One more good reason to completely rethink inheritance tax

While I was standing around in the rain waiting to be interviewed for 5 Live earlier in the week, I got talking to an academic from the University of Stirling.

He specialises, among other things, in the knotty problem of youth unemployment. We talked about the root causes in Scotland, and I wondered to what extent lousy education is to blame. He wasn’t sure about lousy, but conceded that the lack of an efficient apprenticeship or trainee system that put people on the road to careers without a full university education was partly to blame.

We should, he said, be more like Germany, where the apprenticeship system is designed to feed skilled young people into Germany’s phenomenally successful, small and mid-sized family companies – the Mittelstand.

This gets them into work and keeps them in work – and good work at that. So much so that Germany, far from grappling with the labour surplus so exercising the minds of the rest of Europe, is facing a shortage. It, says the FT, “already very close to full employment.”

There is not much to argue with in this. But I wonder if assuming that apprenticeships are an obvious answer is to look at things the right way around. Surely it is not just the apprenticeship system that we need to be recreating at home, but the Mittelstand as well. Without them, the education system is pointless.

So let’s think about why the Mittelstand exist. Is it because the Germans are harder-working than us? More long-term thinkers than us? Or perhaps more family-minded than us?

The myth would have you think so, but there is actually a rather more prosaic reason that at least partially explains the existence of these long-term family companies. It is inheritance tax (IHT).

In the UK, we get 100% IHT relief on business assets (details here) Pass a business you have built up to your kids, and they get it tax-free to do whatever they like with it. They can keep it and self-manage it (all too often a mistake); they can run it down; or they can sell it and pocket the cash.

Either way, no tax is payable, something that makes our IHT rules for family companies the most generous in the world. Not so in Germany.

You can read the details of their system here. The key point is that IHT relief is highly conditional. You can get full relief only if the business is continued for a minimum of seven years, and if over that period your direct wage costs amount to at least the same on average as they did in the seven years before you inherited it*.

See the incentive here? It is to keep the business, rather than to sell it or to merge it, and to make sure it expands a little along the way (productivity gains would mean the wage bill would fall unless you also grew the business), something that in turn encourages getting in professional management rather than letting sometimes useless elder sons have free rein to destroy firms their parents or grandparents have built up.

There is no such incentive in the UK. Yet another reason why our IHT regime has absolutely got to change. See my previous article on the matter here.

* This might be why the Mittelstand account for 70% of Germany’s employment but only 50% of its GDP.

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  • Clive

    I believe Germany’s success is far more to do with having (for them) an under-priced currency, i.e. the Euro. Allows them to be a net exporter. Good for them, but not something we can all do as it’s a zero-sum game.

    That aside, I can’t see how you make the case that Germany’s success is down to differences in IHT. Sure, that’s one thing they have different from us, but just one. Might be they’re not credit obsessed like we are, preferring to save hard and spend relatively little. Who knows. Seems to be you want it to be IHT, so that’s your claim regardless of any real evidence for against.

  • Merryn

    @Clive – it isn’t the only reason of course – if only life were so simple. That’s why I say “partially” above. But people react to financial incentives and the way the tax system is structured is a pretty big one. Note that the Mittlestand make up 50% of Germany’s GDP but 70% of its employment.

  • Tax slave

    Firstly, I would suggest that actions or developments rarely depend on just one factor or tax law.
    Secondly, by confiscating a major portion of a person’s accumulated assets on death through IHT, are governments better equiped or can they be trusted to better deploy/invest the resources than the wishes of the person who most possibly created that wealth?
    Thirdly, What is required is a tax regime that encourages individuals to invest their created/worked-for assets into initiatives, businesses, actions that will benefit the greater public good and well-being or local job creation, rather than using own/BTL residential property as the default option. Then to realise that they have to spend more time and effort trying to minimise IHT liability created by factors like inflation and fiscal drag, rather than further wealth creation? Are there tax beaks for individuals to invest in the provision of much needed shared ownership housing?
    Fourthly, I suggest that hard working people are tired of the institutional, insurance and banking rip-offs that have beset this country for at least the last 20 years and would like tax related incentives to make their assets really work for them and others more directly.

  • Salient Point

    Another nonsense is agricultural relief. Combined with the large increase in the market price of agricultural land, this gives a massive tax benefit to farming families. A farmer recently suggested to me that no-one buying at current prices could make a profit from farming. Yet some of this increase is no doubt caused by wealthy people buying up, or retaining, land because of the tax advantages.

    This also brings to mind agricultural subsidies. No doubt these are necessary, but it is surely bizarre that the resultant high value of agricultural land, combined with the favourable tax treatment, is of such great financial benefit to one particular section of the community.

  • burstingbubble

    Merryn – the kids can’t ‘do whatever they like’ with the business passed on to them. As per the link you gave to HMRC: “If you give away business property or assets in your lifetime, whoever you give them to must keep them as a going concern until you die in order to keep the relief”.

  • Andrew M

    I disagree fundamentally with this. Why should the state push people into running companies that they don’t necessarily want to run, and who aren’t necessarily the best people to run those companies? Perhaps (as a son) I’d rather sell my parents’ business to somebody who will manage it well, rather than try and fail myself. Perhaps (as a parent) I’d rather sell my business to someone who will run it well, rather than be forced through tax law to pass it on to my kids who are already busy with their own careers.

    Besides, more family-owned companies means fewer shareholder-owned companies. This means fewer companies make the leap from private family ownership to stockmarket listing, making growth harder. For German pension funds, there’s a considerable shortage of domestic companies available to invest in.

  • Natalie

    It is precisely because of this family owned businesses that the German businesses are far more successful.

    Our obsession with public ownership makes our corporate leaders far too short term in their management of their companies.

    The stock market is obsessed with quarterly results and not long-term health of the business. This leads to poor M&As and daft things like share buy backs at the top of the market. If your pay is based on what the share price will do in the next five years or rather the next four quarters not how the next generation will benefit from an ever improving company, your time horizon is far too short.

    The Quant family (BMW) would never have done a RBS/ABN-Amro style deal.

  • Merryn

    @burstingbubble I am talking about IHT so my assumption above is that the company is inherited at a family member’s death or kept until that death, yes. Otherwise we would be discussing a different tax regime. But the point is that post the point of formal inheritance it is the heir’s tax free to do with as they like.

  • Merryn

    @AndrewM I think the point is the other way around. Why should the general taxapayer via IHT relief subsidize those who sell up for cash?

  • burstingbubble

    Merryn – we are both talking about IHT, but your assumption is incorrect – most businesses will have a succession plan, and in order to minimize IHT the business will be passed on prior to a parent’s death. So again, my point is that the heir is not free to to whatever with the business, it must be kept as a going concern.

  • MikeP

    Then again, why is Inheritance Tax there in the first place ? What’s so special about death that the event gives the Government a special opportunity to collect tax at that point ?

    Surely we should all be taxed fairly, properly and promptly during our lifetime.

  • CKP

    @MikeP
    I believe IHT has evolved to stop accumulation of vast wealth by a few dynastic families.
    But it seems that the unintended consequences of the current tax regime is that business owners are incentivised to cash out rather than keep the business going and growing. Hence our serial entrepreneur culture that we see in the UK, these lot want to build a company as quick as possible and then flog it on for a profit.

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