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  1. Wealth
February 26, 2018

How to improve ‘migraine-inducing’ inheritance tax

By Spear's

The Office of Tax Simplification needs help to untangle a mess 200 years in the making, writes Arabella Murphy

Americans tell the story of George Washington’s Axe (it’s only had three new handles and two new blades, and is as good as it ever was), also known to philosophers as Theseus’s paradox, where little or nothing of the original now remains, except its name. The UK’s inheritance tax legislation is a bit like that.

A tax on estates was first introduced in 1796, to help fund the Napoleonic Wars, and the legislation grew like a Hydra for a century. As the then chancellor noted in 1894, announcing a near-total rewrite: ‘The whole system is admittedly difficult and complicated. The Death Duties have grown up piecemeal, and bear traces of their fragmentary origin. They have never been established upon any general principles, and they present an extraordinary specimen of tessellated legislation… each successive modification has only left confusion worse compounded.’ Every decade or two, another chancellor similarly bemoans the tax in its current form. Somewhat over a century later, the same words ring true.

Since 1986, the inheritance tax rules have been amended repeatedly, with new sections and schedules cobbled on or deleted with each year’s budget, and the Inheritance Tax Act 1984 now needs to be read alongside dozens of subsequent Finance Acts and other pieces of legislation (not including statutory instruments, Revenue Interpretations, Statements of Practice and other extra-statutory materials). Larger revisions, like the introduction of inheritance tax for property held in foreign companies, have been reverse engineered into legislation that was not designed to bear their weight.

Some things didn’t change: the rate of tax has remained steady at 40 per cent, but that’s now the second highest in the world. Other things changed so slowly that they created new problems: the amount exempted from tax – the ‘nil rate band’ – has increased far more slowly than house prices in particular. In 1986, the first year of inheritance tax, the average London house price was £55,000 and the nil-rate band was £71,000. By 2015, the nil-rate band of £325,000 no longer covered the average £531,000 London home, but no government could take the risk of unflattering headlines about giveaways to the wealthy. Instead, from 2017 a person can leave a home only to their direct descendants, with a specific tax allowance of up to £175,000 per testator, and only for estates up to a maximum of £2 million. This is a fine example of how a good intention (to increase tax relief) is contaminated by the fear of being thought to benefit the rich (or, worse, actually doing so), and becomes instead an embarrassed contortion, so bound up in conditions and exclusions that it loses all its intended utility.

When the Chancellor of the Exchequer says that inheritance tax is ‘particularly complex’, you know that this is a polite admission that it has been responsible for addling the brains of clients and their professional advisers for decades. Previous attempts to ‘simplify’ it have resulted in yet further reams of convoluted, migraine-inducing text, and even the Treasury cannot bear to continue inflicting further misery on those who try to comply with it.

Well, the first two statements are certainly true, and it would be nice to think that the third one was. Here are three suggestions for the Office of Tax Simplification, to help untangle a mess 200 years in the making:

  1. The taxation of trusts is not inheritance tax. Most professionals who have laboured through a ten-year anniversary return for a trust have, at some point in the process, contemplated a career change. Trusts don’t need to be taxed by calculating fractions of what they would pay if they were humans. They could just pay a different tax under a separate Act.
  2. Include fewer reliefs, and draft liberally. Sometimes, the fear that a person might be made fractionally better off than another is palpable in the drafting and it benefits no-one. It doesn’t matter if a home is worth £5 million or £100,000 – the tax rules should either respect and exempt every testator’s home (whoever it passes to), or exempt a single, larger nil-rate band regardless of what assets it represents. Tax rules can recognise the special status of an asset (such as a home), but if so, they shouldn’t impose value judgments on one home over another, or those who own a home but have no descendants.
  3. There is pressure to extend spouse relief to all those who live in a household (whatever their relationship). Spouse relief is not an infinitely elastic concept, but in the 21stcentury, maybe there is room for a new deferral or relief to help households that weren’t so common in 1949 or 1975 or 1986. Or perhaps, like households of unmarried elderly aunts, they did exist, but didn’t suffer tax, so this is simply another way of expressing frustration about the nil rate band and house prices.

Arabella Murphy is a founding partner and private wealth director at boutique law firm, Maurice Turnor Gardner LLP.

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