Section 2: the evolution of IHT estate duty
The Valuation Office Agency's (VOA) technical manual relating to Inheritance Tax.
Estate Duty (ED) was introduced by the Finance Act 1894 (FA 1894). It was imposed on the full capital value of land and applied to all property, real or personal, settled or free, which passed or was deemed to pass on the death of the deceased. The duty was assessed by reference to the “Principal Value” of the property passing for ED purposes. Although the FA 1894 was amended and supplemented by numerous subsequent Finance Acts there was no consolidating Act and it remained the principal Act until the abolition of ED with effect from 13 March 1975 by the FA 1975.
2.2 Purpose of Estate duty and rates of Duty
Introduced as a source of revenue, ED later also became an instrument for the redistribution of wealth. A feature of the duty, controversial at the time of its introduction, was its progressive nature with a rate of 1% for estates between £100 and £500 rising to a maximum of 8% for estates exceeding £1m. Immediately before the abolition of ED the rates of duty were those imposed by the Finance Act 1972. This Act raised the basic exemption limit to £15,000 while the rates of duty ranged from 25% on the slice from £15,000 to £20,000 to a maximum rate of 75% on the slice above £500,000.
2.3 Avoidance of Estate Duty
From the outset opportunities for the avoidance of ED were realised, principally by:-
a) gifts during the life of the donor (Gifts Inter Vivos) and
b) vesting property in “Discretionary Trusts” whereby the trustees had power to distribute the income at their discretion amongst a named group of beneficiaries, but no beneficiary had any right to any part of the income and thus no interest in the settled property passed on death.
To counter avoidance by the lifetime transfer of property, a gift which occurred a limited time before death was treated as passing on the death. The period had originally been 1 year, but was 7 years at the time of abolition of ED.
Various trust and settlement devices set up to prevent a death being an occasion for property passing, or an interest ceasing and being treated as passing for ED purposes, were met in successive Finance Acts by measures extending the basic concept of the duty as originally enacted and widening its incidence.
2.4 Alleged defects of Estate Duty
Because ED arose only on death it did not operate as a comprehensive tax on gratuitous disposals of wealth. Such wealth often passed duty free from generation to generation by lifetime gifts made outside the statutory pre-death dutiable period and by the legitimate use of discretionary and other trusts.
Capital Transfer Tax
Capital Transfer Tax (CTT) was introduced by the Finance Act 1975 (FA 1975) to overcome the alleged defects of ED by taxing transfers of accumulated wealth more effectively. CTT was charged on the value transferred by a chargeable transfer, which included gifts made during the taxpayer’s lifetime. The tax was charged at progressive rates on a cumulative basis except that no tax was payable until the cumulative total of chargeable transfers exceeded a certain threshold. On death the remainder of the taxpayer’s estate was deemed to be transferred giving a final liability to tax.
The rates of tax charged on lifetime transfers were half of those charged on death. Where the donor died within three years of making a lifetime transfer additional tax could become due by the application of the death scale rates in lieu.
There were various exemptions and reliefs, many on broadly similar lines to Inheritance Tax (IHT) described later.
The FA 1975 and subsequent amendments were consolidated into the Capital Transfer Tax Act 1984 (CTTA 1984).
As such it was relatively short lived for by s.100 Finance Act 1986 (FA 1986) the tax charged was to be known as Inheritance Tax and the CTTA 1984 cited as the Inheritance Tax Act 1984 (IHTA 1984).
The Finance Act 1986 made amendments to IHTA 1984 including the concept of potentially exempt transfers, providing for one Table of rates of tax in place of the two scales of rates for CTT and reducing the period during which the values transferred by chargeable transfers are aggregated from ten years to seven years. The rates of tax and threshold limits may be varied by indexation provisions or other legislation.
The administration of Inheritance Tax, the exemptions and reliefs available and relevant VOA procedures are dealt with in detail in the Sections which follow.