Inheritance Tax Forever!

Inheritance Tax (IHT) was said to be the most hated tax and over the past couple of years there has been increased speculation that the previous government would scrap the tax or at least reduce the rate. One of the reasons is that the freezing of the nil rate band and residential nil rate band combined with increased asset values has brought a considerable number of estates into the tax net. This is especially so for those who own property and live within the M25.

It was noticeable that the nearer that the General Election became the less publicity was given to IHT. This was probably the result of a realisation that as tax cuts were being costed it became increasingly unlikely that any Government could afford to lose revenue in excess of ￡7bn especially in the current economic climate.

The Labour party never had any intention of scrapping IHT especially as they commented that it only affected 5%-6% of estates. Now that Labour are in power there is speculation that IHT will become more prominent given the commitment to not raise other taxes.

IHT receipts hit ￡2.1bn from April to June, ￡83m higher than the same period the previous tax year.? IHT receipts in 2022/23 totalled ￡7.1bn This is ￡1bn higher than receipts in the same period a year earlier. There is nothing to suggest that this upward trajectory will not continue. On the contrary inherited wealth will only increase as the “Baby Boomer” generation (defined as people born between 1946 and 1964) declines. Reports suggest that Baby Boomers are set to shift ￡1tn in assets this decade...

Demos an independent educational charity has just published a report “The Future of Inheritance Tax – Options to repair Inheritance Taxation in Britain “?

A major overhaul of IHT to collect more cash from wealthy estates is crucial for funding public services, according to the report. Demos argue that changes to the tax are “the right place to start” for the government, with inheritances “becoming increasingly more important and valuable”

The IHT system could also be made fairer, according to Demos as in the UK the wealthiest estates tend to pay lower effective rates.

Those worth between ￡2m and ￡7.5mn paid 25% in 2020-21, while those worth more than ￡10m only paid 17%. t.?

According to Demos the UK could learn from Norway when it comes to reforming policy by shifting from inheritance and instead towards ‘inherited capital gains’.

Inherited capital gains are uplifted in the UK as they were in Norway but in 2014 the country began taxing these while simultaneously abolishing IHT.

Although Demos highlighted that significant revenue would be lost if the UK did the same, it suggested the UK could begin taxing inherited capital gains while offering a smaller IHT cut.

According to the think thank the most promising opportunities for IHT reform include reworking the exemption for business property to ensure it provides value for money.

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The UK is unusual in offering 100% relief for owned businesses and agricultural property, and not counting most private pensions for inheritance tax purposes. For example, the UK is in a small minority of OECD countries who offers 100% uncapped relief for business assets, does not require any minimum time of ownership for the heir of business assets, and differentiates between listed and unlisted businesses (by offering additional exemptions for shares in unlisted businesses)

The exemption from IHT for business property was introduced in 1975 (under the predecessor of IHT namely Capital Transfer Tax) to ensure that a business did not have to be sold or broken up in order to pay the tax. This is intended to avoid the economic disruption and loss of jobs that would arise.

100% Business Property Relief is given to the following in owned for two years: -

• A business or interest in a business

• Unquoted shares in a company which give the holder control of the company

• Other unquoted shares

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It is unlikely that any Government would want to end the relief because of its original intention but they may wish to seek to restrict the availability of the relief to a more limited number of trading companies. By way of example in recent years companies have been established specifically to take advantage of the 100% relief from IHT. The companies are genuinely trading but in order to attract investors, whose main aim is to qualify for the relief, the profit motive is not present to the same extent as other trading companies.? All governments need to ensure that where tax breaks exist, they are for a specific purpose and encourage investment in areas that are riskier but will result in employment and other economic activity. For example, particular focus in recent years has been on ensuring that Venture capital reliefs are only available for patient capital. That is broadly long-term investment, where investors are prepared to wait a considerable amount of time (3-5 years in some sectors, 10-15 years in others) before seeing any financial returns.

Arguably the business relief solutions do not always fit that definition, but the sector was looked at by the Treasury and it was concluded that the relief was not being abused.

There is also the concept of AIM portfolios that is investment in companies quoted on the Alternative Investment Market that engage in trades qualifying for business relief. Investment in AIM is deemed to be unquoted for this purpose. A portfolio of such companies is established by investment managers and generally the main investors will be those hoping to secure 100% business relief by holding the portfolio of shares for two years.? Of course, there is nothing to stop any investor selecting companies quoted on AIM and qualifying for the relief.

Critics of IHT Business Relief may point to the fact that many AIM companies are well established with substantial market values and hence not deserving of a tax break. This may point to a re-evaluation of the qualifying rules, but cognisance needs to be made of the effect on the market of a mass exodus from AIM if those investing solely for the IHT break did invest en masse.

Currently pension funds left to dependants on death are not included in the estate liable to IHT.? Taxation treatment differs depending on the age of the deceased but broadly although Income tax may apply when funds are drawn by dependants the tax is often not as high as a 40% IHT charge. The government are apparently reviewing this.

Summary

Far from being abolished it looks like IHT is set to become a much more prominent revenue raiser not only because of the freeze in the nil rate band (￡325,000) and residence nil rate band (￡175,000 maximum provided the estate is less than ￡2m) coupled with rising asset values. The increase in inherited wealth and the likelihood that the net will be widened is likely to lead to a very substantial increase in the tax take such that any talk of abolition will be “pie in the sky”. This very brief summary ignores the complexity of IHT, and it is likely that any simplification will result in a higher tax take.

It is mainly the next generation that will be affected so a greater understanding of the tax and possible mitigation by potential beneficiaries before it bites would be advisable. It is certainly set to be a tax not confined to the rich!