November 15, 2024

Horse 3412 - The UK's Inheritance Tax Is Stupid

 https://www.bbc.com/news/business-36014533

The Chancellor Rachel Reeves has announced a series of changes to the inheritance tax rules which she said will raise £2bn a year.

Relatively few people actually pay the tax, but many think they will - either owing to its complexity or because they aspire to be suitably wealthy to end up paying.

Inheritance tax is charged at 40% on the property, possessions and money, external of somebody who has died, above a £325,000 threshold.

- BBC News, 30th Oct 2024

Let's put this on the record, Inheritance Tax is stupid.

It must be said that The Sceptred Isle, that little jewel set into the sea, as a fortress to defend against war and infection, does have some completely bonkers mental hatstand laws. Even though there are Select Committees who look into the drafting of laws, the fact that the House of Lords is unelected and has people who are very much self-interested to maintain the status quo, and the House of Commons has literally no oversight whatsoever that might have curbed it taxation laws, those bonkers mental hatstand laws have bonkers mental hatstand consequences.

One of those consequences is that when it comes to Estates and Inheritances, the laws which are only ever designed to affect the very wealthy, affect people who have run into wealth suddenly, and including circumstances where merely inheriting something doesn't even mean that that new found wealth is realised. 

Perhaps the most egregious outworking of completely bonkers mental hatstand laws having bonkers mental hatstand consequences, is when someone dies and leaves their family the farm. By nature, a farm is a going concern which employs the real estate upon which it sits as the means of productive output. The United Kingdom with its arcane taxation law, hasn't yet quite grasped the fact that a farm, which might very well be a going concern and which might have been in the same family for several hundreds of years, might run at very thin margins, and the imposition of an Inheritance Tax which only happens because someone had the audacity to die, could be enough to shatter the farm as a business. 

His Majesty's Revenue and Customs (HMRC) currently extracts an inheritance tax on the value of an estate when it is passed from one person to another through that unavoidable practice of death. The tax is 40% upon every pound in excess of the value of the estate of £325,000. This sounds reasonable in theory until you realise that in many cases the estate which is being inherited is either a house which someone is currently living or have been hoping to live in or worse, the estate is a family business like a farm or a small manufactory. Especially in the case of a farm, which might already be running close to the edge in terms of profitability, the death of someone causes the inheritance tax to be triggered on a going concern; which the farm as a business might not be able to absorb.

It doesn't take a gammaminus semi-moron to realise that the current inheritance tax system in the UK, is monumentally stupid. Even Blind Freddy can see that the imposition of a tax on the going concern of a farm, or the physical object of a house, where no real profitable action has warranted it, is nothing more than a cruel and cynical exercise in knavery. This is where my little Commonwealth of Australia, which follows in the Westminster tradition of law, is yet again better at some aspect of how the law is written and should be learnt from and copied.

The two biggest principles in the Income Tax Assessment Act 1997 in Australia are found in Sections 6 and 8 of the Act. Firstly, income isn't income until it is income. This sounds like such a basic ontological statement because it is. A thing isn't a thing until it's a thing. Secondly, deductions must relate to the income. If someone decides to go to school, say a hairdresser decides that they have chronic fear of hair and want to become a lumberjack, then learning that new trade is not related but if a lumberjack decides to take a chainsaw course to improve their skills, then that is related.

Those principles were actually right at the heart of the beginning of the Capital Gains Tax legislation debates in Australia in 1985, and they are quite instructive. Generally speaking, most people are not actually in the business of inheriting property from their parents and other family. Having a parent die and then leaving you the farm in a will, is not exactly something which is reproducible; at most it can happen twice. So then, the Capital Gains Tax legislation assumes from the outset that inheritance which is not a reliable source of income, is not necessarily income. We have no direct inheritance tax. 

Upon someone's death, they must complete a tax return. Their estate which is then a going entity also completes tax returns for the period in which it exists; if necessary it might pay tax upon a capital gain if it makes one but in the event when property is transferred from someone to someone else and no consideration has been made, then there isn't really any income to speak of and what we have is a Capital Gains Tax event.

We do not actually have a Capital Gains Tax in Australia. What we actually have is a Tax on Capital Gains; which is keeping in the Section 6 ontological principle that income isn't income until it is income. So what happens?

To simplify this to the point of discussion, upon the death and transfer of a thing, the value is taken up at the date it was transferred. In the case of shares, debentures, and tradable securities, then the market value at the date of transfer is a known and reliable take up rate. As for things like real property where the thing itself might not have been realised, then there is almost always some kind of valuation report before the dispersal and final divestment of the estate. This means that we also have a known and reliable take up value. There are then CGT Rollover provisions which mean that the thing being inherited by the new person, although it might have triggered a CGT Event by virtue of having changed hands (even if one of those hands was dead) still does not constitute income. Income is only income when the thing is finally realised; using the take-up value when the last CGT Event happened; and then is taxed at the usual marginal rates for person/company/trust/SMSF et cetera.

Conceivably a farm could have passed from Jack, to Jack Junior, to Bubbah Jack, to Little Bubbah Jack, and still not have been sold. A farm which remains in the family, remains in the family and if there is never a sale, there is no income upon which income tax can be laid. Income isn't income until it is income; so when that farm is finally sold, that sale would be income and the relevant CGT Event would be looked at.

Very clearly this is a far more sensible system, because it follows the basic ontological principle that income isn't income until it is income. And as the rules were invented in 1985, things which were bought back before 1985 are treated as being exempt from Capital Gains Tax but as that is almost forty years ago, the number of those things is dwindling.  

The other massive provision which the Income Tax Assessment Act 1997 in Australia has but the UK tax system does not, is that one's principle place of residence, that is where someone lives, is also exempt from Capital Gains Tax. This would have two massive effects on British taxation law if it were to be implemented. Firstly, it would mean that someone selling their house quite apart from inheritance provisions, would never incur a tax on capital gain. Secondly, as small family owned farms almost always have a farm house or homestead, then as that farm is also one's principle place of residence, then it would also never incur a tax on capital gain as it is also exempt from Capital Gains Tax.

The reason why these kind of things aren't implanted as part of British taxation law is that law generally and taxation law especially is glacial when it comes to change. This is mostly because the people who are most affected by changes in taxation in a pure raw numbers monetary sense, usually also have the greatest lobbying power with Members of Parliament. Money talks; sometimes it yells. Richer people usually have schemes and plans worked out to avoid tax, and while tax evasion is illegal, tax avoidance and using the legal means to do so is not. People who have eked out an advantage for themselves are highly unlikely to want to change the legislation; even if some other system also benefits them. Law is stickier than people assume that it is. 

John Bull, if you're listening, take some advice from Billy Brown from Sydney Town. You may have exiled us here for stealing sheep and handkerchiefs but in the time that we've been allowed to have a country for ourselves, not only did we improve how the Westminster System works, and how voting works, and how the franchise works before you, but we also improved Capital Tax legislation. 

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