- The most significant tax rises for investors could be those on gains, pensions contributions and inheritance
- It may be worth accelerating actions you were planning to take anyway so you can avail of current thresholds and rates
With the national debt continuing to balloon and reports making the case for a wealth tax and higher rates of capital gains tax (CGT) landing on the chancellor's desk, it seems inevitable that raids on wealth will happen at some point.
But the pandemic has not yet been brought under control and chancellor Rishi Sunak is expected to tread cautiously for fear of putting the economic recovery at risk when he reveals his budget to the nation on 3 March. Nevertheless, he is known to want to avoid pushing the debt too far into the future and onto the shoulders of the next generation.
According to the Institute for Fiscal Studies (IFS), if the UK added one percentage point to all income tax rates, National Insurance contributions and VAT, it would raise an extra £19bn of revenue a year. But observers believe that other taxes and reliefs will be at the forefront of new revenue raising plans in the next budget or further down the line.
Capital gains tax
CGT raises close to £10bn a year for the Treasury and last year the chancellor commissioned the Office of Tax Simplification (OTS) to look at how this tax could be reformed. The OTS review of CGT, published in September, suggested four key changes as part of an overhaul. These included aligning rates of CGT to income tax levels and cutting the annual gains allowance from £12,300 to as little as £2,000 per person, but with fewer assets attracting the charge. Reducing the annual allowance would mean more people would fall into the CGT net, while aligning the rates would mean that the charge for additional rate taxpayers would more than double to 45 per cent from the current 20 per cent. Basic rate taxpayers currently pay 10 per cent CGT on gains made on investments and 18 per cent on taxable property gains, as long as the gains don't push them into a higher tax band. Higher and additional rate taxpayers pay 20 per cent and 28 per cent, respectively.
Other proposals include severely restricting Business Asset Disposal Relief, which allows business owners selling up to pay a reduced rate of 10 per cent on the first £1m of gains. This could be done by increasing the minimum percentage interest to 25 per cent, or by making the minimum holding period 10 years, or by introducing an age-related condition to peg the relief closer to a form of retirement relief.
A business owner who pays additional rate tax and who sells their business for a £3m gain could pay almost three times as much tax – £1.35m against £500,000 - if CGT is aligned to income tax.
“This time last year an entrepreneur could pay tax on the first £10m at 10 per cent following a disposal, now it’s £1m at 10 per cent and the rest at 20 per cent. By early March, they might be staring down the barrel of £1m at 10 per cent and everything else at 30 or 40, so that would be a huge difference,” says Rob Pullen, partner at Blick Rothenberg.
The OTS also proposes removing the CGT uplift on death, whereby capital gain liabilities are wiped out and the value of assets are reset at their current value. It can mean that no inheritance tax (IHT) or CGT is paid on inherited assets in certain situations. If the CGT uplift is removed those same assets could potentially be assessed for both IHT and CGT.
Blick Rothenberg estimates that the chancellor might manage through these measures to double annual CGT receipts to around £20bn.
Kay Ingram, chartered financial planner at LEBC, says that many investors have got out of the habit of withdrawing gains and losses each year, despite the fact that “if you rebase your gains and offset your losses you can actually save quite a lot of tax”.
Lower rates of CGT and the removal of bed-and-breakfasting have probably encouraged investors’ more casual management of capital gains. Yet higher rates might also disincentivise people from managing their investments.
“If we see increases in CGT, it may make people reluctant to deal and more inclined to hold on for too long because they will be worried about paying 45 per cent tax on gains," says Ms Ingram. "This is what happened in previous periods when we had very high taxation.”
The OTS paper could also spell the end for employee shares schemes as it recommends that gains should be taxed as income rather than capital, as they are now.
What you can do
If you are thinking of selling assets that have made gains it could be worth doing it now to benefit from higher annual allowances and/or lower rates of CGT ahead of any rises. Mr Pullen says that the difference between selling now and selling after a change in rates could be an extra 50 per cent tax if the rate is settled at a flat 30 per cent.
Gifting assets with taxable gains to a child or grandchild is also a way of using current allowances and rates. And managing your gains and loses on a yearly basis helps to make use of available allowances. You could also use your spouse or civil partners’ annual allowances by transferring assets into their name.
You can defer paying CGT on realised gains if you reinvest the money into an Enterprise Investment Scheme (EIS) or Seed EIS until you come out of the scheme. Gains made within the scheme are exempt from CGT.
You can gift assets carrying gains to a charity that can sell or keep them with no CGT liability. You benefit because you avoid paying CGT and can deduct the value of the asset at the point of gifting from your taxable income.
A bigger CGT haul would not be enough to make a material difference to the UK's fiscal deficit. So some think that changes might be made to tax relief on pension contributions as this costs the government around £37bn a year. This would be bad news for everyone – especially younger generations who are likely to have much slimmer pension income when they retire.
Ms Ingram would not be surprised to see the relief restricted to the basic rate. “The Treasury has been looking at that for some time and some think-tanks have advocated not giving tax relief at all, but rather treating pensions like individual savings accounts (Isas) whereby you put your money in net of tax and get it out tax free,” she says.
She thinks relief will be limited to 20 per cent because HM Treasury has stated that it would like all defined contribution pensions to move to a relief at source method to benefit the low paid. Under this system, pension contributions are taken from net pay, and the pension provider automatically claims back basic rate relief and adds it to your pot. Higher and additional rate taxpayers have to apply for the extra relief they are entitled to through their tax return.
“If the Treasury is saying that they want everyone to go on relief at source, it is illogical for them to carry on giving higher rate tax relief because it would give them loads more work to do," says Ms Ingram. "They would have to do many more self-assessment returns and refund claims, which indicates very strongly to me that they are planning to go to a flat rate of relief.”
What can you do
Make pensions contributions this tax year if you can afford to because you may find that in the next tax year or two the relief is much less.
Ms Ingram also warns against rushing into higher risk schemes to secure other types of tax relief. “One of the dangers with changes in pension relief, which we saw when the previous restrictions on the annual allowance were made, is that some advisers say you can’t get relief on your pension so invest in EIS or venture capital trusts (VCTs) instead," she explains. "That is all very well if you are able to take this level of risk, but it’s important to see beyond the tax relief and think about the risk and the capacity for loss."
Investors should not cease contributions even if relief is cut because, as well as securing some tax relief, they will still have the tax-free roll up in the fund which should also retain its IHT-free status.
Pension contributions also allow you to reduce your income which is important for higher earners. “Someone earning £125,000 is going to lose their personal allowance on a £2 for £1 scale," says Ms Ingram. "This means that, effectively, for the slice of income between £100,000 and £125,000 they are paying tax at 60 per cent rather than 40 per cent. But if they make a pension contribution of £25,000 they will get tax relief and retain a personal allowance of £12,500 – saving £5,000 in tax.”
The chancellor might look at the thresholds for nil rate and residence relief, or cut what you can give away during your lifetime. “Any value you give away is treated as a potentially exempt transfer (PET), which means that if you survive for seven years it is then fully exempt," says Mr Pullen. "Lifetime gifting might be curtailed with a fixed £30,000 lifetime exemption and anything above that incurring a lifetime inheritance tax charge.”
A paper on IHT by the OTS in 2019 questioned the use of Agricultural Property Relief, designed to keep farms in the family, and Business Property Relief as applied to Aim shares. These rules could be tightened up, so that Aim and EIS investors no longer get an IHT exemption after two years, although most tax experts think that the reliefs are too tricky to tamper with. “If they reformed agricultural relief, they would still want to protect family farms or businesses, so they might leave that alone to avoid throwing out the baby with the bathwater,” says Ms Ingram.
What you can do
Mr Pullen suggests anyone considering making lifetime gifts doesn't delay. “The changes might take a while to come through, but the government has shown willingness and has form in making immediate changes to the tax system, so you should act now,” he says.
Parents and grandparents who want to get value out of their estate could use a trust. “The added benefit of doing that is that when you transfer assets to a trust it is deemed to be a disposal for CGT purposes, just like a gift to an individual directly would be. If you are also worried about CGT increases and want to crystallise the tax charge now, making a gift to a trust to trigger that gain might not be a bad thing, especially for someone with illiquid assets that they cannot realise easily, or because it would affect the price. Making use of trusts can be a minefield, but it’s very popular where it is used as part of a plan to pass on wealth to children and grandchildren. Full advice should always be taken,” says Mr Pullen.
It seems highly unlikely that a wealth tax will be announced by a Tory chancellor any time soon. Something as draconian as the recent one proposed by the Wealth Tax Commission, at least for farmers, business owners and anyone with large pension pots, if based on assets in excess of £500,000, would need far more consideration in terms of its impact. Read more on this in Guest Opinion by Arun Advani on page 61 and see our view in A deeply flawed wealth tax , IC 31 December 2020.
Nimesh Shah, chief executive officer of Blick Rothenberg, says that while the Wealth Tax Commission proposal is for a one-off tax there “is a real risk that a future government would be tempted to make the tax permanent. The argument for making the tax permanent is even more compelling after the considerable time and investment that would go towards introducing it in the first place.”
A less hard-hitting version on an annual basis might be introduced further down the line.
Mr Pullen points out that if trusts were to be exempted from the wealth tax because they already pay tax every 10 years at a rate of 6 per cent – 0.6 per cent a year – a trust might be a cheaper alternative for certain assets.