Four ways the government could increase inheritance tax in upcoming Budget raid

The Chancellor is expected to target a number of exemptions and loopholes in the inheritance tax regime in order to bring in billions of pounds from the estates of the dead

The government is poised to raise more money through inheritance tax in what is forecasted to be the largest tax-raising Budget on record. The Chancellor is eyeing a number of exemptions and loopholes to bring in billions from the estates of the deceased, reducing the amount people can pass on to their loved ones.

At present, inheritance tax is levied at 40 percent on estates valued over £325,000. However, due to various exemptions, including those related to the family home, most people can pass on £1 million without paying the tax. This results in less than 4 percent of all estates being liable for inheritance tax, while the wealthy, with estates worth over £10 million, often reduce the amount paid by utilising various exemptions. Specific changes to the rules will remain confidential until the Budget on October 30, but think-tanks have highlighted areas where inheritance tax loopholes could be eliminated.

The Demos think tank suggested that the UK could emulate South Korea's inheritance tax rules, which would increase the percentage of estates affected by the tax from the current 3.7 percent to 6.4 percent. This would prevent the wealthy from using exemptions and loopholes to evade the tax, potentially boosting government revenue by up to £9 billion annually.

Demos has highlighted: "We could make our system fairer. In the UK, the wealthiest estates tend to pay lower effective rates (the percentage of all inheritance paid in tax). Those worth between £2m and £7.5m paid 25 percent in 2020-21, while those over £10m only paid 17 percent. In South Korea, meanwhile, the effective rate reached 33 percent for estates between £6m and £30m, and 44 percent for those over £30m in 2022."

Discussing potential reforms, they suggest addressing various IHT exemptions and loopholes that could be scrapped. In pensions, individuals are currently able to hand down pension pots potentially worth in excess of £1 million entirely free from inheritance tax should they pass away before the age of 75. It's anticipated that such an exemption might be discontinued resulting in beneficiaries being taxed on such pension inheritance.

Regarding gifts, under current ordinances, people can circumvent inheritance taxes by transferring their money and possessions at least seven years prior to their death. Additionally, up to £3,000 annually can be gifted to loved ones without attracting any tax liability. The Chancellor may consider alterations to these regulations, possibly extending the requisite period for tax-exempt transfers to, say, a decade before a person's demise, while also reducing the annual £3,000 gifting threshold.

Proposals to incentivise wealth transfers earlier in life could have encouraging ramifications for the economy, potentially elevating consumer expenditure. An offshoot could be that more senior citizens opt for smaller homes and bestow substantial sums to assist their offspring in entering the property market, when considering investments. At present, individuals can purchase shares in companies that aren't listed on the stock market, and these shares are not subject to inheritance tax (IHT). This loophole is often exploited by the wealthy to avoid paying IHT.

However, this exemption could be abolished or a limit could be set on the value of shares held in such investments. . Currently, farmland and family businesses can be passed on free of IHT. This has led to some affluent families buying large amounts of farmland without utilising it, simply to dodge IHT. This strategy could be banned.

Rachael Griffin, a tax and financial planning expert at Quilter, commented: "Inheritance tax (IHT) is one of the most hated taxes in Britain, often viewed as unfair. The super-rich tend to avoid it by hiring tax advisers to navigate the complex web of reliefs and exemptions."

She added: "Consequently, the majority of the annual £7bn revenue comes from those who are well-off, but largely because they have worked hard, saved, and invested diligently throughout their lives."

"For many, IHT is an emotive issue. Frozen thresholds mean that a growing number of taxpayers have found themselves caught in a whirlpool of ever-evolving tax codes and regulations. In reality, IHT has been ripe for reform and simplification for years, as it is full of impenetrable and irrelevant details that need to be reviewed."

She further commented: "The Conservative Party, under Rishi Sunak, flirted with the idea of reducing, if not abolishing, IHT to woo voters. If Labour’s reforms are perceived as a hasty tax grab, they are likely to receive significant backlash. Policymakers should tackle IHT reform seriously instead of using it as a political tool and revenue generator."

"For some time, the Labour Party has eyed the reform or even closure of several tax reliefs, such as agricultural and business property relief with a view to potentially removing, capping, or redefining these benefits, which could have the knock-on effect of AIM share losing their inheritance tax break. A move that would seem odd for a government looking to drive growth and investment in UK assets."

"If reports are true and Labour opts to make IHT more punitive, it could choose to balance this by modernising gifting laws. Simplifying the IHT regime and increasing the annual gifting exemption could ease the complexity of transferring assets and help families pass wealth on during their lifetime. Raising the gifting threshold would encourage earlier wealth transfer, reducing future IHT liabilities, and potentially boosting consumer spending."