Abolishing IHT tax reliefs could raise £3bn, IFS finds

Removing three key inheritance tax reliefs could raise £3bn for the Treasury in the current tax year and would result in a fairer system, according to a leading think-tank.

Eliminating the special treatment of shares listed on Aim (the Alternative Investment Market), capping agricultural and business reliefs and taxing defined contribution pension pots when they are passed down would raise £2.7bn in the 2024-25 tax year, the Institute for Fiscal Studies said in a report on Thursday. 

Inheritance tax (IHT), which raised £7bn in the UK last year, has a long list of exemptions, the IFS said. IHT relief on business assets, agricultural property, gifts to charity and homes up to a certain value together added up to costs of about £4.2bn, according to its calculations.

These reliefs, which are used most heavily by the largest estates, have resulted in an effective tax rate of 17 per cent for estates worth £10mn or more — much lower than the headline tax rate of 40 per cent, the think- tank said.

“Inheritance tax is littered with special reliefs and exemptions which make the tax unfair,” said David Sturrock, a senior research economist at the IFS.

There have been rumours that chancellor Jeremy Hunt has been looking at scrapping inheritance tax. But in the Budget last month he introduced a new IHT relief which extends the type of land that can be passed down with no tax implications from next April.

Under UK tax law, shares listed on Aim can be passed to heirs tax free if they have been held for more than two years at the time of death. This “distorts” investment choices for these kinds of shares, the IFS said, particularly for older people looking to minimise their IHT liability.

Abolishing the Aim relief could raise at least £1.1bn in the current tax year, rising to £1.6bn in 2029-30, the think-tank said. These figures could be an underestimate, it added, as Aim relief is used heavily by trusts for which there are no direct statistics available. 

The IFS said that although there is a “strong case” for abolishing agricultural and business reliefs, the government could choose to cap them at £500,000 per person, allowing a transfer of the unused portion of the allowance to a surviving spouse or civil partner.

This would ensure that a couple could pass on a farm or business worth £1mn, the IFS said.

The Labour party has previously ruled out scrapping inheritance tax relief for farmland if it wins the next general election.

The final loophole that could be closed is the tax relief on defined contribution pension pots, which can currently be passed on free of inheritance tax. The IFS said this encourages those who want to pass on their wealth to use their pension as an “inheritance tax avoidance vehicle” which serves no economic purpose and is “clearly unfair”.

This would raise £200mn in the present tax year, with the potential to add £1bn-£2bn in the coming decades as the move away from final salary pension schemes continues to boost defined contribution pension pots.

“A key factor undermining support for taxes is the public perception that there are loopholes a small minority are taking advantage of,” said Mubin Haq, chief executive of the Abrdn Financial Fairness Trust. “Clamping down on a few of the main exemptions could increase the amount raised through inheritance tax by over one-fifth.”