Stick or twist

  • Author : Keith Johnston
  • Date : June 2010
ABOUT THE AUTHOR: Keith Johnston is Director of Policy and Communications at STEP

Throughout the 15-year residential property boom of the 1990s and 2000s that was experienced in the UK, more and more ordinary people were caught in the inheritance tax net. The nil-rate band (NRB), the threshold above which an estate in the UK may become liable to inheritance tax (IHT), was not increased in line with house prices and lagged far behind the rising value of estates, especially in south-east England. In 2008-09 the NRB was GBP312,000, only 45 per cent higher than in 1997-98; meanwhile house prices had risen 250 per cent.

The UK’s economics and finance ministry’s receipts from IHT soared. They peaked in the summer of 2007, when GBP369 million of IHT was collected in a single month.

But the tax brought much resentment among people who did not think of themselves as particularly well off, having only modest savings and a house to pass on to their children.

The UK government ignored this resentment as long as it could. Then in late 2007 the Conservative opposition announced that, if elected, it would raise the NRB to GBP 1 million. Labour’s response was the announcement of a new tax exemption: the transferable nil-rate band. This was designed to fix a perceived unfairness of the system, namely that many couples ‘wasted’ much of their available NRBs.

In the typical sequence of events, the first spouse to die would leave most or all of his estate to the surviving spouse.1 Since inter-spouse transfers are tax-exempt anyway, this meant the first-deceased’s NRB went largely unused.2 So the survivor ended up with a very large estate; and, since she had only her own NRB exemption to use at her own death, a large IHT liability would arise for her children.

With the new transferable NRB scheme, any unused fraction of the NRB from the death of the first spouse can be used at the second death. The calculation is done by noting the percentage (not the amount) of the first spouse’s NRB that was left unused, and applying that percentage to increase the survivor’s NRB.3

In most cases this doubles the IHT exemption available to a married couple’s joint estate. It has been enthusiastically taken up in the past two years, with an inevitable reduction in HM Revenue & Customs’ revenues from IHT. Annual IHT tax take peaked at GBP3.8 billion in the 2007-08 tax year. The following year it dived to GBP2.8 billion, and is expected to drop further to GBP2.25 billion for the tax year 2009-10; a 41 per cent collapse in two years.4

Though the transferable NRB is a big improvement, it has also attracted criticism. It gives no help to some perfectly worthy people, for example: divorced single parents, unmarried couples, or couples who used the full NRB at the first death.

Also, some couples (typically emigrants) have gained little or nothing. If the second spouse to die was foreign-domiciled, the spousal IHT exemption is limited to GBP55,000, so where the estate is above the NRB plus GBP55,000, there will not be a transferable NRB.

Particular problems also arise if the first death occurred many years ago. Firstly, the survivor (or her solicitor) may have lost or destroyed the paperwork for that estate, thinking it would never be needed. Secondly, if the first death occurred before March 1972 there is usually no transfer available. This technicality only affects a small number of elderly widows, but it is still unjust for each of them.

The scheme also has many complications, largely due to its dependence on marriage. What happens when a widow or widower remarries, does the first spouse’s NRB get transferred again, and how many times? What about Scottish common law marriages and polygamous marriages legally conducted abroad? Expert advice should be sought on these and many other questions.

The UK Conservative party’s alternative proposals would keep the transferability scheme, so raising each couple’s NRB to GBP2 million, but also retaining the above complexities. However, it would also lift each individual’s NRB to GBP1 million, removing some of the unfair consequences of the transferable band.

So where does this leave IHT? It now brings in much less than it did and this cannot be welcome news to the UK’s economics and finance ministry, which is strapped for cash. Questions are now being asked about whether the new economic climate will presage a change in politicians’ hearts as well. The UK Labour party has already raised the possibility of a universal estate levy to fund elderly care. At present this is opposed by the Conservative party and it remains to be seen whether a consensus will emerge that IHT needs fundamental reform or continued tinkering.

Throughout ‘spouse’ should be taken to mean ‘spouse or civil partner’, and in Scotland, a spouse under a recognised common law marriage.
At the time, estate practitioners devised various methods of making good use of the first-death NRB, the favourite being the NRB discretionary trust.
The necessary legislative changes were included in the Finance Act 2008, and backdated. They apply where the second death occurred on or after 9 October 2007.
(a) HM Revenue & Customs receipts as at September 2009 (PDF file) HM Revenue & Customs has issued guidance on transfers of unused nil rate bands.(c) February 2009: August 2008:


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