Reform of Inheritance Tax – Part II

In the first of these two articles, James Greig gave a light-hearted defence of inheritance tax (IHT) in its current form, before conceding that change had to happen. You can read James’ article here. In this article, James overviews why he welcomes the recent All-Party Parliamentary Group’s report on Reform to Inheritance Tax.

Inheritance Tax Part II

This report is welcome[1]. It is bold in seeking root and branch change, rather than tinkering and thereby failing to address the underlying perceived unfairness. Indeed the authors challenge the government ‘to be bold in replacing the IHT regime with a more understandable alternative.’

There are, broadly, three central recommendations:

• An eye-catching reduction in the headline rate of tax from 40% to 10%
• The replacement of the famous seven-year gift rule and the myriad reliefs with an annual tax-free gift limit of £30,000.
• An end to the ‘capital gains tax-free uplift’ on death and capital gains tax (CGT) on gifts.

Interestingly, the report comes from an All-Party Parliamentary Group. While not necessarily representing government or party policy, it must be worth paying attention to any report, however informal, from a group of parliamentarians from both Houses and all political shades. The report proposes a reduction in tax rates and greater simplicity and predicts an increase in tax take. As the report puts it, ‘a crucial aspect… is that the rate is low enough to ensure the incentives to plan around it are not worthwhile.’

The reforms deal with the elephant in the room; or rather the elephant who escapes the room scot-free, namely the ability of the super-rich, under current rules, to give away infinite amounts and never be taxed once seven years have elapsed.

The wealthy grandparent can still have the pleasure of providing for a grandchild, but they just need to make sure they start sooner. 18 years x £30,000 means £540,000. No doubt we will see new gift bond products, capable of building a sizeable fund in time for university fees or the first house. Under the proposals, ‘little and often’ would become the norm, rather than giving large lump sums. In fact, I would predict a pattern of greater inter-generational giving, since no-one likes to lose an allowance to which they are entitled.

There would still be a nil-rate band, but only on death. It would not be eroded by lifetime gifts.

Pension funds would no longer get special treatment. They would also be taxed at 10% on the second death.

The ‘running the gauntlet’ for CGT would certainly not be missed. Under current rules, some tax-payers give away assets pregnant with gain and pay CGT, in the hope that their estates will avoid the greater evil of 40% IHT. Unfortunately if the tax-payer dies sooner than expected, the CGT can be entirely wasted.

While on the topic of CGT, the proposals would mean it is only paid on disposals which realise cash, a.k.a. sales. Under current rules, to the surprise of some, CGT is also paid on gifts.  Removing the need to pay CGT on gifts will lift one major current brake on inter-generational giving.

Greater clarity is needed over what parents do for their children. The report seems to suggest that maintenance relief will go. Even without paying private school fees, the latest report from Liverpool Victoria reckons it costs £231,843 to bring up a child. Has a single parent bringing up more than one child, spending £20,000 – £30,000 a year on parenting, lost the chance to set money aside for the children’s future without incurring a tax charge?  One hopes not.

Three alternatives suggested previously have not entirely been ruled out. The first is a tax on inherited wealth received, as happens in Ireland. The more your wealth comes from gifts and inheritance, the higher your rate of tax. Who are the losers in the UK if we ‘go Irish’? Presumably those with childless uncles and aunts. Another approach is to increase tax rates, the remoter your relationship is from the deceased. This ranges from 17% to 50% in the German model. Child heirs pay lower taxes. The ‘cousins German’ (hard to resist, isn’t it?) pay rather more. A third option, favoured by the left-wing Fabian Society is to abolish the tax on the deceased’s estate, add the inheritance to the beneficiary’s receipts and tax him/her at their marginal rate of income tax. All these options have pros and cons.

To be fair, the APPG’s recommendation does what it attempts – provide a bold, understandable alternative. Who would the winners and losers be?

Winners

• HMRC, raising more tax with fewer staff
• The next generation, with a major tax obstacle to giving removed
• Mental arithmetic. Who needs a calculator or excel spreadsheet to divide by 10?

Losers

• Lawyers, accountants, farmers and business people. Not many tears to shed there, then.
• Those grandparents, whose children will suddenly take a lot less interest in their longevity.

Will IHT feature in the Budget on 11 March? It is hard to say. At most, if change is in the air, some anti-forestalling measures could be announced.

As mentioned in the first of these articles, whatever the reasons behind it, IHT has been unpopular for a very long time. A Fabian Society report even claimed that the tax is ‘most resolutely opposed by those who are least likely to pay it’. That being the case, we may at last be about to see change. The current government’s hunger for policies with which to win over a whole new section of the country and the confidence which comes from a sizeable majority, means the days of this ‘most hated tax’ in its current form, may be numbered.

[1] As STEP’s Technical Counsel Emily Dean has written, “We are strongly supportive of reform. The APPG’s report is a welcome addition to this debate…”