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How do we solve the problems inherent in IHT?

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An Institute for Fiscal Studies paper recommending that three inheritance tax reliefs should be ditched could eventually be worth £4bn to UK plc. Philip Fisher offers some thoughts on these proposals.

25th Apr 2024
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Inheritance tax (IHT) has only been around for a few decades. Before that, older readers will recall that the UK operated a system of capital transfer tax.

The differences aren’t necessarily that significant, but we could be on the brink of another change.

If certain factions in the Conservative Party have their way, IHT would be abolished. Their main arguments are that the tax is unfair, effectively taxing people twice, and additionally, the amount that it brings into the Exchequer is relatively inconsequential – though some of the more stingy might regard £7bn per annum as worth having.

The second point does not carry much weight, since if we were to ignore all taxes that bring in comparatively small amounts, they would quickly begin to add up. Surely every penny should count, especially when the economy refuses to grow, despite the King Canute-like wailings of successive Chancellors of the Exchequer and prime ministers, not to mention some of their Shadows. (Before any bright spark points out that King Canute has been badly done by, I know.)

Beef up the legislation

An alternative response to the proposition that the sums involved are relatively inconsequential would be to beef up the legislation, close some loopholes and/or increase rates, in order to increase the amounts at stake.

To that end, last week the Institute for Fiscal Studies (IFS) published a report entitled Raising revenue from closing inheritance tax loopholes written by the University of Warwick’s Arun Advani and David Sturrock.

While accountants love loopholes, they can prove to be expensive and the authors of this report explain that by making just three changes it would be relatively easy to bring in an additional couple of billion pounds a year, while making the system fairer in their view.

Before going into the detail, it is worth considering a statement that has far wider implications. “The fundamental problem here is that once a relief is created, there are always arguments for expanding its scope to avoid some unfairness at the margin. The root of the problem is the creation of the special relief in the first place.”

This applies in so many areas that it should be force-fed to prospective legislators before they pass any new laws that seek to expand reliefs from tax. As suggested in this column in recent weeks, it might also be a good idea to revive the Office for Tax Simplification, ideally with greater powers.

The IHT reliefs that the report’s authors suggest might be closed are each most heavily used by the biggest estates, which is another relevant factor. They provide a fascinating table showing the average effective tax rate by size of the estate.

Well over 50% of estates fall into the under-£500,000 category and have an effective tax rate of no more than 10%. Indeed, the one-third of estates that fit into the bracket of £100,000 immediately above the exempt band pay tax at just 4%.

At the other end of the scale, though the number of estates is inevitably smaller, the tax rate for those over £10m is 17%, significantly lower than for those in the £2bn–£5bn bracket of around 25%. This instantly suggests that some tweaking could be in order.

The current proposals are as follows.

1. Remove special treatment of AIM shares

When one starts to look at various IHT reliefs, few will understand why several should still be in operation. In particular, the authors question the principle that exemptions exist around AIM shares. The status quo becomes even more dubious when one discovers that the relief is very heavily used by trusts.

This change would apparently raise £1.1bn in the current tax year rising to at least £1.6bn in 2029/30.

2. Cap agricultural and business reliefs

As the authors suggest, “There is a strong economic case for abolishing agricultural and business reliefs, which currently cost around £400m and £1.4bn a year, respectively.”

They do accept that political pressure might make full removal difficult and propose an alternative, capping the combined reliefs at £500,000 per person, with the balance transferable to a surviving spouse or civil partner.

Even on this limited basis, they estimate savings of £1.4bn in the current tax year rising to £1.8bn by 2029/30.

3. End the tax-free passing-on of pension pots

One day, someone will explain why this relief exists. It isn’t obvious since “it serves no economic purpose and is clearly unfair”.

The benefits are smaller but £200m this year going up to £400m by 2029/30 would pay for a few desperately needed new schools or hospitals.

Over and above the IFS proposals, an additional idea worthy of consideration might be to raise the IHT threshold to (say) £500,000, removing half of estates from tax, then make up the deficit (and more?) by charging higher rates on very large estates.

Replies (20)

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By Justin Bryant
25th Apr 2024 12:38

I'm always mystified when anyone who should know better pejoratively describes legitimate tax reliefs as "loopholes". I mean, you never hear an ISA described as a tax loophole do you (at least when it's not stuffed full of BPR AIM shares)?

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Replying to Justin Bryant:
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By Amy Chin
25th Apr 2024 12:46

I'd argue that it's more nuanced. The expression 'loopholes' in this context tends to refer to legitimate tax reliefs that are exploited beyond the purpose the relief was originally intended. Your ISA stuffed with BPR AIM shares being a good example.

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Replying to Amy Chin:
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By Justin Bryant
25th Apr 2024 12:58

But whose purpose? The only relevant purpose here is Parliament's and the clear legislative words (purposively construed) are that these are legitimate tax reliefs. The fact is some people (Guardian readers mostly) do not like that fact and accordingly wrongly describe these legitimate tax reliefs as "loopholes", just like they do with the current so-called non-dom tax loopholes, that are actually also legitimate tax reliefs (or concessions/incentives etc.).

At least it's better than some people here who wrongly describe non-criminal tax avoidance as tax evasion.

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Replying to Justin Bryant:
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By Justin Bryant
25th Apr 2024 13:49

See here another classic example of left-wing IHT tax loophole pejorative language (i.e. from those with an obvious, biased agenda) re DTAs of all things: https://www.accountingweb.co.uk/any-answers/dns-latest-tax-avoidance-ana...

Notably also Labour rather dumbly described the new 50% first year non-dom tax rate (for 2025/26 only) as a "loophole" they would close.

If the BBC were reporting this, I doubt their editors would be allowed to describe these things as tax loopholes (without some justifiable context at least).

Non-UK domiciles may decide to set up overseas trusts, utilising IHT exemptions that the UK government has specifically enacted for non-UK domiciles who are UK resident. In fact, the legislation underpinning such EPTs has been in place for decades, yet is also dumbly described by Labour as a "loophole" that they would close.

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By Liam.em
25th Apr 2024 15:40

Not sure what I have just read.

Capping BP and AP reliefs would be a measure that completely disregards the reason that these reliefs exist in the first place. I.e. to prevent the farming sector and SME sectors from falling apart just because business holders and/or farmers have been selfish enough to die.

This shift in attitude towards genuine tax avoidance via use of tax reliefs is extremely frustrating.

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Replying to Liam.em:
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By Justin Bryant
25th Apr 2024 15:53

Yes; that is more or less exactly the same point I am making above (albeit less succinctly).

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Replying to Liam.em:
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By AndyC555
26th Apr 2024 10:46

Agreed. It would pretty much spell the end of any family business. What business has 40% of its value lying around in spare cash to pay an IHT bill? The only likely way of meeting the bill would be to sell the business or liquidate it. Precisely the reason the reliefs currently exist.

It has been previously accepted that the societal benefit of allowing businesses to continue and possibly be passed down the generations outweighs the grasping need to suck ever more tax out of the economy. I guess that acceptance no longer exists in some quarters.

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By ireallyshouldknowthisbut
25th Apr 2024 16:05

The fundamental question around IHT is why? ie are we raising revenue? Or social engineering and tackling entrenched inequality through family wealth?

I would be looking at the latter first and the former second and abolish IHT.

Instea I would more towards a gift tax which is paid at a rate connected to (but might not be) the marginal rate of the recipiant, with some sort of top slicing relief. So rich kids pay more, but poor recipients pay less. It would need to be paid via SA or a standalone system for those outside of SA.

This could be sold around levelling the playing field in the property market if it stems the benefit of the "bank of mum and dad".

Or you could go the other way and tax all estates right down to £50k, but at a very low rate (say 10%) and so reduce the incentive to gift it all away pre-death. It would probably raise more tax as people would just do what they wanted, rather than tax geared disposals.

IHT is essentialy a voluntary tax and easily side stepped as its currerntly stood. Its really only paid by those who die unexpectedly, or those with poor plans.

Agree 100% on the pension pot thing. I cant see why it escapes tax. That one always suprises clients when I explain it.

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Replying to ireallyshouldknowthisbut:
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By Justin Bryant
25th Apr 2024 16:08

Why shouldn't an asset in a trust that's outside your estate be IHT free? A RP trust (with AIM shares) would be the same.

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Replying to Justin Bryant:
By ireallyshouldknowthisbut
26th Apr 2024 14:07

Justin Bryant wrote:

Why shouldn't an asset in a trust that's outside your estate be IHT free? A RP trust (with AIM shares) would be the same.

Pensions post are only outside of your estate becuase the legislaiton says so. It doesnt need to say that. There seems not real rationale on making an asset have any different rules in a beneficiaries hand than it would in the donors. I had a client recently who is terminal ill and in his mid 60's. We packed £180k of reserves from his company through his pension and another £60k in the currenr tax year, so the widow gets it tax free when he dies in the next few months. Why is that permitted? It makes no sense but has deprived HMRC of about £50k of CT and what woulkd have been at least some dividend taxes getting it out any other way. They are minted anyhow, it will barely touch the sides.

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Replying to ireallyshouldknowthisbut:
paddle steamer
By DJKL
29th Apr 2024 17:11

Not also transferring all the couple's shares to him so CGT rebase on his death?

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Replying to ireallyshouldknowthisbut:
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By More unearned luck
25th Apr 2024 21:19

"I would...abolish IHT."

How would you replace the £7.5bn the tax raises? Or what government expenditure would you cut?

You would also be depriving some poor tax advisers and lawyers of the crust they earn by providing IHT planning advice.

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Replying to More unearned luck:
By ireallyshouldknowthisbut
26th Apr 2024 13:59

More unearned luck wrote:

How would you replace the £7.5bn the tax raises? Or what government expenditure would you cut?

With the proposed gift tax.

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Replying to More unearned luck:
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By DJKL
29th Apr 2024 16:40

CGT on death plus CGT on houses like in Sweden (trade up , rollover gain into new property, trade down, pay tax)

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By Justin Bryant
25th Apr 2024 16:51

I note this tax lawyer agrees with me re inappropriate "tax loophole" language:

"Why do journalists publicize the populist view that statutory reliefs from tax are "loopholes", especially if they potentially benefit wealthy taxpayers? Rebecca has provided an admirable analysis of how an IHT charge could be exempt under the UK/Indian Double Capital Taxes Treaty. For those estates which qualify, this is a statutory relief, it is not a "loophole". It is no more a loophole than CGT relief for disposal of private residences, or corporation tax relief for disposal of substantial shareholdings. "

https://www.linkedin.com/pulse/treaty-loophole-rebecca-murray-pf11e?trk=...

Such language is only appropriate for things like this from the Blairs re SDLT avoidance:
https://www.dailymail.co.uk/news/article-10061253/Tory-chairman-Ben-Elli...

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Replying to Justin Bryant:
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By Postingcomments
25th Apr 2024 17:10

I don't think modern article writers dwell on the language they use in the same way that professionals might when they are writing up professional advice.

This article is full of trendy, cheap internet article style phrases. It makes it read like a glossy magazine article, rather than a serious piece that is aimed at professionals. Then again, it is probably just designed to get clicks and comments rather than to inform. So job done, I suppose.

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By Postingcomments
25th Apr 2024 17:05

APR and BPR are not loopholes or schemes. They are explicitly written into the leg in order to give relief from IHT.

Now, if someone was operating some kind of sham farm and claiming APR, that would be a different matter.

It is a shame to see people inside the profession use loaded language inappropriately - and to describe a situation incorrectly. Who needs HMRC when you have friends like this?

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Replying to Postingcomments:
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By Justin Bryant
25th Apr 2024 17:29

Aweb are basically drinking the (DN) Kool-Aid here and it reflects badly on them.

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By FactChecker
25th Apr 2024 20:39

Either I'm learning new facts or maybe the proof-reader was absent before this was published?

* "At the other end of the scale, though the number of estates is inevitably smaller, the tax rate for those over £10m is 17%, significantly lower than for those in the £2bn–£5bn bracket of around 25%"
... should those 'bn's be 'm's?

* "2. Cap agricultural and business reliefs ... Even on this limited basis, they estimate savings of £1.4bn in the current tax year rising to £1.8bn by 2029/30"
... 'savings'?

But I agree with ireallyshouldknowthisbut's question:
* Is the primary intention to raise revenue? Or is it to perform social engineering?
Any argument/opinion may be valid, but it should state its premise transparently!

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paddle steamer
By DJKL
29th Apr 2024 16:37

Okay

AIM- yes, illogical but do consider what happens to individual's holdings if the relief scrapped, what percentage of AIM share prices is based on the IHT relief- a lot of people become seriously poorer, that is fine if intended result.

BPR etc- well if no IHT relief companies will end up being sold to cover the bills , private equity funds will love this, but will companies that needed a second or third generation to really make it big survive or is the UK destined to then be a country of tiny companies?

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