Significant Tax Changes on the way?

Every year the tax system gets a makeover at the time of the Budget, when new rules and regulations are introduced to extract funds from citizens and businesses in order to fund the running of the country and the obligations of the public sector. Over the last decade the frequency of tax regulatory change events has increased with the once annual Budget being replaced by a myriad of spring, autumn and emergency announcements that have ushered in an ever more complex and voluminous tax regime. Indeed last month the draft clauses for next year’s Finance Bill were published the day after Royal Assent was granted to this year’s Finance Act! It’s all rather exhausting and one could be forgiven for thinking that we are on a never ending treadmill.

Despite this, there has been a lot of talk recently about an ‘overhaul’ of the UK tax system by both politicians and tax commentators. The COVID 19 pandemic (together with its £300 billion estimated price tag) appears only to have accelerated and enhanced this proposed overhaul. So it was not really a surprise that during July, the House of Commons Treasury Committee opened an inquiry into the UK tax system called “Tax after coronavirus”. The Committee will look at what the major long-term pressures on the UK tax system are, what more the UK can do to protect its tax base from globalisation and technological change, and whether such pressures should be met with tax reform. The Committee will also seek evidence on what overall level of taxation the economy can bear without undesirable harm to economic growth, the role of tax reliefs in rebuilding the economy, and whether there is a role for windfall taxes in the post-coronavirus world.

The Committee Chair argued it was the right time for such an inquiry for three reasons: it was a long time since there had been any fundamental reform in the UK tax system; the pandemic was going to leave the country with significantly elevated debt levels which would have to be dealt with, and tax would have to play a major part, in his view; and the pandemic had affected groups such as the young and the low paid in particular, and how the tax system dealt with that needed to be considered.

In particular, the Committee Chair was concerned about the taxation of digital companies and the differences in taxation between the employed and the self-employed. He was also very aware of how there was an increasing accumulation of wealth in the hands of a relatively dwindling number of individuals. He further noted that the effectiveness of tax reliefs needed to be reviewed; although some were in place for good reasons, collectively they cost the Exchequer a great deal.

Unpicking the terms of reference and the Committee Chairman’s own views, the following are areas which appear to be high up on the agenda for an overhaul

The Three Person tax issue

There has been a quiet revolution in the jobs market over the last decade, with the arrival of the ‘gig’ economy. In the past, individuals were either taxed as employees working for someone else or self-employed working for themselves. Now the lines are blurred in that a person can be regarded as a ‘worker’ which is somewhere between a self-employed person and an employee. From a tax perspective, the key differences between someone who is an employee and someone is not comes down to whether employer’s National Insurance is payable (at 13.8%) and whether tax needs to be deducted at source under PAYE. Clearly, from a tax generating perspective, the Government want as many individuals to be employees as possible. However the line between employee and self-employed is not always clear and the use of personal service companies [‘PSC’s’] to provide the ‘work’ services of their shareholders to ‘providers of work’ has made the distinction even harder to discern. HMRC introduced the IR35 regime over 20 years ago as a means of collecting PAYE/NIC from PSC’s that were used to employ individuals who in effect worked solely for one customer. Recent high profile tax cases involving media celebrities who used PSC’s have proved how difficult it is to determine the tax status of the individual and their PSC. In response the Government changed the rules in 2018 for public sector employers and put the onus back to the large employer to operate PAYE/NIC rather than the PSC. These rules are now to be extended to include private sector employers from next April. Even with this change, there is still a concern that it is becoming ever more difficult to determine the tax status of many individual’s. There is a lot of tax at stake and it is clear the Government and indeed opposition MP’s want to amend the rules to treat many more individuals as employees for tax purposes. No doubt this will involve making the employers the gate keepers of this decision and of course the rules will look to penalise them if they get it wrong.

Reform of Inheritance Tax?

There has been recent discussion about making significant changes to inheritance tax [IHT] so as to make it apply to more people and thus generate more tax for the government. However this is an unpopular tax and politicians are unlikely to risk the ire of voters by extending the reach of IHT too far.

Nevertheless, a cross-party group of MPs have called for significant changes to IHT, including a reduction in the current 40% rate that applies on death to 10% on taxable amounts up to £2m and 20% on the balance of the estate. The rate reduction would be balanced against the abolition of a series of reliefs, including the seven-year rule on lifetime gifts (which removes IHT liability from assets if gifted seven years before death), gifts out of income and the important business and agricultural property exemptions. The abolition of business property relief would be of big concern to business owners and to address the issue of taxing business assets on death, the report recommends that where tax arises on business assets, there is an option for the tax to be paid in instalments over 10 years. While the instalment option would make it less likely that beneficiaries will need to sell the business to pay the tax due, the abolition of the current reliefs would have significant implications for business owners.

The report further advocates that the small annual gift exemptions are abolished and replaced with one simple annual exemption of £30,000. Once the annual allowance is exceeded, a lifetime tax at 10% would be applied.

One additional significant recommendation is that when IHT interacts with capital gains tax [‘CGT’] on the death of an individual, that, instead of beneficiaries inheriting assets at their probate value (i.e. the value at the owner’s death), they should inherit the deceased’s original acquisition cost for tax purposes. The impact of this would be that CGT would more likely arise if a beneficiary sells the inherited asset, as the base cost of the asset would no longer be the value at the date of death.

If some or all of these changes were to be introduced, significant revisions to IHT planning would have to be considered, even for those with well thought out existing strategies.

Is a Wealth tax on the way?

One of the significant sources of tax for many countries around the world is a wealth tax, which in simple terms is an annual tax that is payable based on the value of assets that are owned by individuals. For example, a wealth tax could be imposed in the UK by applying a rate of tax on the market value of all property and other tangible assets owned by an individual. It would be a sure fire way to raise taxes but would be deeply unpopular with voters. It would also require a significant amount of detail and specific exemptions and reliefs for certain classes of assets. There would almost certainly have to be a de-minimis amount of value owned by an individual before the tax would apply and there would also likely be a sliding scale of rates that increases as the value of a person’s estate rises. On top of this, special consideration would have to be given to assets held by trusts and offshore entities. Indeed it is probably for the above mentioned reasons that it is unlikely that a Conservative-led government would introduce such a tax. However, in the ‘post coronavirus’ world, where the UK economy is not going to be in great shape, one should not entirely rule out a move to some form of wealth tax.

Tax on Globalisation

To a certain extent the horse has already bolted on this issue, as in April this year the UK introduced the Digital Services Tax, aimed at large (mainly US) ‘on line’ vendors. The tax was introduced in advance of a globally agreed system to apply to such organisations, the introduction of which may be several years away. Whist this has not gone down well in the USA, it will be the first step towards a more joined up global system to make large corporates liable to taxation in countries where they make sales but don’t necessarily have a physical footprint (which is a key requirement in order to be taxed in a country under existing laws). The Treasury Committee will no doubt want to ensure that the UK tax system is appropriately structured to enable the UK to get its fair share of tax from the global internet giants who sell to UK customers.

Removal of tax reliefs

There are a myriad of tax reliefs and exemptions included in the UK tax code. A recent report highlighted that many of these were poorly targeted and unjustifiable in terms of lost tax. This report may give the Government cover to remove certain reliefs. Some high profile reliefs which have been signalled for the chop include:

  • 1) Removing or reducing the Private Residence Relief, which normally exempts or significantly reduces the capital gains tax that arises when an individual sells the home they live in. Whilst removal of the relief entirely is unlikely, there is the possibility that, unlike the complete exemption that currently applies, the amount of the relief will be limited to a maximum cap, with capital gains tax arising on gains in excess of that amount.

  • 2) The last budget saw a significant reduction in the value of Entrepreneurs’ Relief, as a result of limiting the 10% tax rate to gains of £1m or less from the previous limit of £10m. There is still the possibility that the relief could be reduced further or even abolished.

  • 3) Prior to 1985, the Government taxed non trading income of privately owned companies that was not paid out as dividends to its shareholders. This was called the close company surcharge. Whilst the removal of the surcharge was technically not a relief, its re-imposition would be an unwelcome tax charge, although it would have the potentially beneficial effect of encouraging companies to commence trading, thus limiting their investment income.

There are a lot of ways that the Government can look to raise taxes. There could, of course, be increases in tax rates on income both for individuals and companies. However the current Government is less likely to do this than a future potential Labour Government. Having said that, there is a prospect that the CGT rate could rise as the current main rate of 20% looks light compared to the top income tax rate of 45% – but again such a rate increase would go against the grain of a Tory Government. As we will eventually say goodbye to the EU at the start of next year, there could be changes to the VAT regime, but at 20%, the main VAT rate is already quite toppy and it would be surprising to see it rise.

Predictions on future tax changes is somewhat akin to picking a winner at the races – but without the enjoyment of a day out! Whilst some, all or none of the points raised in this article may come to pass, one thing is for certain, there will be significant changes to the tax code over the next year and it is unlikely that many of those will result in less tax being paid!

Eamonn Donaghy

Tax Director