Money: The tax temptation Labour must resist

Speculation is growing that the Government is revising inheritance tax rules as part of its "green Budget". John Whiting, a tax expert, examines the options.

There is old cartoon that shows two Egyptians standing next to the Great Pyramid. One points to an adjacent, vastly shrunken pyramid. "This one had to pay inheritance tax," he explains.

Received wisdom about the ability of clever tax planners to ensure little or no inheritance tax (IHT) is paid nowadays would probably portray the erstwhile miniature pyramid at roughly the same size as its big brother.

Undoubtedly, IHT is a tax that can be planned for, and bears less heavily on certain kinds of property - but that planning often requires giving wealth away during life, which is not necessarily a practical route.

The previous government said it wanted to abolish IHT when it could afford it. In fact the tax raises modest amounts of money - about pounds l.6bn, which represents about 1.5 per cent of Inland Revenue receipts. The pounds 20m its predecessor, capital transfer tax (CTT), raised in the first part of this century, represented 20 per cent of Inland Revenue "take". So in absolute terms IHT could easily be dispensed with, though governments are rarely flush with tax revenues.

There is a moral argument that IHT should be abolished. It is a levy on the assets that a taxpayer has accumulated during a taxpaying life. Why should the deceased be forced to make a final contribution to the Exchequer?

When estate duty, as it was first called, was introduced in 1894, one justification was that the deceased could not control his or her assets; only the State permitted some sort of control mechanism. Estate duty was a fee to let the deceased's wishes take effect.

Is this valid today? I suspect that, moral arguments or no, we are not going to see the abolition of IHT under the current government. It is more likely to be retained and tightened. Probably some reliefs will be restricted and there is clearly a possibility that we will go back to CTT, with some form of lifetime gifts tax.

That would be a backward step - the lifetime charge was difficult to administer, raised minimal amounts, and got in the way of one of CTT's aims, to encourage the redistribution of wealth.

Almost certainly, attention will be paid to the major reliefs, At present, business and agricultural property can both attract 100 per cent relief - exemption, in effect.

These are key reliefs to ensure that businesses and farms are not broken up to pay tax bills. But investors in such properties can get relief as well, so there may be an attempt to focus squarely on the businessman or working farmer rather than the investor.

The useful ability to carry out a "deed of variation" to rewrite the deceased's will is almost certainly approaching end of its life, too.

The heritage property relief, whereby tax bills can be mitigated in return for allowing your property to be viewed by the public, will almost certainly remain, but with tougher conditions. You really will have to let people tramp round your house to see that old master most days of the week, rather than just on the second Tuesday in Lent provided there is a full moon!

Of course, we could see radical action. Possibly IHT could become a true inheritance tax by focusing on the amount an individual inherits, rather than the amount left in the estate. Thus, spreading your wealth among all your children and grandchildren would lead to less tax than if you passed it all to one heir. This is along the lines of the accessions tax that the Liberal Democrats have suggested.

Another thought, and one that deserves serious consideration, is to go ahead with the abolition of IHT - but to reintroduce CGT on death. Currently there is no CGT on death and the heirs take the assets at market value at the date of death. There is the important point that the family house is outside CGT, and would thus be outside the new CGT/IHT. Currently, too many people whose estates are essentially their homes, plus a few savings, creep into the IHT net which closes in on values above pounds 215,000.

There would have to be continued exemptions for business, agricultural and heritage property under a CGT/IHT regime. That would sensibly tie in to length of holding the asset - seven years and you're out, perhaps?

Undoubtedly, any reform along these lines would need to be thought through carefully, to assess wider impacts. But, whatever changes are in the offing, we need proper thought and planning, not over-hasty plugging of perceived gaps. Whilst the State may feel it is entitled to share in a deceased's wealth, that share should be a modest fee, not something that looks like a swiping of a large part of what the grieving relatives might otherwise have had.

The writer is a tax partner at Price Waterhouse.