OECD report on inheritance tax
The OECD have published a report Inheritance Taxation in OECD Countries which explores the role that tax could play in raising revenues (given the Covid-19 crisis) and to address wealth inequality and improve efficiency in the future.
Based on a comparative assessment of 36 of the member countries, the report identifies reform options that governments could consider to improve the design and functioning of taxes on wealth transfers. The rationale is that in the last two decades wealth inequality has broadly increased. Furthermore, if trends continue, and with the baby boomers getting older, inheritances are expected to increase in both size and number.
The report finds there is a case for greater use of inheritance taxation on equity, efficiency and administrative grounds and makes several recommendations for reform, subject to country-specific circumstances. We highlight the following findings and note similarities with recent recommendations in the UK from the Office of Tax Simplification’s (OTS) and All-Party Parliamentary Group for Inheritance & Intergenerational Fairness (APPG):
- A recipient based inheritance tax (IHT) may be more equitable than an estate tax on the total wealth transferred by donors. This would allow for progressive taxes to be levied on the amount of wealth received by beneficiaries. This encourages the division of the estate and reduces concentrations of wealth. However, the OECD acknowledges that it is administratively harder and costlier to collect tax from a number of beneficiaries rather than from one estate.
- A fair and efficient approach would be to tax beneficiaries on gifts they receive over the course of their lifetime above a certain (modest) tax free amount. This would involve a curb on renewable thresholds such as the UK’s nil-rate band which can be replenished every seven years.
- Exemptions or reliefs for business assets should be carefully designed and alternatives considered. The report finds that family businesses tend to benefit from generous concessions. It cites the OTS report in finding that ownership of businesses tend to be concentrated among the wealthiest households, who benefit most from this type of relief. Their recommendations include any relief being subject to strict eligibility criteria, for example a minimum ownership period and a continuation condition (i.e. the business must continue after it is transferred and, if not, relief would be subject to clawback). Countries could consider capping the amount of available relief or introducing some form of means-testing. An alternative reform is to have a relatively low rate of IHT and allow tax payments in instalments (echoing the recommendations of the APPG).
- Other recommendations include scaling back exemptions for which there is no strong rationale (the OECD identify private pension savings and life assurance proceeds, which can escape inheritance taxes).
- Another recommendation is to consider the position on unrealised capital gains at death. The Report states that “there is a strong case for removing the step-up basis for unrealised capital gains at death, especially where inheritance taxes are not levied” (page 128 of the report). This change has also been advocated by the OTS. The reason given for this is that unrealised capital gains make up a large portion of the richest tax-payers’ assets. The report considers two bases of taxation: (i) the step-up basis (which is what we currently have in the UK) where an asset is uplifted to the market value when transferred on death and (ii) the carry-over basis, where an heir takes on the gain but the gain is taxed when he or she sells the asset (levied on the total increase in value). The report considers two disadvantages of carry-over: (i) it requires the recipients to track the base cost of the asset and (ii) the capital gain may become disproportionally large for the business and cause an incentive to keep the asset long term. A potential reform is to tax unrealised gains at death but allow for flexible payment arrangements such as deferral where necessary (but presumably not in addition to IHT!).
- More widely, the report identifies a strengthening of reporting requirements and notes that governments will be able to track wealth transfers under digitalisation of the tax system.
Recent reports suggest that the Chancellor, Rishi Sunak, may be minded to consider raising IHT rates, though the timing and precise nature of any change remains uncertain. Many of the OECD proposals would represent a radical departure from the UK’s current IHT system. What’s more, there is little evidence that a recipient based tax raises significantly more revenue. Plus, this system is not ideally suited to jurisdictions like England and Wales, which have no forced heirship provisions and make significant use of trusts.
It remains to be seen whether there is appetite for such fundamental IHT reform in the UK, but with the OECD now weighing in, on top of the OTS, APPG and wealth tax commission, some sort of change may be inching closer.
This article first appeared in our Spring 2021 edition of our Private Client & Tax Newsletter.