Inheritance Tax October 2024 Budget changes – an explainer

This is part of a series of explainers on topical tax issues produced by the Chartered Institute of Taxation

How does IHT work? 

Most commonly, it is a 40% tax upon death on the value of someone’s estate (i.e. assets in their ownership) which exceeds a ‘nil rate band’ of £325,000 plus potentially a ‘residence nil-rate band’ of £175,000 if the residence (or the equivalent proceeds if already sold) are left to children or grandchildren. Because these allowances can be passed on to a spouse (or civil partner) if unused, surviving spouses can potentially have up to £1 million of nil-rate band on their eventual deaths (two nil-rate bands plus two residence nil-rate bands).

Various reliefs are available, the most common of which are transfers between spouses, gifts to charities and reliefs for business and agricultural property.

AGRICULTURAL PROPERTY RELIEF

How does agricultural property relief for IHT currently work?

Agricultural Property Relief (APR) gives 100% relief from IHT on the agricultural value (not necessarily the total value) of land and ‘character appropriate’ buildings occupied for agricultural purposes, including residential farmhouses.

To get full APR the land must have been occupied by the person who has died for the two years running up to their death. Land which is occupied by someone else – for instance a tenant farmer – can still give 100% relief provided it has been owned by the landowner who has died for seven years. Some land subject to older (pre-1995) tenancies may only offer 50% relief.

Further information on what qualifies for APR can be read here.

There is currently no limit to the amount of the relief.

How much does it cost the government?

According to the Budget notes, APR cost HM Treasury £550 million in 2021-22 (although, confusingly, HMRC’s spreadsheet of the costs of tax reliefs puts the cost at £315 million (2021-22) to £365m (2023-24)).  These figures should anyway be treated with some caution if assessing the effect on government finances if APR were removed or amended.  For instance, it does not consider (if APR were removed) what other reliefs might then have applied or what behavioural changes might be made by the owners of agricultural land and property (such as giving the property away early and surviving seven years). Indirect consequences such as the potential effects on agricultural land prices are also unlikely to be factored in.

What are the government proposing to do?

From April 2026, owners of farmland will be able to claim 100% APR on up to £1 million of agricultural property; values above this amount will only attract 50% relief. 

This £1 million allowance will also include relevant business property qualifying for 100% Business Property Relief (BPR – see below). The existing 50% APR rate category remains unchanged. 

Any unused £1 million allowance is not transferable after death.

In a separate change, from April 2025, the definition of agricultural land for APR purposes will be extended to that managed under an environmental agreement with, or on behalf of, the UK government, devolved governments, public bodies, local authorities, or relevant approved responsible bodies.

What are the arguments for APR?

Supporters of APR argue that the rationale for the relief is as strong now as it was in 1984 when the current relief was introduced, i.e. to keep the country producing food. Without this, many farms would have to be sold or broken up to pay the IHT, which may cause them to cease activity resulting in drastic effects for the UK economy and food production as well as the future of smaller family farms.

The President of the National Farmers Union has said that “APR is what makes it possible for small family farms to pass from one generation to another”. The NFU says that the return on capital for farming can be very low and having to pay IHT would remove any ability to invest in the business. It does seem true that farmers in particular have liquidity problems as their farming income tends to be small and even if they are also developing other sources of income (e.g. wedding receptions or lettings) overall they do face liquidity issues.  

What are the arguments against APR?

Critics of APR generally make the case that IHT should be levied on someone’s entire estate with as few exemptions as possible, and that all exemptions create an opportunity for abuse.

“Many super rich families – with no real connection to farming – are increasingly buying farmland in order to exploit this loophole,” say Tax Justice UK. Critics point to people like Sir James Dyson, of vacuum-cleaner fame, who is reputed to own 36,000 acres of UK farmland, and Anders Holch Povlson, a fast-fashion entrepreneur, who is said to own more than 220,000 acres. Whilst this is presumably all productive farmland, it is undoubtedly also a useful way to shelter fortunes from IHT.  On the other hand it could be argued that bringing outside capital and expertise into farming might modernise farming practices.  

Critics argue that most recipients of APR are not small family farmers. A recent report from the Centre for Analysis of Taxation (CenTax) found that between 2018 and 2020 around 1300 estates a year benefitted from APR but almost two thirds of that benefit went to the top 200 estates, which each claimed more than £1 million in relief, with an average estate value of £6 million. Analysing IHT and income tax records the report’s authors conclude that only a minority of those benefiting from APR in this period had identifiable trading income from farming in the five years before their death and that even among these active farmers trading income from agriculture was in most cases a minority of their income (although this could be because the yield from farming is so poor that farmers are forced to diversify). The authors controversially suggest that many small farms may fall within standard IHT allowances giving their owners no need to make use of APR.  As explained below this has been strongly disputed by many farmers who argue that the £1 million cap does not take into account items such as stock or machinery which sends them significantly over the threshold.  

It has also been suggested that the existence of APR drives up land values, forces out smaller farmers and prevents young farmers from entering the industry, by encouraging wealthy investors to buy farmland in order to avoid IHT.

The suggestion is sometimes made that APR should only be available for working, in-hand farms rather than landlords who treat farmland as a tax-efficient investment. However, restricting APR in this way may in fact encourage landowners to sell up or get rid of tenant farmers altogether thereby encouraging the entry of private equity into farming who will not have the same liquidity concerns.   

What are the arguments for limiting APR (the government’s plan)?

Limiting the relief as the government propose is an attempt to target the relief in a way that enables the smallest family farms to continue to benefit fully from it while limiting the extent to which it benefits the wealthier.

The government expect almost three-quarters of estates claiming APR in 2026-27 (the first year under the new rules) to be unaffected by this reform (although as set out below this figure is disputed). The government argues that “it is not fair or sustainable for a very small number of claimants each year to claim such a significant amount of relief. This also contributes to the very largest estates paying lower average effective inheritance tax rates than smaller estates”.

Limits on capital taxes exist in other places. Business Asset Disposal Relief for capital gains tax is capped at £1 million in one’s lifetime (£10 million prior to 2020) – so this proposal for APR/BPR mirrors that allowance.  

The IFS had recommended a cap of £500,000 per person covering both APR and BPR, with the unused portion of the allowance being transferable to a surviving spouse or civil partner (so a couple could pass on a farm or business worth £1 million). Of course, an issue with caps is that, unless inflation proofed, their value becomes eroded over time. 

What are the arguments against the government’s proposals?

The NFU say that the Treasury’s figures which claim this will only affect one in four British farms are misleading. They argue that very few viable farms are worth under £1 million and that, if implemented, the proposals would lead to many family farms being broken up to pay IHT and becoming unviable. In particular tenant farmers are worried that landowners will simply now sell up and invest in something more profitable if the relief is not 100%.  

There is a further argument around the introduction of a major change such as this at short notice. Is it fair, when people have taken long-term decisions based on a particular set of tax rules, to radically change those rules with very little notice especially if a farmer is elderly and may not be able to survive the necessary seven years to effect IHT planning?  Of course this isn’t to say that no tax relief should ever be withdrawn – or that people should expect tax reliefs to continue to apply for ever.  But – particularly where long-term decisions are taken (e.g. those relating to pensions and IHT, in particular) – there is an argument that transition should be more gradual or incremental.  Here the only transition is a delay until 6 April 2026.  It might have been fairer to have had (say) 75% APR/BPR (that is, a 10% rate) for a few years and then a further reduction.

Perhaps the most cogent argument against this change is that it won’t actually raise much money but will be a bonanza for valuers and lawyers with more lifetime giving and changes in wills required.  Better off farmers will seek advice to avoid the IHT.   Even on the government’s figures it only raises about £520 million a year across the APR and BPR changes and of course it will involve a much greater need for valuations.  At present HMRC can take many years to agree valuations on a death thus delaying the winding up and distribution of an estate and increasing uncertainty for executors and beneficiaries.  Is this very productive work for practitioners, clients and HMRC to be doing for relatively low yield?   Most well advised younger farmers and businesses are likely to make lifetime gifts earlier and thus avoid the restrictions.  

So are those figures for the proportion of APR-claiming estates which will be affected accurate?

It’s hard to say as this is more complicated than it at first appears. 

The source of the claim that the government expect almost three-quarters of APR-claiming estates to be unaffected appears to be their figures indicating that in 2021-22 (apparently the latest figures available) 73% of APR claims were for assets of £1 million or less in value. However it is common for an estate to claim both APR and BPR so an estate making a combined claim of up to £2 million split equally between the two reliefs would fall below the £1 million threshold for each but would not fall below the combined £1 million threshold which the government are proposing to introduce.

It seems unlikely to us that the figures for the value of assets claimed for APR currently are reflective of the full value of farms in the UK today. Beyond anecdotal evidence there are data indicating that the average price of farmland in England is £27,900 per hectare and that the median farm size in England is around 35 hectares. Multiplying the former by the latter gets you to just under £1 million as a rough estimate for the (median) average farm value in England (even ignoring the farmhouse, farm buildings, plant and machinery, etc – admittedly nil-rate bands will knock out some of this though farm owners may also have other savings and assets to counterbalance this). 

So are you saying half (or more) of farms will have to pay IHT after this change?

No. We are saying it appears that more than half of farms have a value of more than £1 million, so over the allowance for APR/BPR. But whether the changes will bring them into the scope of IHT will depend on the interaction of APR not just with BPR but with nil-rate bands and other reliefs as well as potential behavioural changes including more lifetime gifting to family members and changes to the structuring of farm businesses.

Additionally, while the £1 million APR/BPR allowance is not transferable between spouses in the way nil-rate bands are, a farm jointly owned by a couple could potentially use two £1 million allowances (as well as two sets of nil-rate bands and residence nil-rate bands) if a share of the ownership of the farm was passed to the next generation on the first death and the remainder on the second. However note that an individual starts to lose their residence nil-rate band once the value of the net estate goes above £2 million. (NB. The law in this area is complicated and we would strongly recommend taking advice from a specialist before taking this approach, as we would with gifting or restructuring a farm or other business!) By not making the £1 million transferable on death the government has greatly added to the complexity of the relief. 

What about the claims that beneficiaries of farms won’t be able to afford to pay the IHT bill?

The IHT position is particularly challenging for farms (compared to other businesses) because of the peculiarly illiquid nature of farming – high capital values but low yield (often less than 1%).  Ignoring the first £1 million, 50% relief equates to a 20% effective rate of tax.  Payable in instalments over 10 years that could be said to be a 2% p.a. charge for 10 years.  For a conventional business – perhaps yielding 5%-10% - that may be do-able out of annual profits.  But for a farm where the yield is less than 1% it is far more problematic.   

To give an example, if you take a farm of a couple of hundred acres plus house, farm buildings etc. that could easily be worth £4 million. You get £1 million tax free.  Assume other nil-rate bands are used elsewhere.  The remaining £3 million at a 20% effective rate produces an IHT bill of £600,000 or £60,000 a year for 10 years.  But the farm may only be yielding 1% - say £40,000 a year.  How can a farmer pay this? Borrowing may be an option, but most farms already bear considerable debts. Indeed banks may be concerned about a farm’s viability if they now realise that an elderly farmer may have to pay IHT on death and the farm is already heavily geared.

BUSINESS PROPERTY RELIEF

How does BPR for IHT work?

BPR gives 100% relief from IHT for businesses which are predominantly trading – sole traders and partnership shares come under this heading, as does ownership of unquoted trading company shares and controlling securities. AIM stock also benefits from this relief (see below). 

A rate of 50% is available for assets personally owned by a shareholder or partner which are used by their company or partnership and in rare cases for controlling shareholdings in quoted companies. 

How much does BPR cost the government? 

According to HMRC estimates, BPR cost HM Treasury £1.3 billion in 2023-4 (the Budget note figure is for 2021-22 and is £1.05 billion).  As with APR this costing ignores other reliefs and behavioural effects if the relief were abolished.

What is the government proposing to do?

The £1million allowance for APR from April 2026 applies equally to BPR; a taxpayer could therefore claim £1million worth of 100% BPR, or combination of BPR/APR totalling £1million e.g. £400,000 of 100% APR and £600,000 of 100% BPR over an owner-occupied farm. 

As with APR, relevant business property under BPR above that £1million will qualify for a new 50% rate. The existing 50% rate categories will remain unchanged.

What are the arguments for BPR?

According to the government, the aim of BPR is to “ensure businesses do not have to be sold or broken up following the death of the owner”.

Campaign group Family Business UK say that removing or capping BPR “would be catastrophic to family businesses, lead to the loss of good jobs, weaken the economy and leave Britain a poorer place.”

Like those surrounding farms and APR, these arguments are based principally around liquidity problems - the concern that an estate may not have the liquid assets to pay IHT and so would have to sell off all or part of the business. There is a second argument used for BPR and this is that it incentivises investment, both by the owners of businesses and by outside investors.

What are the arguments against BPR?

As with APR the starting point tends to be the principle of minimising exemptions, noting that once you start drawing distinctions between treatment of different assets you create incentives, distortions and opportunities for abuse. 

Before one can really judge whether BPR should be abolished or restricted one has to work out what the policy is behind the relief and this remains unclear. It might have been preferable for the government to consult on this first and perhaps articulate the arguments for and against relief.  For example, is the purpose of BPR to keep family businesses intact? That used to be the stated argument but there is nothing to stop the heir selling the asset after the death of the owner without any clawback of relief.  By contrast both Ireland and Germany who both have similar BPR incentives at 100% have measures to stop this. However, is it a good idea to stop an heir selling a business if they are not capable of running it?   

An alternative argument is that BPR is an incentive for investment by third parties in AIM companies or in other unquoted trading vehicles.  In that sense it is similar to Enterprise Investment Scheme (EIS) or Venture Capital Trust (VCT) relief.  It would have been helpful to have been able to explore these arguments in greater depth. 

CenTax, in their recent report, conclude that BPR “is a major contributor to the regressivity of IHT at the very top”. They calculate that, amongst estates worth £30 million or more, BPR lowers the effective average IHT rate from an average of 23% to 12%.

As noted above the IFS recommended a cap of £500,000 per person covering both APR and BPR, which they estimate would raise £1.4 billion across the two taxes in the current tax year. With a cap of £1 million per person the government has estimated that only £520 million will be raised across BPR and APR through the proposed changes (annual figure for each of 2028-29 and 2029-30). This lower figure is mainly due to behavioural change – an assumption that people will simply make gifts earlier. 

What are the arguments for limiting BPR (the government’s plan)?

As with APR the argument for capping is that it can protect small businesses while still raising revenue. Limitless exemptions often raise questions about fairness and level playing fields within tax. 

As with APR, an argument against capping is that a cap benefits smaller (and potentially less profitable) businesses but penalises larger businesses.  Why would you want to penalise more successful businesses and give incentives for them to restrict their growth? Also, unless the cap rises in line with inflation, it is effectively being reduced each year. And once again we are faced with the problem that people will simply make gifts earlier or split shares and thus obtain minority discounts; in short all it does is increase hassle for the average businessman and farmer (because they now have to think about IHT earlier) and create work for tax advisers and valuers in terms of lifetime planning. 

AIM SHARES

What are AIM shares and why do they have special treatment?

The Alternative Investment Market (AIM) is a sub-market of the London Stock Exchange which is designed to help smaller companies raise capital. 

As companies listed on AIM are often fledgling businesses they are generally much riskier investments than established companies, so generous tax reliefs are provided to incentivise investment for these businesses (According to the LSE, in 2023 over 770,000 jobs were supported, directly and indirectly by AIM companies, which accounted for £68 billion gross value added to the country’s GDP).  Income tax and capital gains tax benefits are potentially available for investors in such companies which are treated as unquoted for purposes of capital gains tax reliefs; a further IHT incentive for would-be investors is offered by allowing the AIM stock of trading (rather than investment) companies the benefit of BPR. 

The head of AIM has estimated that £6.5 billion of investment in AIM companies is held through funds specifically marketed towards customers seeking to limit their IHT bill. The average investment per individual is less than £200,000; they tend to hold the investment for a long period of time and they will be in their mid 80s.  

What is the government proposing to do?

From April 2026, AIM shares – and other shares designated as “not listed” on the markets of recognised stock exchanges – will only attract BPR at a rate of 50%.

What are the arguments for restricting this tax relief?

It can be argued that IHT reliefs, in so far as they should exist at all, should be reserved for situations where there is a substantial risk that the business might have to be split up on the death of the owner (so typically for active/owner-managed holdings in trading entities).  This rationale will rarely apply to AIM companies. Whilst the risks may be greater, investment in AIM stock represents a 100% limitless exemption from IHT which, its critics argue, should at least be subject to some limitation.

Some economists (eg. IFS) dislike the distortion that giving IHT relief for AIM shares creates. 

What are the arguments for keeping the status quo?

Small companies, such as those listed on AIM, often cannot attract capital injection by any other means and, it is argued, their survival will often depend on finding would-be investors; without such an injection they may not survive. Given the inherent risk of investing in such companies, potential investors need greater incentives and cost-offsets in the event of losing their money; BPR is a valuable relief and affording this to AIM stock provides a valuable incentive to include such stock in a varied portfolio.

To turn around the IFS’s argument above, supporters of the exemption point out that distorting investment choices is a deliberate intention of the relief. Governments incentivise investment in start-ups in various ways and this is one of them.

IHT AND PENSIONS

What are the current tax rules on inheriting a pension pot?

If the owner of an uncrystallised pension pot dies under 75, any payments made from the pension within the next two years are income tax-free for the beneficiaries; lump sums exceeding the ‘lump sum & death benefit allowance’ (currently £1,073,000) will cause excesses above that amount to be taxed at the beneficiary’s marginal income tax rate. 

If the owner was 75 or over upon death, irrespective of whether the fund is otherwise crystallised or not, beneficiaries are subject to income tax at their marginal rate on anything they receive. However, this tax charge can be managed by the beneficiaries drawing it out as a pension or annuity over time.  It is not necessarily an immediate income tax charge on the whole pot.  

For the deceased, the pension pot is generally outside of their estate for IHT purposes and is not assessed upon death.

What change is the government proposing?

From April 2027, inherited unused pensions and death benefits will be within a deceased’s estate for IHT purposes. The income tax rules for beneficiaries (as stated above) are not changing; from 2027 pension scheme administrators will become responsible for reporting and paying any IHT resulting from the pension’s value.

What are the arguments for change here?

Pensions are essentially investments, like any other held in cash or shares, and all those other investments (except AIM) are subject to IHT. However, this was never the point of pensions – they were to provide for one’s retirement, not to be a vehicle for tax-free succession planning. As far as IHT is concerned, there is no limit on the size of the pension being outside one’s estate and thus exempt from IHT; therefore, there are potentially large amounts of value which could be tapped into to secure more governmental revenue. 

By giving preferential treatment to pensions the current set-up incentivises those who can afford to do so to use up other assets while they are alive and leave the pension untouched. According to a former senior Treasury adviser this is a particular concern to Treasury officials since the abolition of the lifetime allowance. 

What are the arguments against these changes?

There are concerns it might discourage pension saving. It has been policy over many different governments to encourage saving for retirement. 

There is also a fairness argument. Having been encouraged to make payments into their pension on the understanding it was exempt from IHT (even the un-used part), it could be seen as unfair to change the rules retroactively and subject people’s pension savings to tax. 

The cumulative effect of potentially paying both IHT for the deceased’s estate and income tax for the beneficiaries on pension pots is a further pragmatic reason for the current system.  Previously there were situations when the combination of both taxes (and certain other clawbacks) could lead to effective rates of up to 83%.  While income tax and IHT are different taxes and serve different purposes, this is not always widely understood.  It was largely in an attempt to relieve the perceived unfairness of these combined rates that the current system arose.  There needs to be some allowance between the two and the interactions dealt with properly otherwise the family could be worse off than if the payer had not saved in a pension at all and instead had just saved through an ISA particularly for higher earners where the upfront tax relief may be very limited by virtue of the annual contribution limit.  

There are also administrative complexities that should not be underestimated. For example the executors will no longer be able to ignore pensions when distributing the estate. They will now need to find out about them as the nil rate band will be pro-rated between the pension and the free estate.  But many pension trustees at present do not agree to provide any information to the executors as the pension monies are outside the individual’s estate and in a separate trust.   Now the executors will have to find out about this which could be difficult where someone has moved jobs frequently as typically they will have many small private pension pots.  The government needs to ensure that pension trustees co-operate in providing full and speedy information to executors otherwise there is just more delay caused in distributing the estate and submitting the IHT forms at what is already a difficult time.   

This explainer was written by:
Chris Thorpe, Technical Officer, Chartered Institute of Taxation
John Barnett, Chair of Technical Policy and Oversight Committee, Chartered Institute of Taxation
Emma Chamberlain, Joint Chair, Private Client (International) Committee, Chartered Institute of Taxation
George Crozier, Head of External Relations, Chartered Institute of Taxation

Originally published 6 November 2024, edits 19 November 2024.