is too flawed to work properly. Abolition is also rejected broadly on principles of fairness. A reformer is therefore faced with two alternative wealth transfer tax systems. The first system levies tax on the donor (an estate tax). The second charges the donee on gifts and legacies cumulatively over that donee’s lifetime (an accessions tax). The current UK IHT is an estate tax system. Ireland is an accessions tax system.

Although superficially attractive, accessions tax poses significant problems in terms of administrative complexity, compliance and record keeping, and above all in terms of trusts, where the model tends to break down. The author therefore favours the flat rate gift tax (an estate tax) detailed in the APPG report, which provides detailed analysis including worked examples. This article examines the reasons for that view, looking at some design aspects that must be considered for a wealth transfer tax to work effectively.

Design issues for wealth transfer taxes

The scope of the charge

One has to consider the following factors:

  • the residence of the donor;
  • the residence of the donee; and
  • the situs of the asset being given.

Currently, IHT offers a rather arbitrary form of relief. Foreign domiciled donors who have been in the UK for less than 16 years only pay IHT on UK assets; and even after 15 years will not pay IHT on foreign assets settled into trust before the 16 year deadline. Hence, IHT is linked not only to long term residence but also to the concept of domicile of the donor. The residence or domicile status of the donee is irrelevant, which is logical for an estate tax but leads to avoidance and leakage. A family now entirely based in the UK can have access to wealth held in trust IHT free for generations if the settlor was foreign domiciled when the trust was established.

It is suggested that domicile is abolished altogether as a relevant concept in taxing transfers of wealth. Liability should depend not on someone’s domicile but be linked solely to an objective test of long-term residence. Logically, an estate tax should be charged only by reference to the residence status of the donor, and an accessions tax by reference only to the status of the donee. However, this could lead to significant leakage. It is suggested that whatever model is adopted, the tax base should be extended to cover all transfers where either the donor or donee is a long-term UK resident (say, resident here for more than ten out of the last 15 tax years).

One difficulty this raises is double taxation. For example, Geoffrey, who has lived in France all his life, leaves foreign shares worth £10m to his daughter Ruth on his death. Ruth is a UK resident and domiciliary. Under IHT there is no tax. Under the above suggestion, however, Ruth would pay UK tax on receipt, but Geoffrey would also be liable to tax in France. Hence, a mechanism must be given for assigning taxing rights and providing reliefs where two different people are liable for tax on the same event – death. Our current treaties are largely inadequate for this purpose.

What happens if the long-term resident leaves the UK? It is suggested that the donor/donee would need to remain within the scope of wealth transfer taxes if UK resident for ten out of the last 15 tax years to prevent deathbed emigrations. Again, the double tax consequences of this would need to be considered carefully, as the donor may be subject to death taxes in two countries.

As regards the situs connection, it is suggested that regardless of the system, all UK assets should (as at present) be subject to wealth transfer tax, including residential property held in enveloped vehicles.

Spouses, cohabitees and relatives

Most countries provide for some relief, if not outright exemption, on transfers of property between spouses and civil partners (although the UK was almost the last to do so in 1972 under estate duty). Some think that spouse exemption should be extended to cohabitees or even siblings living together.

The argument for spouse/civil partner exemption is greater where rates are higher, as the hardship suffered on the first death is greater. However, a progressive estate tax raises further issues, as the surviving spouse will pay more on a single estate of £1m than they would on two estates of £500,000 each. In the case of accessions tax there are other complications. If, say, a husband’s inheritance from his deceased wife is spouse exempt, should this inheritance be ignored altogether in calculating the rate of tax on the husband’s other inheritances? Does it make a difference if the husband inherits a life interest from his wife, rather than inheriting outright?

A related question is whether gifts to distant relatives or friends should be taxed more heavily than gifts to (say) children, on the basis this is more in the nature of a windfall. This is more relevant to a progressive accessions tax than a flat rate estate tax. Any differentiation in favour of close family members would arguably increase concentrations of wealth, when one of the main objectives of this system is to disburse wealth more widely. The Resolution Foundation favoured an accessions tax in 2018 and did not suggest differential rates.

Special reliefs

Currently, the UK gives generous tax breaks to trading businesses and agricultural land. Should these continue? Much depends on the rate of tax. A high rate will generally require greater reliefs for family businesses, which will object that otherwise they need to be sold to pay the unplanned tax due on death. However, the current IHT system also creates avoidance and distortion by encouraging donors to retain the business until death to obtain the CGT step up. Most high rate wealth tax systems provide some relief for businesses. A low flat rate estate tax could instead offer no reliefs for businesses other than instalment relief over ten years. The effective cost for business at a 10% rate is 1% p.a.

Whatever the system, it may be sensible to exclude any gift not exceeding £250 in value (the current small gifts exemption) and, instead of the current medley of lifetime reliefs, have a higher annual allowance of, say, £20,000 or £30,000 p.a. (per donor if estate tax or per donee if accessions tax). This would allow some limited tax free lifetime giving without significant cost but larger lifetime gifts would be caught. The nil rate band, residential nil rate band, and all other lifetime and death reliefs other than spouse and charity exemptions would be abolished.


Fundamental to any wealth transfer tax design is the question of rates. Should tax rates be progressive or flat? At what level should tax start to be levied? If rates are low, there is less need for reliefs. The problem with the 40% IHT headline rate is that it leads to many reliefs that tend to favour the better off. But a flat rate seems non-progressive.

The type of system adopted also influences rates. The principle of accessions tax, which taxes a donee on all accessions of inheritances, necessarily envisages a progressive cradle to the grave system. The flat rate system recommended by the APPG was a 10% rate on all lifetime gifts above £30,000 and on death for estates between £325,000 and £2m; thereafter, 20% would be charged on death for estates of over £2m. There would be no nil rate band available in life but a single death allowance of £325,000. While this might seem a large headline cut from 40% to 10%, the effective average IHT rate currently rarely goes above 20% anyway and even that figure ignores lifetime gifts outside seven years.


Trusts and similar entities, which provide benefits to people without actually transferring wealth to them, always pose problems in any wealth tax system. In many trusts, income accrues to one group of beneficiaries, while capital accrues to another. How should these different interests be taxed? Should the trust be treated as transparent to the settlor or taxed as a separate entity?

HMRC suggests that taxation should be neutral between outright gifts and gifts in trust so that a donor uses a trust for purely non-fiscal reasons. (See, for example, the consultation on the taxation of trusts published in 2018 by HMRC at The current IHT system is far from neutral. It is broadly very favourable to trusts set up by foreign doms and harsh on trusts set up by UK doms, besides being complicated for little actual yield.

Trusts pose particular problems for accessions taxes. The general effect of trusts is to maintain concentrations of wealth and discourage distributions, which is the opposite of the objectives of an accessions tax. If you tax a life tenant at the same rate as an outright gift to him, how does this affect that individual’s lifetime cumulative accessions total, particularly if he never actually receives any capital but just an income interest? Is it fair to tax the donee at a higher rate and as if he had received the underlying capital if he merely takes a revocable income interest? If you tax him on the value of an income interest, how is it to be valued if revocable? What rate should be imposed on entry into a discretionary trust, given that it may have no history of inheritances as donee? Even if you cumulate all discretionary trusts set up by the donor, this does not necessarily fulfil the objectives of an accession tax, which focuses on the tax position of the donee rather than the donor. It is less easy to work out a compensating ‘neutral’ position for trusts compared with outright gifts under an accessions tax system.

It was suggested above that tax should be levied in relation to estate tax and accessions tax if either the donor or the donee were UK resident. Given this, one option is to impose wealth transfer taxes on trustees wherever resident, if any of the following are satisfied:

(i) the assets of the trust are UK situated;

(ii) the settlor is a long-term UK resident; or

(iii) any beneficiary is a long-term UK resident.

Under this route, the residence of the trustees (which can easily be manipulated) is irrelevant. However, (iii) could raise significant design problems. For example, a foreign resident settlor who settles foreign assets into trust may be able to avoid the entry or periodic charges for some time simply by ensuring that there are no long-term UK resident beneficiaries named, even if later added. France has adopted this type of model with limited success. Is it fair that even the presence of a discretionary beneficiary can subject the trust to periodic charges?

A better option (at least for a flat rate estate tax) may be as follows:

  • Discretionary trusts set up by a long stay UK resident settlor are subject to a 10% entry charge (in the same way as a lifetime gift to an individual) or a 20% charge if made on death from an estate of over £2m.
  • Discretionary trusts set up prior to the settlor becoming a long-term UK resident would be subject neither to the 10% entry charge, nor to the periodic charge while the settlor was not a long-term UK resident, even if there were UK beneficiaries.
  • Discretionary trusts are subject to a periodic tax of 3% every ten years from the date the settlor first becomes a long-term UK resident (and for as long as the settlor remains a long-term UK resident). There is no nil rate band so there would need to be some lifetime allowance of, say, £30k for each trust below which no periodic tax is payable. The residence status of the beneficiaries is ignored while the assets are held in a discretionary trust. It is the status of the settlor that determines the periodic charge.
  • However, a distribution from any discretionary trust to a long-term UK resident beneficiary would be subject to estate tax at 10% (with a possible credit for the past periodic tax paid), even if the settlor has never had any connection to the UK.
  • A life interest trust set up by a long stay UK resident settlor would be subject to a 10% or 20% tax on gift into trust, irrespective of the status of the life tenant. A trust set up by a settlor with no UK connection would also be subject to 10% tax if the life tenant was a long-term UK resident beneficiary, in line with the principle discussed above that if either donor or donee is long term UK resident tax should be paid.
  • On death or on earlier termination of the life interest, 10% or 20% tax would be payable if the life tenant was a long stay UK resident in the same way as if it was an outright gift to the donee. Hence, the current long term IHT tax free status of trusts set up by foreign doms would be curtailed.

Interaction with other taxes

Wealth transfer taxes cannot be viewed in isolation. Some of the arguments for and against an annual wealth tax or mansion tax in conjunction with a wealth transfer tax have been considered in the APPG report and the Mirrlees report on taxation of wealth, and for reasons of space are not considered further here.

Should CGT be charged on death? When CGT was first introduced in 1965, death was also an occasion of charge, although deductible against estate duty. The charge was abolished in 1971 and a step-up introduced. The abolition was for the practical reason that (in the government’s view) the levy of two taxes on the same event, CGT as well as estate duty, imposed an excessive burden on estates, and particularly family businesses. By contrast, the CGT charge on lifetime gifts remains unless the gifted asset is a qualifying business or is given to a lifetime trust, in which case the gain can be held over (see TCGA 1992 s 260). In the case of an estate tax, the liability for both CGT and estate tax on gifts will fall on the donor. In the case of accessions tax, the donor bears the CGT and the donee pays the accessions tax. Nevertheless, it is still likely to be perceived as double taxation. In itself, this is not necessarily irrational, as the two taxes are doing different things; however, whether in practice this would be tolerated is doubtful, quite apart from the additional compliance burden on executors as many more estates would be brought into charge.

A compromise may be to roll over the accrued gain on any gifted asset (whether transferred during lifetime or on death) to the donee. In this way, the gain will be subject to tax in the long run but the double charge to CGT and wealth transfer tax on the same occasion is avoided. However, this will require heirs to track the original base cost of the deceased or donor. On assets such as farms and businesses that continue for several generations, the CGT bill may become disproportionately large and harder to calculate. Inflationary gains may be taxed. How would main residence work? Would credit be given for the deceased’s period of occupation? On that basis, if John died having owned and occupied a house for 15 years and his children sold the house five years later having rented it out, only 75% of the gain would be exempt.

Final thoughts

In conclusion, there are no easy solutions but, in the author’s view, taxing wealth better requires some radical reforms, rather than more tinkering with IHT, and some consideration given to CGT as well. Cut the rates and abolish the reliefs, and try to bring lifetime giving into a more rational system for transferring wealth.