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Caught in the IHT net

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IHT seemed to have been taken off the political agenda until the Mirrlees report recommended an overhaul. Gregor Watt looks at he political debate around IHT

Few taxes attract the level of opprobrium that inheritance tax does. Maybe it is the element of double taxation that crops up with IHT that people find objectionable or maybe it is the 40 per cent charge on assets above the nil-rate band.

The fact the threshold for IHT has increased at a much slower rate than house prices has added to the dislike of the tax. At the beginning of 2001, the IHT threshold was £234,000 while figures from Nationwide show the average house price was £83,540.

By 2011, the personal IHT allowance had risen to £325,000 but house price growth had substantially outstripped this to stand at £165,600. While house prices have grown by 98 per cent in the last 10 years, the IHT threshold has increased by 38.8 per cent.

The decision to formally link married couples’ or civil partners’ nil-rate bands and allow beneficiaries only to apply the unused allowance on second death, effectively creating a nil-rate band of £650,000 for a couple, has gone some way to mitigate this complaint.

However, there is still a general feeling that IHT is a tax designed for the super-wealthy but that the Government is benefiting by allowing more middle class, mass-affluent people with few assets outside a large house, to be caught by the tax.

For this reason, IHT takes on real political significance. The Tories seem to have an instinctive dislike for it as a tax on achievement and success and this has seen them launch several reforms efforts.

One of the Tories pre-election pledges was to increase the individual threshold to £1m, with their 2010 general election manif-esto saying: “We will raise the inheritance tax threshold to £1m to help millions of people who aspire to pass something on to their children, paid for by a simple flat-rate levy on all non-domiciled individuals.”

IHT reform was one of the Tory casualties of the coalition agreement last May, being ditched to make way for the LibDem policy of increasing the income tax personal allowance towards £10,000 to lift the lowest paid out of the reach of income tax.

It looked like the question of IHT reform had been taken off the political agenda. However, there is a chance that it might sneak back in.

The Mirrlees review of tax carried out for the Institute of Fiscal Studies and published in November 2010 was tasked with mapping out reform of the UK tax system to make it fit for the 21st Century. The review recommended that IHT be overhauled and the current system be replaced with a more straightforward tax on the transfer of assets.

The report says: “The current UK inheritance tax is unfair in many ways - it fails to tax those who pass on gifts during their lifetime and benefits those who can arrange their affairs to escape taxation at death, while taxing more highly those (usually of more modest means) who cannot arrange their affairs so as to avoid taxation. It is inefficient because it creates many tax-driven behavioural changes and leads to some asset classes, such as agricultural and business assets, being tax favoured for no clear reason except, presumably, the influence of the agricultural and family business lobbies.”

There have been further calls for an overhaul of the current IHT rules following the publication of the Office of Tax Simplification review of tax reliefs earlier this year.

The Office of Tax Simpli-fication was set up by the Treasury specifically to review the numerous tax exemptions that have built up over the years and draw up a list of recomm-endations of which could be scrapped. Alongside a reco-mmendation that a number of individual tax exemptions are scrapped, one of the five key theme’s of the tax simplification report was that the Government should look again at the IHT regime.

The report said as the system of reliefs is inextricably linked to the tax itself, and due to the unfairness of who ends up paying IHT, the whole tax needs a thorough review.

The report concludes: “In the light of all this, our conclusion is that there should be a proper review of inheri-tance tax, whether by HMRC, HM Treasury or the OTS. This would clearly be a longer-term project. In short, this is a tax that needs a top-down review.”

For a tax that attaches so much dislike, it effects a surprisingly small number of people. According to figures from the Office of Tax Simpli-fication, just over 2 per cent of all estates paid IHT in 2009. In the year 2009/10, the amount raised by HMRC was £2.4bn, a figure which has dropped sharply from its peak in 2007/08 when it raised £3.8bn.

Still, it seems that many people still pay some form of death duty needlessly.

Figures from unbiased.co.uk suggest that £1.3bn is paid every year needlessly by people who do not take relatively straightforward action to mitigate against the tax.

Chief executive Karen Barrett says: “Vast sums are being paid unnecessarily in inheritance tax every year because the deceased had not made adequate provision. “With the IHT threshold frozen for ano-ther three years, it is important to make sure your financial affairs are in order to protect your family and loved ones.”

Until the system is overhauled, it seems that there is plenty of scope to help clients cut down on their bills for what is described as an optional tax.

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