Robert Peston on risks of abolishing inheritance tax
Many resent a tax that targets grieving families, is a levy on wealth that has already been taxed, and kicks in at a punitive 40 percent. Scrapping IHT may look simple, but there are a host of reasons why Sunak may think twice, so don’t get your hopes up and don’t stop planning for it.
The first issue is that it would be politically difficult, as Labour could portray axing IHT as a tax break for the rich.
Most voters will see no benefit because they will never pay it anyway, said Joe Neal, tax manager at Blick Rothenberg. “In the 2020/21 tax year, just 27,000 out of 722,000 deaths incurred any IHT, which works out as just 3.73 percent.”
With careful planning, married couples can currently pass up to £1million to loved ones free of IHT, via the £325,000 nil-rate band and £175,000 main residence allowance. “The vast majority of people will never actually pay IHT and those that do are some of the richest people in the country,” Neal said.
Scrapping IHT would cost the Treasury up to £8billion a year, which will have to be made good from elsewhere, he added. “To replenish these lost funds would need a one percent increase either to income tax or the current VAT rate.”
Either change would hit tens of millions of voters, to help just tens of thousands. The electoral sums don’t add up.
There is another reason why voter shouldn’t get too excited about the prospect of IHT reform. It’s been suggested before. By the Conservative Party.
In January 2018, then Chancellor Philip Hammond tasked the Office of Tax Simplification with a two-part review of the complex and confusing levy. Apart from a few technical fiddles, nothing changed.
Even if Sunak does pledge to scrap IHT in the Tory manifesto ahead of the next election, it may never happen, with the party so far behind in the polls.
It won’t be a priority for the Labour Party if it wins, said James Ward, head of private client at law firm Kingsley Napley.
Shadow Chancellor Rachel Reeves may have recently ruled out a wealth tax, but Ward says we already have one in the shape of IHT. “Reeves may come to rely on IHT as a lever in her tax-raising armoury instead.”
Instead of paying less IHT, there is a danger we could end up paying more of it under Labour.
Scrapping IHT would have unexpected consequences that might deter Sunak, said Liz Palmer, partner in Howard Kennedy’s private wealth practice.
One of the main beneficiaries would be so-called “non-doms”, UK residents whose permanent home, or domicile, is overseas.
They only pay tax on money earned in or brought to the UK, or property owned here. “If IHT is abolished, we will remove one of the few taxes they actually do pay here,” Palmer said.
Abolishing IHT may also hit the charity sector. Brits who donate 10 percent of their estate to charity see their IHT charge fall from 40 percent to 36 percent. “By slashing the levy, the government may abolish an important incentive to donate to charities, impacting those in need,” she added.
It could also cut the supply of funds to around 700 growing UK businesses listed on the alternative investment market (AIM).
Investments in AIM shares benefit from IHT relief if owned for two years. “They may become less popular if they no longer provide a tax advantage,” Kennedy added.
Some even reckon AIM could collapse without this IHT break.
Rather than simply axing IHT, one option is to cut the punitive 40 percent rate, said Ian Dyall, head of estate planning at UK wealth manager Evelyn Partners.
Another option is to revert to scrap the current freeze on IHT tax bands and start hiking them in line with inflation again. Astonishingly, the nil-rate band has been frozen at £325,000 since April 2009, Dyall said.
“With the average property worth £279,569, according to Halifax, it can be quickly eaten up. If it had risen with inflation it would now be close to £500,000.”
The same should apply to the £175,000 main residence allowance. This only applies where a family home is left to children or grandchildren, bringing added complexity, and some want it rolled into one simple £500,000 IHT nil-rate band. That might satisfy many IHT critics.
Neal said Sunak should also consider increasing IHT gifting allowances, too, as their value has been eroded over time. “The £3,000 annual exempt gift allowance has stayed the same since 1981, and the £250 small gift allowance since 1980.”
Speculation about the end of IHT may backfire as it could tempt many to delay plans to reduce their exposure, warned Paul Barham, partner at accountancy group Mazars. “There are many strategies to efficiently pass wealth through generations, but most need time. So carry on planning for it.”
He’s right. The Tories have had 13 years to axe inheritance tax, but they haven’t done it yet. Families should continue to treat the death tax as a live threat.
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