Britain's most hated tax 'should be extended to more homes'

A major shake-up in inheritance tax to grab more cash from the estates of the wealthy people is vital to fund public services, according to the think-tank Demos.

It argues changes to the tax are “definitely the right place to start” for the Government, with inheritances “becoming increasingly more important and valuable”.

It suggests the proportion of estates which attract what some have described as a “death tax” could rise from around 3.7 percent to 6.4 percent if we copied the system that applies in South Korea.

Currently, if a homeowner’s estate is worth more than £325,000, they are liable to pay a flat rate of 40 percent tax on anything over that figure.

However, there is no tax to pay if you leave everything above the threshold to your spouse or civil partner, while the threshold can increase to £500,000 if you give away your home to your children or grandchildren.

At the same time, there are various other ways to avoid “Britain’s most hated” tax - for example by passing on wealth at least seven years before death.

There are also several other exemptions, including for those passing on private pensions, certain types of investment and farmland, which could be wiped out under any shake-up.

The report, titled “The Future of Inheritance Tax”, does not make specific recommendations, but sets out several options it considers the “most promising”.

It argues that Labour could try to win public support for the shift by pledging that the additional revenue is earmarked for specific areas — such as social care or homes for the next generation.

Demos’s analysis of OECD data found that only 3.7 percent of deaths in the UK in 2020-2021 resulted in an inheritance tax charge.

This compares with 6.4 percent of deaths in South Korea and 9.3 percent of deaths in Japan.

Researchers at Demos suggest following inheritance tax rules that apply in South Korea could raise as much as £9 billion extra each year.

Senior researcher at Demos, Dan Goss, said: “The new Labour government are promising change for the country. Unfortunately, given the current fiscal environment, they have very little money available to deliver that.

“Reports suggest they are looking at changes to inheritance tax as a way to unlock more public funds. We think this is the right place to start.”

He insisted it is possible to make changes to the tax regime to raise billions “while bearing no cost on the vast majority of people”.

Mr Goss said following the system that operates in countries such as South Korea would deliver a regime that is fairer, simpler and more transparent.

It would involve closing loopholes that allows the very wealthiest of families to minimise their inheritance tax bills. There would also be new taxes applied when older people pass on their wealth during their lifetimes.

“While in the UK, around 4.2 percent of inheritance passed on in 2019-20 was paid in tax, the figure in South Korea was 9.7 percent in 2022,” said Mr Goss.

“If taxing the same proportion of inheritance in 2019-20, the UK government would have raised around £11.6bn – an additional £6.5bn compared to what it actually raised.

“If also taxing the same proportion of lifetime wealth transfers as South Korea (9.1 percent), we would have raised an additional £2.5bn on top.”

He said removing loopholes would see the very wealthiest families paying more in heritance tax.

Mr Goss said: “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.”

Demos said another option would involve scrapping inheritance tax and replacing it with a system of capital gains tax on death, something Norway has done already.

It said: “We could shift taxation away from inheritance per se, and towards ‘inherited capital gains’ – the growth in an asset’s value between being bought and being passed on as inheritance.”

Demos said: “Norway, despite abolishing inheritance tax, seems to have achieved more public support for their system of taxing inherited assets, while potentially not losing revenue, by taxing inherited capital gains at a higher rate than they taxed inheritance.”

Urging change, the think tank said: “Looking abroad shows us how the UK could have a more ambitious and hopeful vision for reforming inheritance tax – one that raises more revenue while also making it fairer.”