IHT and CGT tax the same assets, they tax them at different times under different circumstances, but do we need both? I am going to propose scrapping them and replacing them with one tax. We could also extend the argument to Stamp Duty but I won’t spend much time talking about that.
There’s been some discussion about aligning Income Tax with CGT, but that’s a subject for another day. However, I am just going to throw in being rid of Basic Rate CGT and having a bigger Annual Exemption in its place. Let’s assume 24% is the number. If stamp duty is incorporated then it might have to be a higher, potentially a lot higher.
With CGT and IHT, one is usually only paid when the other isn’t, so they are imperfect mirrors of one another, they also have similar reliefs available:
| Capital Gains Tax | Inheritance Tax |
| Taxed on the increase in asset values when sold or gifted but exempt on death | Taxed on total asset values on death and some gifts |
| Inter-spousal transfers hold-over the gain | Spousal exemption and Transferable NRB |
| Main Residence Relief | Residence Nil Rate Band |
| Hold-over relief on business or agricultural assets | Business Relief and/or Agricultural Relief |
| Rollover relief on many business and/or agricultural assets | Replacement Relief |
| Discretionary settlements qualify for Hold-over relief up to £325k | Discretionary settlements are exempt from IHT entry charge up to 325k |
They are both leaky buckets through, with many people not paying either and occasionally both being paid.
Wealth Tax
Changing tack for a minute, I keep hearing a lot about wealth taxes. It’s easy to see why people think this is a good idea. You just get rich people to hand over a bit of their money every year, and direct it to whatever your pet project is.
There aren’t many good examples of wealth tax, IHT is arguably one or at least it would be if it wasn’t so easy for rich people to avoid.
Council tax is sometimes thought of as a wealth tax but it’s clearly not. You pay it if you rent (so don’t own the asset) or if you have a mortgage on the assets it’s levied on. It’s therefore got nothing to do with wealth. For some people, an expensive property is more of a liability.
CGT on the other hand is not a wealth tax as is charged not on wealth but on the increase in wealth. Though I think the distinction might be blurry for many.
Stamp Duty is charged on transactions so nothing to do with overall wealth.
Is Inheritance Tax fair?
IHT is certainly unpopular, many think it’s unfair to tax pre-taxed wealth again. It’s also very complicated and discriminates against people who aren’t married or who don’t have children or those who die suddenly or unexpectedly.
Proponents think it’s fine as taxes rich people (or least they think it does).
For my part I think these two groups of people are having two separate conversations and usually won’t listen to each other long enough to realise it.
For me there are two separate questions:
- Are inter generation taxes fair?
- Is Inheritance Tax fair?
As dead people have given up all practical use of their assets, death is usually a good time to levy a tax. Inheritance Tax is not fair, it’s easy for rich people to avoid and catches out people with relatively modest wealth. Gifting allows people to avoid it, but is at least partially a matter of luck as to whether it’s successful. Business Relief and Agricultural Relief make sense to stop small businesses being broken up but that hardly translates to AIM shares and ITS services.
Capital Gains Tax
CGT is relatively straightforward and reasonably fair, but for the gain being wiped out on death. This can be a matter of luck, but also people with more money are more likely to be able hold assets until death.
Neither or Both
There are some circumstance when you need not pay either but occasions when both might be payable, one such example is Held-over gifts:
If your gifts qualify for Hold-over relief you can kick the CGT can down the road, and also avoid IHT if the donor survives 7 years. You exchange a definite 40% for a maybe 24% at some point.
However, if the donor dies within 7 years, what would have been just 40% on death is exchanged for 40% in the failed CLT, plus maybe another 24% at some point when the asset is sold.
I think taxes they should be levied fairly and evenly, not based on luck or misfortune. While we should make suitable allowances for liquidity, we should not make unnecessary give always.
Merging Taxes
Lets talk about how we can amalgamate them. We could just abolished IHT and tweek CGT. I think this will look like a tax giveaway for the rich, as news articles talk about abolishing IHT and skipping over the changes to CGT. Far better to abolish both and have a new tax.
For now let’s call the replacement “Asset Tax” split down into Asset Sale Tax, Asset Gift Tax, Asset Death Tax, it’s a 3 in 1 (like a Kinder Surprise). It would work like this:
| Sale | Gift | Death | |
| Most assets | tax on the gain in year of sale | Tax on gain in year of gift | Tax on the gain in year of death |
| Main residence | Rollover allowed if buying new main residence, else taxed on gain | Tax on gain | Tax on Gain |
| Transfers to spouse | Gain held-over | Gain Held-over | Gain Held-over |
| Agricultural Property | Rolled over if buying new agricultural property or business property, else taxed on gain | Gain Held-over | Gain Held-over |
| Business Property | Rolled over if buying new business or agricultural property else taxed on gain | Gain Held-over | Gain Held-over |
| EIS (after 3 years qualifying period) | No tax on gain, but any deferred gain is revived | Base cost recalculated to current value. Any Deferred gain is revived against donor. | Base cost recalculated to current value. Deferred Gain either revived against the estate or base cost adjusted to account for it. |
As you can see I have merged Business and Agricultural Relief with Hold-over Relief, enabling Businesses and Farms to be passed down in tact and doesn’t make a distinction between gifts and bequeaths.
Part of the benefit is that tax is not lost if something is miss-characterised it’s just delayed into the future.
If wealthy people buy farms just to avoid the tax on death, then their kids will just pay the tax when they sell the farm. An issue which won’t effect multi-generational farmers because they won’t sell the assets, a nice climb down opportunity with no U-turn required.
It doesn’t tax pre-taxed assets only growth, it makes the tax harder to avoid through the leaks between rules. It’s a tax on something which can reasonably be perceived as wealth but is not a wealth tax.
The most controversial bit I think is replacing Main Residence Relief with rollover relief. I would suggest though making this work as capital out first instead of gain out first. This would allow downsizing or equity release to consume the capital before the taxable gain was triggered.
Will it raise more tax?
I am not really in a position to say whether this would bring in more or less tax than at present.
My hunch is more, even though we replace IHTs 40% with CGTs 24% in most cases that 24% is collected in more circumstances.
24% is less than the combined marginal rate of tax and NI for a minimum wage workers, so nobody should really complain. It could even be that 24% seems palatable enough that many people will be happy to pay it rather than take risks with BR assets or mess about with trusts.
As an added bonus, because the tax is almost certain to be collected at some point it could reasonably be included as an asset on the Governments balance sheet, though there would difficulties maintaining records, though for some assets this would easy such as electronically traded investments, while others be could valued as part of a hold-over/rollover claim.
Trusts
“What about Discretionary Trust” I hear you ask. Well, cliff notes version, I think they should be subject to Corporation Tax, at least until I write a post about how the whole business tax regime should be revised.
Phil