| I thought it would be prudent this week to focus our attention on deciphering the noise around the Budget, and highlighting the implications of possible tax rises.
We have had a lot of queries from clients as to what actions should be taken to head off possible tax changes announced in the Budget on October 30th. The forward guidance from the government is that it will be painful.
Let us steer you through the emotion of it all.
On our agenda this week:
- Introduction
- The UK economic outlook
- Taxes in the Budget
- Supporting growth initiatives
- A brief nod towards investment markets
- Summary
Introduction
There is the possibility that the changes in the Budget may not be as dramatic as feared. A well-worn strategy is to stir up worry and anxiety, only for the populace to breathe a sigh of relief when it turns out not to be as bad as expected.
However, with the government having such a majority and beginning a new parliament, now is the perfect time to instigate significant changes with a ‘black hole’ in our finances.
The prospect of Capital Gains Tax equalisation to Income Tax levels is proving the biggest concern for our clients. Businesses are very concerned, but the tax implications may not be as onerous as anticipated with the government stating that they are committed to growing the economy.
The Chancellor, Rachel Reeves, needs to do something to arrest the decline in public services, to fill the ‘black hole’ of debt and to find a compromise tax solution which is palatable.
The UK economic outlook
The UK’s Gross Domestic Product (GDP) has proved better than expected this year allowing us to come out of recession and, at the same time, look favourable compared to many western developed economies. However, it’s important not to mask the years and years of economic decline and lack of investment. Sure, there have been many challenges but there have also been some very poor policy decisions which have seen opportunities slip through our fingers.
The £22 billion deficit refers to the amount of public overspending, just this year. Furthermore, government debt has been forecast to rise rapidly by the end of the next decade due to stagnant productivity and increasing public spending.
The Office for Budget Responsibility’s Fiscal Risks and Sustainability Report, published yesterday, warned that the current debt projections are on an “unsustainable path” with debt predicted to reach 274% of GDP by the late 2030s.
Taxes in the Budget
For this section, I have leaned into some text from accountancy and business advisory firm BDO, but paraphrased their messaging:
Capital Gains Tax Changes
This is the one that most people are concerned about. Rates of Capital Gains Tax (CGT) are at historic lows, so increasing them seems a likely option. In 1988, the then Chancellor Nigel Lawson changed the CGT from a flat 30% to taxing gains at income tax rates. Interestingly, this was Tory policy and now Labour may well replicate what Lawson did!
Lawson said at the time: “In principle, there is little economic difference between income and capital gains, and many people effectively have the option of choosing to a significant extent, which to receive. And in so far as there is a difference, it is by no means clear why one should be taxed more heavily than the other. Taxing them at different rates distorts investment decisions and inevitably creates a major tax avoidance industry.”
So, what could happen?
- A return to taxing all capital gains at Income Tax rates
- Taxing gains at one fixed rate below the top rate of Income Tax, i.e.30%
- Reintroducing some form of tapering for longer-term gains and taxing short-term gains more heavily as is the case in the USA
- Reducing the most widely used exemptions – for example, setting a ceiling on the private residence relief of say £2 million
- Introducing CGT on disposal on death (in addition to IHT) – perhaps at a lower rate/s than lifetime rates.
Whatever the changes, when could they happen?
Regardless of what the changes will be, there is then the question of when they will come into force. CGT is a transaction-based tax and therefore changing the tax part way through the year shouldn’t be a major administrative burden. However, announcing that rates will change from April 2025 should create a lot of activity and create disposals as certain types of investors look to save tax in the short-term. Good for the government’s coffers, of course!
Personal Tax Relief
Apparently, the cost of various pension tax reliefs costs the government around £50 billion a year. On the face of it, this would seem an obvious place to make some savings, but it is a politically difficult area. It wasn’t that long ago that Jeremey Hunt abolished the Lifetime Allowance to placate Doctors and prevent mass retirements.
However, if the government’s finances are as bad as they appear, then early in the parliament is a good time to tackle tax reliefs around pensions.
BDO have highlighted a number of options which may be considered:
- Removing the Inheritance Tax exemption for pension funds on death
- Reintroducing the lifetime allowance on total pension savings, perhaps exempting public sector pensions
- Cutting the overall rate of Income Tax relief on contributions to 30% or imposing an annual maximum relief in cash terms
- Imposing an annual maximum on the National Insurance Contribution exemption, from employer pension contributions
As always with changes in pension legislation it can be difficult to implement across the board. The Chancellor may be reluctant to venture into too many changes around pensions because this may also have implications for public sector pensions too.
Inheritance Tax (IHT)
It would seem to make sense that the government may wish to overhaul current Inheritance Tax rules and allowances. It may well be the case that the government looks to abolish the residence nil rate band, but this may only be for wealthy tax payers.
The main possibilities here are as follows:
- Removing the Inheritance Tax extension for residuary pension funds on death
- Introducing progressive bands of Inheritance Tax starting at say, 25% and perhaps rising to 50% for the largest estates
- Reducing and/or capping 100% business relief (BR) and agricultural relief (AR)
- Tightening the BR and AR qualification criteria
Changes to BR and AR would be of particular concern to business owners. Despite their high combined cost to the government, it seems unlikely that these important reliefs that allow the passing on of family businesses will be withdrawn altogether. Instead, we would expect them to be restricted by technical amendments to the rules.
For example, it would be relatively straightforward to limit the relief for shares in unlisted companies so that companies listed on AIM no longer qualify for relief. Similarly, the current two-year holding period requirement could be extended, perhaps with bands of relief at different rates rising over the years before full relief is obtained.
Another alternative could be to limit the relief for very large estates on death – for example, such that the first £20m of business assets could qualify for 100% and higher values only qualify for 50% relief.
A new wealth tax
There has been some talk about a new wealth tax, levied by some countries, yet it appears as though there isn’t the appetite for this just yet. This could adversely impact those who have low incomes, but live in highly valued houses.
Longer fiscal drag
Rachel Reeves has already committed to freezing Income Tax and other thresholds until 2028, so extending that freezing for a year or two could be an attractive option in helping to balance the books.
Fiscal drag is expected to be a big earner for the Treasury as more and more people will move into the high rate and additional rate tax band by 2028. This approach however doesn’t deliver instant gratification for the Treasury, and it is likely that this will be delivered in harmony with more instantaneous tax cuts.
Property taxes
Although council tax was not mentioned in the Labour manifesto, it did make a public commitment not to change council tax bands. However, a revaluation of properties has not happened since 1991, so the Chancellor may now decide that levying taxes on valuations over 30 years out of date is not sustainable given the current pressures on government finances. As a result, a revaluation exercise may be announced.
Business tax changes
The Labour manifesto included pushing a road map for business taxation within 6 months of the election and the Chancellor has confirmed that this will be published on budget day.
Pledges to freeze Corporation Tax at 25% and retain full expensing capital allowances should be confirmed but other measures may also be included.
Supporting growth initiatives
Labour has promised to create a formal industrial strategy for the UK for the next ten years and lay out its proposals for supporting growth in different areas of the economy. Like the business tax roadmap, this should give businesses some long-overdue certainty about government policy and enable them to plan ahead for investments with more confidence. Publishing the strategy before or alongside the Budget would be a welcome development.
The strategy is likely to include a number of net zero transition goals and proposals as well as sector-specific plans such as energy security proposals, tech sector support, skills programs and, potentially, new grant funding schemes planned for later in this parliament.
Specific proposals for the launch of the proposed National Wealth Fund are also likely to feature in the strategy as it is to be used to invest in the steel industry, ports, green hydrogen technology, automotive gigafactories, carbon capture projects and other industrial clusters. Labour’s pledge to implement full gigabit broadband and national 5G coverage by 2030 may also be fleshed out with funding details. We also expect the Budget to contain an update on the creation of Great British Energy – perhaps when it will start trading and news on its first co-investment ventures.
A brief nod towards investment markets
This week, the European Central Bank reduced interest rates for a second time this year due to falling inflation and mounting signs of slower growth.
In the US, the feeling is now not about whether the Federal Reserve will cut rates this month, but by how much. We will find out next Wednesday but for now, equity markets are rejoicing about the long-awaited reduction, with technology stocks leading the way.
The last 5 days performance of the major indices as of 9am on Friday 13th September:
FTSE 100 0.67%
FTSE 250 0.31%
Eurostoxx 600 1.37%
S&P 500 1.61%
Nasdaq Composite 2.52%
Hang Seng 0.56%
Nikkei 225 2.17%
Summary
Predicting what will happen at the Budget is very difficult. It is also difficult to make changes to one’s own situation without knowing what you are dealing with. There is a danger that many of us could crystallise tax gains now but find that they are unnecessary, with hindsight.
One thing is for sure, significant tax receipts need to find their way into government coffers and quickly. This suggests that the government may not implement some of the changes until the end of the tax year resulting in lots of short-term liquidations and desirable tax receipts.
We will be contacting applicable clients over the next month to evaluate their current Capital Gains Tax position and the implications of possible changes at the Budget. We will also encourage clients to make the most of pension tax relief, particularly those in the higher income tax bracket.
Have a great weekend. |
