A tax opposed like no other
All taxes tend to be unpopular, but IHT is by far one of the most emotive for the public, with 50% of people saying that it is either ‘unfair’ or ‘very unfair’ according to a recent YouGov poll. A key driver of this perceived unfairness is the double taxation of earnings. However, as Tax Policy Associates have rightly pointed out, this could equally apply to VAT charged on purchases, such as buying a glass of wine, which most individuals then pay for out of income which has already been subject to Income Tax.
Double taxation and ‘death duties’
I would suggest that double taxation is a factor, but the root of the public’s continued opposition to IHT lies with the high headline rate of 40% (compared with VAT at 20%). This is coupled with paying what opponents have called ‘death duties’, in what is seen by them as one final opportunity for the state to extract taxation from individuals who have worked hard to accrue their assets in the hope of passing them down to their loved ones.
How many estates actually pay IHT?
However, despite the rhetoric, the reality is that the overwhelming majority of estates are not subject to IHT. As the IFS states, around only 5% of deaths generated a tax bill. In the past tax year (2023/24), IHT charged on those estates cumulatively raised £7 billion.
Furthermore, the effective tax rate is significantly lower than the 40% rate in practice. For instance, the average rate is actually 13% for estates of £1m and rises to a peak of 25% for estates between £3 million and £5 million.
The impact on reform
Despite the impact being felt by a relatively small number of estates and for a lower effective tax rate than the headline 40% figure, there continues to be widespread opposition to IHT across all segments of society. It's important to consider this when looking at the proposed reforms advocated by the IFS.
Business Property Relief and Agricultural Relief
One of the key factors of the lower effective rate of IHT is the use of IHT reliefs such as Business Property Relief (BPR) and Agricultural Relief (APR). Historically these reliefs have ensured businesses and farms did not have to be sold as a result of a death in the family, a measure which is critical in supporting family businesses.
As part of their report, the IFS has suggested that there's a strong economic case for abolishing APR and BPR. However, the IFS also recognises that this would be politically untenable for an incoming government. Instead, they've proposed a cap of £500,000 per person for APR and BPR respectively, with the unused proportion of the allowance transferable to a surviving spouse.
The IFS states that this would raise £1.4 billion in the current tax year. However, these relatively low thresholds for APR and BPR are likely to see many family businesses subject to IHT and potentially forced to sell their business interests to meet the liability.
Removing the investment incentives for AIM
Another suggestion is simply restricting the scope of BPR. At present, the assets covered by BPR includes AIM listed shares, which benefit from a 100% tax relief if they're held by an individual for at least two years before death.
The IFS has suggested removing this relief to generate around £1.1 billion in the current tax year. Taken at face value, selling AIM listed shares to pay an IHT bill does not have the same wide scale implications that the sale of a business or farm for the same purpose.
However, in practice the abolition of this relief would likely have a significant negative impact on AIM, as the IHT relief is a key driver for investment. There's also a wider issue of capital flight from the London stock market, which would exacerbate the impact on AIM from such a move. Taken together, it seems unlikely that either the Conservative Party or Labour Party would implement such a policy change after the upcoming general election.
Defined contribution pension relief
The think tank has also proposed removing IHT relief for defined contribution pension pots, which would raise a more modest sum of £200 million in the current tax year. However, this would remove a key incentive for individuals saving for their retirement, in the knowledge that their spouse or civil partner would be adequately provided for after their death.
Labour’s review of tax reliefs
The Labour Party has previously ruled out scrapping or amending APR but the same pledge has not been made about BPR. Indeed, the shadow chancellor, Rachel Reeves, has proposed a comprehensive review of tax reliefs to generate at least £4 billion in revenue for pre-election spending commitments.
Conclusion
It's too early to say whether IHT reform will become a key election issue, but if the Labour Party continues to hold a commanding lead in the polls, this will provide greater latitude for policy changes as the election approaches. Regardless of who wins the next election, the next government will have a mountain to climb to convince a sceptical public of IHT’s merits.
How might IHT affect your estate?
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