That's a headline in today's Financial Times. What is going on?
Rate
A first thought that comes to mind when reading this headline will be that inheritance and gift tax rates will be increased. Such a rate increase is suggested with regularity. After all, “The Hague” is diligently looking for sources to balance the budgets with. But as far as we are aware, a rate increase is not yet on the table.
Interest
The potential increase in inheritance tax is caused by the planned adjustment of the flat rates used to calculate that tax. Those flat rates are now “as old as the road to Rome”. It is therefore not surprising that they are being considered for updating. For instance, the inheritance and gift tax (since 1979!) calculates an interest rate of as much as 6%. The actual long-term interest rate is now a lot lower. Similarly, the life expectancy used in valuation dates back to 1979, and since then, actual life expectancy has increased considerably.
The effect of lower interest rates makes itself felt especially when the tax base of inheritance and gift tax is eroded through the accrual of debts. This is the case when a deceased person does not have a will whereby the legal distribution applies. Incidentally, many wills follow this distribution (which is then referred to as quasi-statutory distribution). A (quasi-)legal distribution implies that the surviving parent acquires the assets and debts and the children settle for a non-recoverable claim against their surviving parent.
The debt owed to the children by the surviving parent under this (quasi-)legal distribution is increased annually by interest. Based on current legislation, this interest can be between 0% and 6%. As long as the surviving parent lives, this interest is added to the debt and therefore leads to a lower estate of the surviving parent (with the addition of interest, the estate of the surviving parent is eroded). Obviously, if the (maximum) interest rate is set lower than the current 6%, the surviving parent's estate is eroded less, resulting in more inheritance tax being payable.
Acknowledgement of guilt
Another way known in estate planning to erode a future estate through interest is the so-called debt acknowledgement. The parent(s) then makes a gift to the children, but does not pay out the gifted amount. The tax law then requires the parents to pay annual interest to the children, and this too is aligned with the flat interest rate of 6%. This interest is actually paid by the parents to the children and since it is the payment of interest, obviously no gift tax is payable. On the death of the parents, the interest paid is no longer part of their assets, so no inheritance tax is payable on it.
If the interest payable on a debt acknowledgement is set lower than the current 6%, the estate is eroded less (tax-free) resulting in more inheritance tax being payable on the death of the surviving parent.
Connecting to reality
Of course, it is nice that (inheritance) tax can be saved by using estate holding out with the lump-sum interest rate. But anyone looking at this with a neutral view will still recognise that a flat rate is currently very much above the actual interest rates. Whether the flat rates will be adjusted is up to politicians in the Hague.