Exchequer revenue, house price inflation and social mobility: Why inheritance tax thresholds should rise

In recent months, there has been a near clamour from government TDs for a significant reduction in inheritance tax. The actual proposal doing the rounds is for a doubling of the Class A capital acquisitions tax (CAT) threshold – the amount children, stepchildren and certain foster children can inherit tax-free from their parents – from €335,000 to €670,000.

The core argument for the increase in the threshold and consequent reduction in the tax is that average house prices in Dublin and other cities are now well above €335,000 and children shouldn’t have to pay tax on a family home they inherit from their parents. Of course, in many cases the estate is divided between several children and the €335,000 threshold increases accordingly. However, that doesn’t necessarily prevent children from having to pay tax on the inheritance of a fairly standard family home.

The current inheritance tax regime has been in place since 2010 and hasn’t generated much in the way of political debate until now. Prior to the global financial crisis, the threshold was just shy of €415,000 and the CAT rate payable was 20 per cent as opposed to 33 per cent today. The collapse in property prices in Ireland at that time rendered the increase in the tax moot for the majority of people. And to this day, it hasn’t occasioned much of an outcry.

Now that the ball has been put into play, the momentum appears to be gathering behind some form of increase to the threshold. While no finance minister ever wants to give up a valuable stream of revenue, the support for an increase in the threshold from both of the main government parties would appear to be irresistible at this point.

Of course, any proposals for a tax change have to make it through the Department of Finance first. Officials in the Department will crunch the numbers to determine the potential impact on the Exchequer. Very importantly, they will also look at any recommendations made by government advisory bodies like the Commission on Taxation and Welfare and the Tax Strategy Group (TSG), the latter of which is actually chaired by the Department of Finance. And that’s where things could start to get interesting.

A recommendation to lower the thresholds

Unburdened by political considerations, the Commission considered the question in 2022 and actually recommended a reduction in the thresholds. It said that the overall yield from wealth and capital taxes, including property, land, capital acquisitions and capital gains taxes should increase materially as a proportion of overall tax revenues. It also came down in favour of a significant tightening of the qualifying conditions for agricultural and business relief.

In addition, the Commission recommended a fundamental change to the way wealth is treated on the death of an individual. It proposed a change such that the transfer of assets on a death is treated as a disposal for capital gains tax purposes. In other words, capital gains on share portfolios or other assets such as non- principal private residences would be subject to capital gains tax payable by the estate. Inheritance tax in the form of capital acquisitions tax would still be payable by the recipients of any bequests.

The Commission also recommended that the capital gains tax principal private residence relief should be restricted over time. In other words, a ceiling would be placed on the value of homes which can be transferred tax-free.

Adding a bit of spice to the mix, the TSG has suggested a new requirement to file a tax return on all inheritances and gifts, no matter how small. Currently, recipients are obliged to file a capital acquisitions tax (CAT) return only when they pass 80 per cent of the relevant lifetime tax threshold. The logic advanced for this change was to save people the trouble of retaining records of small gifts for a long period of time.

However, it is more likely that the real reason is to make sure that no gift is left undeclared. The TSG justifies the need to tax inheritance appropriately as follows: “In receiving unearned wealth in this way, inheritances and gifts can provide increased social mobility and opportunity for those who receive them. However, if concentrated amongst a few, they may perpetuate inequalities in these same areas.

Research also indicates that the expectation of future inheritances can affect consumption and savings decisions of individuals, meaning that inheritances can have an impact across a lifecycle and not just at the time the inheritance occurs.”

Significant changes to agricultural and business relief were also recommended by the Commission on Taxation and Welfare. At present, these reliefs reduce the taxable value of the business property or agricultural holding on which CAT is calculated by 90 per cent, subject to certain conditions. The Commission has recommended tightening these conditions to ensure that the relief is only available to individuals actually working in the business or on the farm.

The minister and his department will be duty-bound to take these suggestions and recommendations into consideration should they decide to look at gift and inheritance tax, which they almost certainly will.

Filing returns for every gift received would be in no one’s interest.

However, the tide of opinion appears to be running in favour of an increase in thresholds and the retention of the existing agricultural and business relief regimes. This would most certainly be the most sensible outcome. At present, an average family home in Dublin left to one child would result in tax being payable.

That is not a desirable outcome. The threshold has not been increased to take house price inflation and the proposed doubling is probably long overdue in the current circumstances. Furthermore, the concept of double taxation on inheritances in the form of CGT and CAT should not be countenanced.

In addition, filing returns for every gift received would be in no one’s interest. It would lead to a massive increase in the compliance burden both for taxpayers and the Revenue and it is extremely difficult to see how it could be policed in a cost-effective manner. Indeed, it could well become one of those taxes that costs more to collect than it raises in revenue.

Even more importantly from an economic perspective, the agricultural and business Property reliefs should not be reduced or ringfenced in any way. Changes of that nature would result in viable family farms and businesses being sold simply to pay tax. This would not be in the best interests of the country and would almost certainly have adverse employment considerations.

Of course, no one apart from the minister can predict the contents of a budget with any degree of certainty. People of a nervous disposition who are concerned about the prospect of an adverse change to the inheritance tax regime can take steps to address the issue by transferring assets now under the current  thresholds. It is worth noting that the prospect of change is not the only reason for taking such steps. Succession planning and the tax-efficient and orderly transfer of assets should be part of the normal financial planning discussion regardless of the political backdrop.

Published online by The Currency on Wednesday 21 August 2024.