Taxing horizons and fiscal black holes

Major tax rises for individuals were notable by their absence in the UK budget earlier this year (despite a significant proposed Corporation Tax rate hike, effective from 2023).  However, a super-massive black hole at the centre of the nation’s finances means that tax reform and rates rises look increasingly likely.

Most economists had been arguing against acting to raise revenue through tax reform now before the economic recovery gathers steam and, with borrowing rates at historic lows, the Chancellor appeared to have some breathing space to allow economic growth to do its work in getting the deficit under control. However, the Government knows that deficit-reduction measures will only become politically harder as the next general election looms larger and that a window of opportunity to raise further revenue from individual taxpayers is fast closing.

Health and Social-Care Levy / dividend rate increase

Indeed, the Prime Minister on 7 September set out plans to fund the social care system through a new Health and Social-Care Levy of 1.25% on both employees’ earnings and employers’ payrolls from April 2022. For the first year this will be in the form of a 1.25% increase in National Insurance contributions (NICs) and from April 2023, it will become a separate levy on earned income. The Government has also announced a 1.25% increase in dividend tax rates from April 2022, taking rates to: 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers. 

However, given the state of the nation’s finances, the Government could go further and the Chancellor is due to deliver this year's Autumn Budget on 27 October.

In this article, we scour the horizon for the potential further tax changes lurking in wait for individuals and anticipate what form they are likely to take, with the rate of capital gains tax (CGT) looking particularly vulnerable to a rise and an increase to the rate of income tax (on top of the current proposals to increase NICs and the dividend rate) and reform of inheritance tax and CGT also possibilities.

CGT

Rate increase

Given the Government appeared to have tied its hands to a certain extent on the three main revenue-raisers (income tax, value-added tax (VAT) and NICs), promising a “tax-lock” on three taxes in its 2019 manifesto, the rate of CGT has been looking increasingly vulnerable to an increase, although perhaps not until an improvement in the health of the economy is seen.

A recent CGT report by the Office of Tax Simplification (OTS), suggested harmonisation of CGT rates and income tax rates, meaning certain gains could be taxed at up to 45% (up from 20%) for taxpayers in the highest tax bracket. It is expected that any increase in the CGT rate will be mitigated by "taper relief" (which is designed to provide some relief from the effects of inflation).

However, individuals are likely to have advance notice of any rise, allowing them to bring forward disposals and wealth transfers, to lock in the current lower rates. This is largely because the Government does not want to incentivise taxpayers to hold on to highly-appreciated assets until they die, with a view to passing them on to the next generation (in some cases, tax-free). The Government would rather have the revenue windfall resultant on taxpayers seeking to secure the current lower rates.

Reforming the CGT "tax-free uplift" at death

CGT is not payable on the transfer of assets on death (unlike lifetime transfers). Instead, assets are inherited at their market value at the time of death, and any pre-death gains are ignored on a future disposal. As inheritance tax (IHT) is charged at death, the relief precludes what would otherwise be a double tax charge on death in respect of a deceased’s assets. Indeed, the OTS CGT report noted how the relief incentivises owners to delay asset transfers until death to mitigate the incidence of both IHT and CGT.

The OTS report also recommended a less distortive “no gain no loss” approach (except in relation to a person’s main or only home) so that in effect the beneficiaries acquire assets at their cost to the deceased. That change would pose administrative challenges, for example, in establishing a historical base cost, even if, as suggested by the OTS report, rebasing to 2000 was allowed. Nevertheless, reform of the uplift remains a possibility, particularly in circumstances where assets benefit from IHT relief.

Entrepreneurs: End of Business Asset Disposal Relief (BADR)

BADR (previously Entrepreneurs' Relief) is a potentially very valuable relief which allows business owners to make certain disposals of qualifying assets to benefit from a reduced rate of CGT (10%, down from 20%). However, the Chancellor has described BADR as “expensive” and “ineffective” and, in 2020, restricted the availability of it to £1 million (from £10 million). That may not be the end of it. Labelled by the OTS as “mistargeted”, BADR may soon be gone for good, possibly being replaced, as the OTS recommends, with a relief focused on individuals who are retiring. Individuals may, therefore, want to bring forward disposals to benefit from BADR while they can.

IHT

Despite an All-Party Parliamentary Group report published last year recommending a flat 10% gift tax payable both on lifetime and death transfers, to replace the UK's IHT system, a radical overhaul of the IHT regime appears unlikely. In his 2021 Budget, the Chancellor preferred the more modest approach of increasing IHT revenue by freezing the "nil rate band" IHT threshold at £325,000 until 2026. This, with inflation, effectively widens the 40% IHT net each year, to capture lower value estates.

Reform of IHT reliefs

However, despite the quantum of additional revenue raised through IHT receipts being low relative to certain other taxes (in the 2019/2020 tax year, IHT receipts were £5.2 billion compared, for example, to CGT receipts of £9.9 billion), IHT reform is not necessarily off the table. Possible changes include, as recommended by an OTS report in 2019, a scaling back of IHT reliefs, for example, by making shares traded on AIM no longer eligible for business property relief or redefining the level of trading activity required for business property relief to bring it closer in line with the higher test used for gift holdover-relief from CGT.

Lifetime gifts

The Chancellor may also pay heed to OTS recommendations to reform the taxation of lifetime gifts. Currently, there is no gift tax in the UK and individuals can gift assets to anyone without an IHT charge if they survive the gifts by seven years and do not retain a benefit from the gifted assets. Certain gifts, for example to spouses, are entirely exempt.

Possible changes on the horizon include replacing the numerous lifetime gift exemptions with a single personal gift allowance; shortening the seven-year window during which gifts may become subject to IHT to five years; and ending relief for gifts made with the seven-year window but three years before death.

With a reform of IHT increasingly likely, individuals should be looking to carry out a health check on their estate and succession planning.

Income tax

Although the Government preferred to freeze income tax bands and thresholds in the 2021 Budget earlier this year, it has now announced proposals to increase NICs and dividend tax rates by 1.25 percentage points from April 2022 to raise money for health and social care.

Further increases to the rate of income tax appear unlikely but cannot be ruled out. To make an effective contribution to revenues, however, any further increase would probably need to apply a wide spectrum of taxpayers and so any increase in the rate is likely to be small. Alternatively, a less effective increase, labelled as temporary and exceptional, might be aimed at high-earners.

Pension relief

A Treasury Committee report published earlier this year recommended that the Chancellor urgently reform the entire approach to pension tax relief and it is possible the Chancellor may consider restricting the availability of income tax relief for individuals contributing to a pension.

Harmonisation of employed / self-employed rates

The Treasury Committee report also concluded that reform of the taxation of the employed and self-employed is "long-overdue". Given that the overall income tax and NICs rate for self-employed individuals is generally less than for employees earning the same amount, there is scope for harmonisation but not before some lengthy consultation to resolve the plethora of technical difficulties present in doing so.

Rate of corporation tax / family investment companies

The main rate of corporation tax will increase from 19% to 25% from 1 April 2023. This rate will apply to companies with annual profits exceeding £250,000. A “small profits rate” at 19% will be introduced so that companies with annual profits below £50,000 will not be impacted by the change to the main rate. Where a company’s profits fall between the upper and lower limits, marginal relief provisions will apply to bridge the gap between the two rates. Notably, the small profits rate will not apply to “close investment holding companies” which by definition will include many family investment companies (FICs).

In addition, following the conclusion of a recent review of FICs, HMRC has confirmed its dedicated FIC team has been absorbed into the wider Wealthy and Mid-Size Business team and going forward FICs will be looked at as “business as usual”.

Stamp Duty Land Tax

The stamp duty land tax (SDLT) “holiday”, already extended in the Budget earlier this year to the end of June, is now over and further such “holidays” look unlikely.

So too do imminent increases in SDLT rates, following the introduction from April this year of a 2% surcharge for purchases by non-UK residents, in addition to the existing 3% SDLT surcharge for purchases of additional dwellings.

That said, wider reform (or at least a consultation or OTS review) may be in the pipeline with a recent Treasury Select Committee report acknowledging widespread perception of SDLT as distortive and recommending “the Government treat SDLT as a priority for reform.”

Wealth tax

With the Chancellor reportedly stating that there never will be a time for a wealth tax, it is thought that the current Government are unlikely introduce a wealth tax in any form. That is despite a report published in December last year by the “Wealth Tax Commission”, a group of academics and tax professionals, strongly endorsing a one-off wealth tax. That said, talk of wealth taxes may well resurface as part of the wider public debate on how to raise revenue, as the next general election approaches, most probably driven in policy terms by Labour.

VAT

Despite increased flexibility to reform the UK VAT system post-Brexit, and the Treasury Select Committee recently recommending a consultation, significant VAT reform is unlikely given the manifesto pledge not to raise the VAT rate. Given that VAT affects taxpayers across the board, including those struggling to make ends meet, and the manifesto promise not to increase the rate of VAT, a rate rise is considered unlikely.

A Big Bang budget?

With UK debt standing at £2.2tn, the Office for Budget Responsibility has recently warned that the costs of higher interest rates are now six times greater than they were before the 2008 financial crisis. As the impact of the coronavirus pandemic and Brexit is felt on the public finances, this makes it all the more likely that the Chancellor will look to ensure that any further spending plans are paid for by higher taxes rather than increased borrowing. As a result, the nation’s fiscal black hole may force the Chancellor into a big-bang tax-raising budget and the proposed increase in NICs and the rate of tax on dividends may be just the beginning.