Inheritance tax and non-doms: likely changes under the new Labour government

In the second of our articles on potential tax changes under the Labour Government, we look at inheritance tax and the abolition of the non-dom regime. If you missed our first article, it can be found here.

Inheritance tax

The UK has a relatively unusual inheritance tax (IHT) regime in the international context. The majority of European countries have a recipient-based tax regime; only Denmark and the UK levy estate taxes on deceased donors. The UK is an outlier in having a very generous regime for gifts to the next generation, which generally pass tax free where the transferor survives seven years.

However, the UK has a combination of a relatively high tax rate (40%) and low threshold (￡325,000), which means that the UK’s tax take from IHT is comparatively high. In the EU, only Belgium, France and Finland collect more IHT as a share of overall tax revenues.

The ￡325,000 nil rate band has been frozen for over a decade, dragging more estates into the IHT net as assets prices have risen. It is unlikely, therefore that the rates of IHT will go up, or the nil rate band be lowered. Instead, reliefs may be targeted such as business property relief (BPR) and agricultural property relief (APR).

BPR is intended to avoid disruption to trading businesses when the proprietor dies, but offering complete or partial relief from IHT. APR offers a similar relief for agricultural land, so as not to disrupt farms. The IFS suggested capping these reliefs at ￡500,000, but it is difficult to see why more successful businesses and larger farms should be penalised. One possibility is to reduce the level of the relief, perhaps to 50%, but to allow payment of tax over 10 years to avoid selling off all or part of the business to pay the tax liability.

It would be more sensible for the Government to restrict some of the edge cases where BPR and APR are used as tax planning tools:

·?????? BPR is available on AIM shares, but the policy rationale for this is unclear. AIM-listed companies generally have many shareholders, and the death of one will is very unlikely to interrupt the business. AIM shares are widely used for planning towards the end of life to avoid IHT, and this could be scrapped.

·?????? APR applies not only to farmers, but also to landowners who rent the land to tenant farmers. This has led to wealthy individuals buying-up agricultural land to avoid IHT by claiming APR. This would be a politically easy relief for a Labour Government to remove.

One further change could be to tighten the qualifying criteria for BPR. Currently, businesses which are part trading and part investment can qualify for BPR so long as the trading element is larger than the investment element. This 50% test could be updated to an 80% trading test, which is already used for business asset development relief (formerly entrepreneurs’ relief).

Inheritance tax and non-domiciled individuals

In the March 2024 Budget, then-chancellor Jeremy Hunt announced changes to the non-dom regime and inheritance tax IHT from April 2025.?

The fundamental change behind this announcement was the move away from the concept of domicile, replacing it with tax residence. Domicile is a more subjective test of where one’s long-term home is, whereas tax residence is a prescriptive annual test.

The geographical scope of IHT is currently based on domicile:

·?????? If you are domiciled (or deemed domiciled) in the UK then your worldwide assets are subject to UK IHT.

·?????? If you are non-UK domiciled then UK IHT is limited to your UK assets.

The previous Government proposed that this be changed to a test based on tax residency:

·?????? If you have been tax resident in the UK for 10 or more years then your worldwide assets are within the UK IHT net.

·?????? If the residency test has not been met, UK IHT is limited to your UK assets.

The sting is in the tail: more precisely, the 10- year tail. Once your worldwide assets are within the scope of UK IHT, it is proposed that it would take 10 years of non-residency for your non-UK assets to fall outside of the UK IHT net. There has been much push-back from tax professionals on this point, and conceivably the Labour Government could shorten this tail when they announce their proposals.

The non-dom regime

Labour’s proposals are likely to be very similar to the Conservative’s (who, after all, took them from Labour). We covered the Conservative proposals in a previous article.

Labour have said that they will make the transitional provisions less favourable, but the biggest proposed change is that trusts will no longer be effective in mitigating IHT. This is likely to apply to existing trusts, exposing many non-doms to 40% tax on their worldwide assets. This in turn would likely accelerate the number of wealthy individuals leaving the UK, which is something that we are already seeing in practice.?

In our final article next week, we will look at possible changes to the taxation of pensions and ISAs, and VAT on private school fees.

The information contained in this article is general guidance only. The application and impact of laws can vary widely depending on the specific facts involved. The information in this article is provided with the understanding that the authors and presenters are not giving legal, tax, or other professional advice and services. As such, it should not be used as a substitute for consultation with professional legal, tax or other competent advisers. Before making any decision or taking any action, you should consult a Child & Child professional.

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