Two big questions of particular interest to investors were awaiting answers at the Tory party conference this week. Would the northern section of HS2 be scrapped, and would the prime minister confirm he was considering axing inheritance tax (IHT)? The answer to the former was in the affirmative – you can read our analysis of the decision here – but while we learnt that young Britons will be prevented from ever taking up the habit of smoking, and that A-Levels are being consigned to the dustbin, Rishi Sunak failed to address the specific issue of IHT, apart from a fleeting reference to his wish to deliver tax cuts.
For now, IHT is staying, without even a hint of a review on the way. Sunak may still promise an overhaul ahead of the election on the basis that the tax is disliked to a degree out of all proportion to the amount it raises (just £7bn a year) and the number of estates it impacts. Fewer than 4 per cent of estates paid IHT in 2020–21, but that’s set to top 7 per cent (and to bring in £15bn) a year, with significantly higher rates in London, within a decade according to the Institute of Fiscal Studies (IFS).
The perception of the tax as unfair is one reason it has been altered in various ways over the years, for example adding transferability to the nil-rate band and the introduction of the residence nil-rate band, and also why the debate around the tax is unlikely to die down. At one extreme is the argument, made on egalitarian grounds, that estates should be taxed at 100 per cent on death with no nil-rate band, the idea being that this would break a system where wealth can be passed down safely and completely within families, perpetually bestowing financial security on a lucky few. However, even an extreme reform of this nature might not achieve its goal of increased social mobility given that by the time people typically receive an inheritance, big wealth inequalities by parental background already exist, according to IFS research.
At the opposite end of the scale is the case for abolishing IHT on grounds such as that the state has no right to redistribute an individual’s estate and because more and more 'ordinary' families are falling into the net.
In between lie more moderate views – some argue that it would be fairer to replace the UK system with one that permits inheritors to receive a certain amount before it is taxed, or that the rate should be cut from its current 40 per cent, or the threshold raised from £325,000, alongside a tightening of the rules around reliefs and exemptions – the nil-rate band could rise to £500,000, for example, with the residence nil-rate band withdrawn.
The Labour Party is believed to be considering eliminating certain exemptions, in particular those that allow farms (including those let out to someone else after seven years), businesses and some Aim (and other) shares to pass down tax-free. The exemptions exist to prevent disruption, job losses or forced sales to pay a tax bill – but they also offer a handy tax planning opportunity for investors.
The IFS argues that there is a clear economic case for removing the special case for farms and businesses. First, it says, by foregoing this revenue, the government has to raise it elsewhere, and second, that “from a productivity [point of view] there is little case for [maintaining] family ownership”, a claim it bases on a paper from 2010 which showed that non-family-managed businesses perform better than businesses owned and managed by a family. But evidence to the contrary also exists (see our feature 'Do family companies make better investments?'). Other countries including Germany, Ireland and the Netherlands offer similar special protections.
The IHT exemption for defined-contribution (DC) pension pots could also come under scrutiny, especially now that the pensions lifetime allowance has been abolished, which means those who can afford to preserve their pension pot for passing down in effect secure an additional allowance.
A redesign remains on the cards, but given the future predicted value of IHT revenues, it seems likely that any reform will amount to altering the dimensions of the tax rather than abolishing it.
