RIP IHT?

Death duties, originally imposed as Estate Duty in the late 19th century, were intended to raise revenue from the very rich. In the intervening century Estate Duty has been replaced by Capital Transfer Tax and then Inheritance Tax (IHT) in 1984. John Newth charts the course of the controversial tax

During the past 30 years numerous changes to the duty have occurred. Under the current IHT regime, lifetime gifts and bequests on death to spouses (and now civil partners) are free of tax. Lifetime gifts to others are exempt once seven years have expired.

However, problems arise when an estate has been left by a surviving spouse (or partner) to the next generation or others. Where the estate mostly comprises a business or agricultural estate, business property relief or agricultural property relief provides substantial relief. This then leaves the family home and personal savings as the items likely to suffer IHT.

Anti-avoidance

In the past, it was said that death duties were a voluntary tax, and well-off taxpayers could pay for sophisticated schemes to legally avoid paying millions of pounds. Anti-avoidance legislation in the form of the gifts with reservation legislation and the pre-owned assets provisions has made IHT planning that much more difficult. Now the 2006 Budget has introduced Press Notice BN25, which effectively spells the “death knell” for most accumulation and maintenance trusts and interest in possession trusts.

In the current political climate it is doubtful if existing or new avoidance schemes will be effective, as the Government and HM Revenue & Customs (HMRC) are intent on ensuring that every citizen of the UK pays the “correct amount of tax”.

Current consequences

Among various issues there are two that impinge on the future of inheritance tax. The first is that, because of a fairly low exemption threshold, the tax has become a cash cow for the Government, bringing in nearly £3bn in 2004/05. This is 1.6% of the total taxes raised, and a slight increase in the tax take is projected for 2005/06. It would be difficult for the Chancellor to abolish IHT altogether in one year without a corresponding increase in income tax of one penny in the pound.

Second, the current value of family homes, particularly in London and the south-east, has brought many lower earning families potentially within the IHT net simply because of the value of the family home. Minor relief was granted in the 2006 Budget, increasing the current IHT exemption limit from £285,000 to £325,000 over four years, but all this achieves is keeping the exemption limit in line with projected property inflation.

The result of this is that, in many instances, the family home must be sold on the death of the surviving spouse/partner in order to raise funds to pay IHT. A recent press campaign in the Daily Express and comment in other national newspapers have highlighted this dilemma.

Professional comment

Co-incidentally the leading Comment article in Taxation magazine (2 March 2006 edition) by the editor, Mike Truman, considered the whole question of the abolition of IHT. He observed that different surveys showed that IHT will be payable by between 3.6m and 8.2m people when they die. He also pointed out that the yield from IHT is still projected to be more than that for capital gains tax in 2005/06.

In 1968/69 Estate Duty raised 5.9% of the total tax take, but nearly a century ago it comprised 19% of total taxes. Truman’s view was that 5% of direct taxes should come from IHT. The nil rate band should be reduced to £100,000 and 20% tax should be charged on the next £200,000, with 40% on chargeable estates above that figure.

Matthew Hutton, solicitor and well-known speaker on capital taxes, was still angry about the Budget announcements about trusts when I spoke to him. He considered that Budget Press Notice BN25 signified a “return to the dark ages of capital transfer tax”. The proposals will have a dramatic retroactive effect. There seems to be a widespread suspicion in HMRC of trusts generally, offshore as well as onshore, which demonstrates that tax officers are not “living in the real world”.

I also spoke to ACCA’s head of taxation, Chas Roy-Chowdhury. He pointed out that, globally, both Italy and the US had abolished death duties, and they also did not exist in Australia and New Zealand. IHT was a draconian tax, and was unreasonable as, in effect, it imposes double taxation on money already taxed and saved. Gifts of capital should not be taxed. It is Middle England that suffers the brunt of IHT.

Roy-Chowdhury suggested two possible solutions. One was a complete phasing out of IHT, say over between three and five years, which would have little effect on the coffers of the Treasury, and would be manageable in the context of the country’s finances. The other idea, which I have heard mentioned elsewhere, is for the family home to be completely exempt from IHT, as for capital gains tax (CGT).

Malcolm Gunn, tax consultant with Squire, Sanders & Dempsey, and former editor of Taxation magazine, stated that it was very clear that the UK Government does not intend to relax the scope of IHT - far from it. Indeed, it hopes to increase the yield. So the Budget announcements are a clear confrontation of the right-wing press campaign for the abolition of the tax.

It seems likely that the Government will have to relent on its proposals in relation to trusts for children; the relief for them has been set in stone since 1974 and the proposed change has caused an outcry. Gunn’s guess is that the Government will drop it as a quid pro quo for continuing with the new tax charge on setting up other trusts, but this is pure speculation of course. Even so, it will not be easy to get the Government to reconsider, as the existing tax reliefs for child trust funds and for trusts for vulnerable beneficiaries are geared to absolute entitlement at the age of 18.

A political football

Taxation and politics are closely intertwined, and I make no apology for introducing this element here. As it happens, the Keith Joseph Memorial Lecture was given by Lord Forsyth of Drumlean on 20 March, two days before the Budget. Lord Forsyth stated, among other things, that “there is no moral case for inheritance tax. It is double taxation, and it discourages thrift and self-reliance”.

No doubt, if the Labour Party was asked to comment, it would state that IHT was part of the means to redistribute wealth and capital. I cannot see, therefore, any current government making any radical alterations to IHT because of (in the case of Labour) betrayal of political principles and, in the case of all parties, the fear of electoral repercussions.

Personally, I like Roy-Chowdhury’s two suggestions. The first, which mirrors Lord Forsyth’s comments, is for a complete abolition of IHT over between three and five years. A government determined to introduce that measure could find other ways to fill the gap in funds. Roy-Chowdhury’s other suggestion is even more attractive and logical. This is that the private residence should be exempt from IHT. Both suggestions deserve serious consideration by any political party really committed to serving the people of the UK.

John Newth was deputy editor of Taxation magazine for over 13 years until 2002. He has since worked as a freelance tax journalist, winning the prestigious LexisNexis Tax Writer of the Year Award in 2005.