Budget could be focused on wealth

It’s not an easy time to be Chancellor of the Exchequer. Rishi Sunak has racked up an enormous bill during the course of the pandemic and already hiked a number of taxes to help pay for it. Last March, he set out a plan to raise corporation tax to 25 per cent from 1 April 2023 and has frozen income, capital gains and inheritance tax thresholds until at least 2026. The pensions lifetime allowance has also been frozen at £1,073,100 until 2026. And last month the government announced a manifesto-breaking 1.25 per cent rise in National Insurance contributions and dividend taxes from the start of the next tax year, to fund health and social care. 

Sean McCann, chartered financial planner at NFU Mutual, thinks that although “the chancellor is unlikely to hit earnings again [he] may instead focus his attention on wealth taxes in order to raise cash”.

These could include alterations to tax-free allowances and tax relief. 

Capital gains tax

The Office for Tax Simplification (OTS) completed its review of capital gains tax (CGT) in May and recommends changes such as aligning CGT rates with income tax rates. CGT is currently 10 per cent or 20 per cent, and for property 18 per cent or 28 per cent, depending on which tax band you are in. But investors might get some sort of inflationary relief so that they are only taxed on above-inflation gains.

However Laura Suter, head of personal finance at broker AJ Bell, says:  “Any relief would reduce the tax take for the government so that may be quietly ignored in any final rules."

In a less radical move, the government could cut the annual CGT allowance – the amount of capital gains you can make outside tax wrappers tax-free – from £12,300. The allowance has been frozen until 2026 but, as Suter points out, “now the manifesto promise of no tax increases has already been cast aside, there’s no barrier for Rishi Sunak to cut the allowance”.

Chopping the annual CGT allowance to £6,000, for example, could generate £480m a year for the government and cutting it to £2,500 could boost Government coffers by £835m, according to the OTS. 

Other more technical recommendations by the OTS include changing what is defined as a capital gain rather than income, such as extracting profits from a small company. However, given the need for economic recovery, the chancellor is unlikely to want to make changes that discourage investment or entrepreneurship.

“Options could include a smaller rate rise, say, to 30 per cent, CGT rate increases only on disposals of more passive types of investment such as rental property and more technical changes to CGT reliefs,” says Ami Jack, head of national tax at Smith & Williamson.

She adds that any changes could be immediate, so if you are already planning to make disposals or gifts you could consider doing this sooner while CGT rates are relatively low – as long as it suits your financial and investment objectives.

The government could also give notice of a future increase to incentivise disposals and accelerate CGT receipts. 

Inheritance tax

The chancellor could also increase inheritance tax (IHT). “IHT appears to be a likely candidate as it is largely a tax paid on death so cannot be avoided as easily as some other taxes," says chartered financial planner Kay Ingram. Changing this "could be politically popular if it is perceived [as] taxing the better off".   

Ingram thinks that it is likely the chancellor will opt for reforms that will raise more tax without increasing the 40 per cent IHT rate on the value of estates over £325,000.The nil-rate band hasn’t increased since 2009, so by the 2019-20 tax year it should have risen to £423,000 just to keep pace with inflation. It’s now frozen until 2026, so will gradually lose more value in real terms and bring more estates into the scope of IHT. 

The OTS put forward proposals to reform IHT in 2018, some of which could be included. You can give away a total of £3,000-worth of gifts each tax year without them being added to the value of your estate. This is known as your annual exemption. You can also give as many gifts of up to £250 per person as you want each tax year and if your child is getting married or entering a civil partnership you can give them up to £5,000 tax-free. If your grandchild or another person is getting married you can give them £2,000 and £1,000, respectively.

But the OTS has proposed a combined annual allowance for all lifetime gifts of around £11,000 per donor. This would simplify the administration of estates and update allowances first set in the 1970s and 1980s. 

The Treasury could abolish the gifts from surplus income exemption. At present, gifts made from surplus income on a regular basis are exempt from IHT – regardless of the amount. If, for example, you have a high income you can use this exemption to cascade wealth down the generations of your family without incurring IHT. 

Another OTS proposal was to reduce the time it takes for a gift not covered by the exemptions set out above to become IHT-free from seven to five years, but reduce the taper. Currently, gifts not covered by the exemptions set out above become wholly exempt from IHT if you live for seven years after making them, with the taxable value of the gift reducing by 20 per cent a year after year three.

Life assurance policies currently form part of your estate on death and could be subject to tax when the beneficiaries make a claim – unless placed in trust. The OTS proposes that where these are fixed-term policies they should be exempt from IHT. 

Ingram says that to ease the burden of estate administration it is important to keep your will up to date. You should also keep a record of all gifts made over the previous 14 years, ensuring that records of assets and investments are up to date and accessible to the executor of the estate named in the will. And consider whether making lifetime gifts could reduce your heirs' eventual IHT liability. 

Pensions

A concern before every Budget is the availability of higher-rate income tax relief on contributions to registered pension schemes, which for higher and additional rate taxpayers is 40 per cent and 45 per cent, respectively. The chancellor could restrict this to the basic tax rate of 20 per cent or limit contribution allowances further. 

However, Tom Selby, head of retirement policy at AJ Bell, says: “removing higher-rate relief would be a direct attack on middle Britain, leading to people who do the right thing and save for their future being hit with extra tax costs. It is also far from clear how a flat rate of pension tax relief would be applied to defined-benefit schemes where contributions come from pre-tax net pay.”

If HM Treasury wants to save money on pension tax relief the annual allowance is the simplest relief to restrict. “The annual allowance is currently £40,000, while savers can also carry forward up to three years of unused allowances as well," says Selby.

Lowering this to £30,000 or even £20,000 – in line with the annual individual savings account (Isa) allowance – would raise revenue for the government while only affecting those who make very large pension contributions. The lifetime allowance could also be reduced. But as it was frozen for the rest of this parliament at just over £1m in the last Budget, this seems unlikely.

The government could also impose more taxes on inherited pensions. At present, pensions do not form part of your estate for IHT purposes and your pension can be passed on tax-free if you die before age 75. If you die after 75, the recipient of your pension will pay tax at their marginal rate on withdrawals. If the chancellor decides to bring pensions within estates, there might be a protection regime for existing funds to avoid angering those who have preserved their pension on the basis of death benefits.  

“In order to soften this blow, the chancellor could make life insurance policies exempt from IHT – something the OTS has recommended," says McCann. "This would save families hundreds of millions of pounds as latest figures show more than 6,000 estates paid IHT on insurance policies worth over £700m in 2018-19.”

The government has already confirmed that the state pension ‘triple lock’ will be suspended for a year. This guaranteed that the state pension will increase every year by inflation, average wage earnings growth or 2.5 per cent – whichever is highest. But the furlough scheme resulted in unusually high earnings growth of 8 per cent so that part of the lock has been dropped.  

Fuel duty

As Suter puts it, the government is caught between a rock and a hard place with fuel duty. Tax on petrol and diesel has been frozen for the past 11 years, but with the Cop 26 climate summit due to take place shortly after the Budget it could seem like a ripe time for increases. However, surging oil prices and the recent petrol crisis have already driven prices up. 

“With this particular political hot potato it feels likely that the freeze will be over but with the government delaying the tax increase to next year – in the hope that fuel prices will have reduced by the time it kicks in,” says Suter. 

As energy prices are the biggest concern facing many households with winter approaching, the government could extend the Warm Home Discount scheme to allow more people to benefit from it, or increase it from the current level of £140.

The winter fuel payment could also be increased for pensioners who spend a large proportion of their income on energy and will be among the hardest hit this winter. This has been frozen for years but there is a precedent as a temporary uplift of £50 was made for 2009-11, although by a Labour government.

However, the government has already announced a £500m Household Support Fund for councils to distribute to help people in England pay for daily needs through the winter.