Anew mortgage allowing homeowners to pass on their mortgage debt when they die and thereby cut the inheritance tax bill faced by their heirs was launched this week. It comes as pressure mounts on the Labour party to increase inheritance tax thresholds or scrap the tax altogether as growing numbers of the middle classes are caught out by this wealth tax.

The Kent Reliance Building Society’s “inter-generational mortgage” allows consumers to pass on their home loan to their children or another beneficiary on death. The scheme will mean that homeowners will never repay any of the money borrowed to buy their home, as the mortgage works on an interest-only basis.

It has also been touted as a way of eliminating inheritance tax levied on estates above £285,000 after debts have been subtracted. The theory behind the scheme is that a child inheriting a £400,000 house with a £150,000 mortgage would not pay inheritance tax because the total value of the estate passed on would be £250,000, below the current IHT threshold. If the full value of the house were passed on, there would be a tax bill of £46,000 at 40 per cent of the value of the house over £285,000.

Mike Warburton, senior tax partner at Grant Thornton, says the new mortgage would have limited applications, however. “If you take out a £100,000 mortgage on your property, you still have to give the money away seven years before you die to avoid your descendents paying tax on it,” says Warburton. “You have to think seriously about whether you want to be tied in to a mortgage at that age and how you will fund the payments on the interest-only loan.”

Borrowers would also be paying over the odds for interest. Interest repayments on a £200,000 loan over 50 years could reach £500,000 after which the original loan would still be outstanding.

The new mortgage comes as Stephen Byers, a former cabinet minister, called for IHT to be scrapped. He said that the tax was “a penalty on hard work, thrift and enterprise” and suggested replacing it with higher green taxes.

The Treasury immediately dismissed his proposals as impractical. However, his statement has fuelled the inheritance tax debate that has been gaining momentum for the past few years. The number of homes worth more than the IHT threshold has risen by 72 per cent in the past five years, according to Halifax, reflecting the sharp rise in house prices.

Britain’s largest lender this week called on the government to link the tax threshold to house prices as it reported that 30,451 estates were liable to pay inheritance tax in the tax year 2003/4.

Inheritance tax has risen by 85 per cent since 1996 but Halifax said that if the threshold for inheritance tax had been increased in line with house price inflation it would now stand at £430,000.

“The steep increase in the number of estates paying inheritance tax highlights that the current inheritance tax threshold is too low,” says Tim Crawford, group economist at Halifax. “Significantly, families with lower-valued estates are paying an increased share of the total inheritance tax take while the super-rich are paying a smaller share.”

The National Association of Estate Agents joined Halifax in urging the government to raise the IHT threshold in line with house price inflation. Peter Bolton King, chief executive of the association, says: “IHT has morphed into an unfair tax on the thousands of people who inherit properties worth a modest amount. It is truly shocking that the majority of estates that have paid inheritance tax over the past few years were valued at less than £500,000.”

IHT revenues have grown steadily since Labour came to power, from £1.6bn in 1996-97 to a Treasury estimate of £3.6bn for 2006/07. The government has said it intends to increase the threshold to just £325,000 in 2009/10.

Many independent financial advisers and accountants who specialise in estate planning are also calling for an end to IHT. Allen Chubb, a solicitor at Child & Child, believes the government is swimming against a tide of opinion as more and more countries gradually abolish inheritance tax and death duty.

He believes a fairer alternative to IHT would be to switch it for capital gains tax (CGT), cancelling the exemption from CGT that occurs on property and assets when people die.

“Instead of IHT the government should just levy CGT on people’s assets,” says Chubb. “But it should keep the principle residence exempt from CGT so that people’s homes are not taxed on death.”

However, it is unlikely that the current Labour government will scrap IHT altogether.

Andy Gadd, head of research at independent financial advisers Lighthouse Group, says: “In my opinion there is absolutely no chance the chancellor will scrap IHT; he has already set the nil rate band until 2009. I expect he will be keen to increase the amount of money he is able to raise from inheritance tax.”

There could be more change if the Conservatives come to power. George Osborne, the shadow chancellor, has said he is looking at ways of easing the burden of IHT, including the possibility of exempting a deceased person’s main home from the levy.

But even he has conceded that it is an expensive tax to abolish and has added that as a possible future chancellor, it would be “irresponsible” for him to commit the Tories to scrapping it.

It would be hard for any political party to get rid of IHT, however. It would require a brave chancellor to explain how the government would plug the £3.6bn cost equivalent with a penny on income tax or 18p on petrol duty.