In this special edition of The Digest, we focus on four areas in which a future Labour government might shake up the current tax regime and what you can do now to prepare.
Although the next general election could be held as late as January 2025, it is widely expected that it will be called earlier – probably in Autumn 2024. Current opinion polls suggest that it is very likely that the next government will be a Labour one.
While the Conservative Party has recently been flying various policy kites, most recently the abolishment of inheritance tax, in this article we focus on Labour's policy proposals.
Labour has yet to publish its manifesto, but some interesting announcements have been made, most recently by Rachel Reeves, the Shadow Chancellor of the Exchequer, in an interview with the Sunday Telegraph last month. She stated she would not introduce a wealth tax, nor increase Capital Gains Tax or the top rate of Income Tax. This would seem to limit Labour's options for raising tax to adjusting the thresholds at which various tax rates apply (i.e. more "fiscal drag") and/or altering reliefs and exemptions.
We focus on four possible tax changes that may impact you and the steps you can take to plan for them.
Click on the links below to learn about:
- The planned addition of VAT to independent school fees
- Possible changes to Capital Gains Tax
- Inheritance Tax proposals which will affect estate planners, farmers and landowners
- Proposals to abolish the non-UK domiciled regime
Independent schools are currently exempt from charging VAT on their fees, but Labour confirmed earlier this week that it plans to scrap this exemption, resulting in a hefty 20% VAT charge being added to bills. School fees won't necessarily rise by a full 20% as if schools start charging VAT on fees, then they can also recover VAT on their input costs (such as building work). Schools should therefore be able to reduce the fees slightly before adding the 20% but, even taking this into account, there is still likely to be a significant increase in fees. What can you do to plan for this if you have children or grandchildren already attending a fee-paying school or contemplating the independent route?
First, find out whether the school has a pre-payment scheme in place. Some schools offer these schemes, which generally give a discount on fees if a lump sum is paid in advance. Depending on the nature of the scheme offered by the school, by paying fees now, any future VAT could potentially be avoided. Check with the school and discuss the pros and cons with a financial advisor. Be aware that if the school has financial difficulties and enters administration, the pre-paid funds would be at risk of being lost. The terms of the scheme should be carefully checked – both from a legal and tax perspective (HMRC are known to take some unhelpful views and there are traps for the unwary).
If the pre-payment scheme doesn't appeal or the school in question doesn't offer one, but you are, perhaps, a grandparent wanting to make gifts to help parents pay school fees, make sure you do so in an Inheritance Tax efficient way:
- If you have spare income, then you could use the "normal expenditure out of income exemption" to assist with paying fees. If you do not spend your income each year, you can give the excess away and this will immediately be outside your estate for Inheritance Tax purposes. To use this exemption it is important that you make a regular series of gifts as the exemption would not apply to a one off gift. If you take this route you should keep clear records of any such payments that you make, as well as your annual income and expenditure, so that it is easy for your executors to provide evidence to HM Revenue and Customs that such gifts were from surplus income and do fall under this exemption.
- If you have spare capital rather than income, you can make gifts from this instead. The first £3,000 that you give away in each tax year is covered by the "annual exemption", so does not count for Inheritance Tax purposes. You can also carry forward one unused annual exempt amount to the following tax year and give away £6,000 that year.
If you are giving more than the annual exemption, then you will need to survive seven years from the date of making the gift for that amount to be outside your estate for Inheritance Tax purposes. It is usually advisable to make one lump sum gift of capital so that the seven year clock starts as early as possible. Again, you should keep careful note of any such gifts by recording the date they are made, who they are paid to and how much the gift is for.
Whether making regular payments of surplus income or a one-off gift of spare capital, if you do this by direct transfer to the parents of the child, the funds would be exposed in a divorce or bankruptcy situation and it is not very tax efficient for the parents either. For these reasons, we often help clients to set up a discretionary trust or a bare trust to hold the funds and we recommend that you speak to your usual WBD contact to discuss the advantages and disadvantages of these options.
Although in August, Rachel Reeves stated again that she had no plans to increase Capital Gains Tax, it is notable that rates of Capital Gains Tax are historically low. A higher rate taxpayer pays Capital Gains Tax at 20% on most gains and at 28% on gains relating to residential property. These rates are significantly beneath the tax rates which apply to income and it is likely that a Labour government may seek to tax capital wealth to a greater extent than is the case at present (albeit taxes on capital do not raise a large proportion of overall revenue).
A change to exemptions and/or reliefs could increase the amount raised from Capital Gains Tax, without any change to the rates. This was the tactic used by Rishi Sunak when he was still Chancellor - he cut the Capital Gains Tax annual exemption from £12,300 to £6,000 and there is a further cut to £3,000 from the next tax year.
Plan for future changes to Capital Gains Tax by:
- Selling or gifting assets in this tax year, rather than next, to take advantage of the current £6,000 annual exemption.
- Sharing the disposal of an asset with your spouse or civil partner. If you own the asset you want to sell or gift, you can transfer half of it to your spouse or civil partner first, as there are no Capital Gains Tax implications to such gifts. You can then jointly make the gift and use each of your annual allowances.
- Finding out if there are any exemptions or reliefs which apply to your circumstances. For example, with care, gains can be held over on assets transferred to a trust so that there is no immediate Capital Gains Tax charge. Also, personal belongings like furniture and paintings are not subject to Capital Gains Tax provided the value of each item is below £6,000. Finally "wasting assets" are exempt from Capital Gains Tax. These are assets with an expected useful life of 50 years or less such as wine held as an investment (although careful attention needs to be given to HMRC's guidance in this area). Whether these reliefs and exemptions will still apply under a Labour government is uncertain, so make use of them now if you can.
A Labour government could herald the introduction of a less generous threshold for determining if business property relief (BPR) applies to save Inheritance Tax when considering a "Balfour" claim.
A Balfour claim can be extremely useful for farmers and landowners. A typical estate might be used for a number of activities – in hand farming, let farms and cottages, land used for solar panels, shooting, firewood sales etc. Let cottages or land occupied by solar panels are classed as investment type activities which do not qualify for BPR, but in hand farming, firewood sales or running a shooting business count as a trading activity for which BPR is available.
When calculating if and how much Inheritance Tax is due on the death of a landowner whose estate was used for a range of activities, a Balfour claim is a very useful tool in the armoury. It can be used to argue that the whole estate was run as one business and that more than half of its activities were trading. If HMRC accepts that, it allows the whole business to be treated as a trading business and BPR is, therefore, available on the entire value of the business.
At present, as long as more than 50% of the business is made up of trading activities, a Balfour claim may in principle be successful (although there are a very wide variety of factors which need to be considered in detail). There is concern that the 50% threshold is very generous and allows a lot of extra relief to be claimed, so an incoming government might increase this threshold. Under Capital Gains Tax legislation, the threshold required to show a business is a trading one is that 80% of its activities must be trading. If this 80% threshold were to be applied for BPR from Inheritance Tax instead of the current 50%, then many farms and estates might find they would no longer qualify as trading businesses.
What can you do?
This is an area of planning which definitely needs input from an accountant, land agent and solicitor and the position should be regularly reviewed. Start by finding out where your business sits in relation to the current 50% threshold and have a plan if that threshold increases.
If you have substantial assets which would fall on the investment side of a business, these could be given away or hived off into a separate entity. By way of example, if you are considering diversifying, perhaps by introducing a solar farm on part of your land, as a solar farm is an investment activity and therefore would not count towards the trading activity threshold for a Balfour claim, you can restructure to plan for this. Well in advance of applying for planning permission, you could transfer the land earmarked for the solar farm into a trust, claiming agricultural property relief (APR). This would separate the land from the rest of the business so that, in due course when the solar farm is up and running and producing substantial income, it will not jeopardise a Balfour claim on the rest of the business.
Finally, there has been a push towards land being taken out of farming for use in environmental schemes instead. While this is very good for the environment, it is less positive for the landowner's Inheritance Tax liability. APR applies only to land which is used for agricultural purposes. So if, for example, a farmed area is allowed to return to being a natural wetland, APR will no longer be available. There is significant industry pressure being put on the government to address this and in the Spring Budget Jeremy Hunt announced a consultation about granting APR for land used in environmental schemes. It may be that the government changes before the results of any consultation are implemented, but Labour has a strong green agenda, so conceivably they may continue the work to resolve this issue.
Labour has made it clear that it intends to abolish non-domiciled ("non-dom") tax status. What is less certain is what would replace it.
If an individual is non-UK domiciled, it broadly means that, while they may currently live in the UK, their permanent home is abroad and they intend to leave the UK at some point. If they claim non-domiciled status on their tax return, the benefits are significant. They are liable to UK tax on the "remittance basis", generally meaning that only income and capital gains that they bring into the UK are taxable; tax on everything else can be deferred unless and until anything related is brought to or enjoyed in the UK. In addition, on death, Inheritance Tax is only paid in the UK on a non-domiciled individual's UK assets and not their worldwide estate. Please let us know if you'd like to see our brief summaries of residence, domicile and the remittance basis.
Labour would like to end non-domiciled status. Research suggests that if non-domiciled individuals have to start reporting and paying tax on gains and income from overseas on their UK tax returns it would raise £3.2 billion in revenue (Advani, Burgherr and Summers, 2022). Of course, that's predicated on non-domiciled individuals continuing to stay in the UK if the tax position changes as Labour plans. Many commentators think that the research is flawed, and that a more realistic result is that revenue will drop significantly due to resident non-domiciled individuals restructuring their affairs to ensure that they become non-UK resident.
What, if anything, will Labour replace the non-domiciled regime with for people living on a non-permanent basis in the UK?
Labour might consider putting tax rules in place around short-term residence as an alternative. That would mean applying special tax rules for people staying in the UK on a temporary basis, for example, two, five or ten years. We do not know what those rules would look like, but they might still allow a person to avoid paying tax on non-UK income and gains or to pay tax at a reduced rate up to a maximum number of years living in the UK or provide alternative tax breaks for those moving to the UK (certain other jurisdictions recognise that targeted tax reliefs under equivalent regimes can incentivise foreign investment in their national infrastructure).
Beyond this level of detail, however, a change of policy is fraught with complexity. A Labour administration would have very difficult decisions to make about how to replace the relevance of domicile for Inheritance Tax generally, but also about how Inheritance Tax, Income Tax and Capital Gains Tax should apply to existing structures (including trusts) which many non-domiciled individuals have created. We anticipate that in this second area in particular precipitate action without careful consultation on proposals is likely to greatly exacerbate the risk of individuals who currently make a significant economic contribution to the UK economy ceasing to be resident here.
Those who are potentially affected should be considering how to prepare now. If you are a non-domiciled individual living in the UK, keep your affairs under regular review and stay in touch with your usual WBD contact so that you can be best prepared for any changes. If you are a non-domiciled individual and you are considering a move to the UK to become UK resident, it is crucial to take advice well in advance of your move.
Links and resources:
- Tax, private school fees and state school spending
- No plans to increase capital gains tax, Labour says
- No wealth tax under Labour, Rachel Reeves pledges
- What would a non-dom replacement tax regime look like?
- The UK’s ‘non-doms’: Who are they, what do they do, and where do they live?
- Arun Advani - Reforming the non-dom regime: revenue estimates