The Big Question: How did inheritance tax become such a contentious political issue?


Why are we talking about it now?

The Shadow Chancellor, George Osborne, wants to raise the threshold for inheritance tax to £1 million, effectively abolishing it. The house price boom, especially in the south, has pushed more middle-class households into paying a tax that was once assumed to be for plutocrats. Given that the family home is the main asset of most people, it is, effectively, a property tax.

Such levies have never been popular, the most notorious being the poll tax or community charge, which helped end Mrs Thatcher's time as prime minister. With an imminent general election being widely speculated, Mr Osborne is no doubt hoping that his idea will attract voters in marginal constituencies, with an eye on their inheritance.

How much is inheritance tax?

Part of an estate over a threshold of £300,000 is taxed at 40 per cent; thus a £400,000 estate would be liable for £40,000. Spouses and civil partners are exempt.

What's wrong with inheritance tax?

It is now targeting people it was never meant to hit, though that can be a London-centric view. House prices have risen so rapidly in the capital that the average home passed the threshold last year, with the rest of the south-east not far behind.

However, UK average house prices are still some way off, though the gap has narrowed markedly. In 1997 the threshold was set at about twice average house prices; now it is about 50 per cent higher. Increases in the thresholds and a cooling property market should stop many more estates falling into eligibility in the near term.

Its enemies regard inheritance tax as a "tax on death" and a disincentive to work hard, save and pass wealth on to future generations. Attempted avoidance can lead to family arguments about money, which aren't much fun.

What's right with inheritance tax?

It's redistributive. Like all such measures it tends to reduce the advantages the well-heeled already enjoy and promotes a more meritocratic society, with inherited wealth a less powerful factor in dictating life chances. Crucially as well, all previous capital gains on the family home are exempt from tax (unlike any other investment).

The Government's view is that "inheritance tax is a fair and necessary means of raising revenue for public services, and is paid by only six per cent of all estates. No previous administration has ever linked tax thresholds – including inheritance tax thresholds – to price movements of any particular asset, such as housing, and this Government is no different."

The Chancellor announced in the Budget that the zero-rate threshold would increase again, and will continue to increase until April 2010 – when the threshold will reach £350,000 – ensuring that 94 per cent of estates continue to pay no inheritance tax. Anyone who wants to abolish inheritance tax needs to explain exactly how they plan to fund the £3.6bn cost – the equivalent to more than 1p on income tax; or 18p on petrol duty; and almost double what we are spending this year on counter-terrorism and security.

Who pays it?

About 38,000 people, against say 27,000 in 2002, but much lower than the 61,000 who were caught in 1976, when Denis Healey was Chancellor in the last Labour government and had promised "howls of anguish" from the rich.

Is it worth it?

Yes and no. It is growing at quite a clip; about £4 billion projected this year, up from £3.3 billion in 2005 and £2.3 billion in 2002. Mr Osborne's proposal would knock around £3.1 billion off that, leaving £800 million. However all these figures this must be set in the context of a total tax take of £453 billion.

Death and taxes; whose idea was it to put them together?

Pitt the Younger was the Tory prime minister when "legacy, succession and estate duty" came in as long ago as 1796. The scope of estate duty was gradually extended in the 19th century. However, unless the assets were valued at £1,500 or more (perhaps £500,000 in today's terms), the taxes were often not collected. Legislation in 1853, 1894 and 1909 (the so-called "people's budget" of David Lloyd George) further reformed the system, in the latter case to help pay for dreadnoughts and the newly introduced old age pension.

After the Second World War punitive death duties led, among other things, to the demolition of many stately homes. Capital Transfer Tax was introduced in 1975 to curtail people gifting assets to others while still alive to avoid tax.

Can I dodge inheritance tax?

Not easily. This Government has been vigilant in closing loopholes, even going to the unusual length of retrospective legislation to shut down one popular wheeze, that of placing the family home in a trust. Various levies on trusts, imputed tax liabilities on homes given away but still occupied and "pre-owned assets" rules closed off most escape routes. One tax efficient possibility would be to raise a mortgage on the home, and give away the money, with the debt forming a charge on the estate on death. But this would mean servicing the cost of a mortgage.

Alternatively a couple could split the value of the home (technically severing a joint tenancy and becoming "tenants in common") so that when one of them dies that part of the house, usually below the threshold, is left to the children. However the offspring could force the surviving parent to sell their home. Interfamily agreements can help, but if they are strong enough to protect mum or dad they'd probably fall foul of the tax rules.

Andrew Tailby-Faulkes, tax partner at Ernst and Young, advises many clients "don't bother" when it comes to protecting the family home from tax. Probably the only reliable way of not paying it is to use an offshore trust, thought this is reserved for non domiciles – ironically the people Mr Osborne is targeting with a £25,000 levy in order to pay for his inheritance tax changes.

Any other ideas?

If you are feeling philanthropic, you can leave your property, tax free, to a UK charity, a museum, university, the National Trust and, if you're feeling especially magnanimous, UK political parties. Giving away money, shares, art, stamp collections, gold coins or other goodies is usually easier because you can do it incrementally; you can simply gift these up to £3,000 a year and they won't count towards your estate for tax purposes.

Is inheritance tax unpopular?

Yes. In 2004, 69 per cent of respondents in a MORI poll agreed that it was "unfair" to tax property after death, with 41 per cent thinking it ought to start at a much higher level, and about two thirds favouring banding rather than the relatively blunt instrument of a flat rate of 40 per cent.

So should we ditch inheritance tax?

Yes

* It is not just taxing the super rich, but now affects middle-class families as well as those inheriting large estates

* In some areas of the country, the threshold is actually below the average house price and the gap is closing everywhere

* More than two-thirds of the population see it as an unfair tax, while 40 per cent think the threshold is too low

No

* There should be a tax on income that has not been earned, but only received because of the family one is born into

* It should continue in a more flexible form, such as banding used for council tax and income tax

* Abolishing it would cost the Treasury £3.6bn, which equates to more than an extra 1p on income tax

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