RSM and AJ Bell were among the industry experts today (15 October) flagging their expectations of measures likely to feature in the UK Labour Government’s first Budget on 30 October.
With the UK Chancellor promising that there will be no return to austerity, tax rises seem inevitable but who will bear the brunt?
RSM said in its Budget predictor today (15 October) that the government ruled out rises in income tax or National Insurance contributions (NICs) for working people in its election manifesto and capped the rates of VAT and corporation tax so could businesses end up shouldering much of the burden through increased employment taxes?
Will we see short-term tax raids, or will the Chancellor stick to longer term measures to signal the government’s commitment to certainty and stability?
Whilst VAT on private school fees has been pre-announced, there are also rumours of changes and potential rate hikes for capital gains tax (CGT) and inheritance tax (IHT). The challenge the Chancellor faces is that whilst CGT and IHT may be soft targets politically, neither are significant revenue raisers. Estimates show that, together, they contributed around 2.5% of the total tax collected by HMRC in 2023/24. It’s difficult to see how changes to them could raise the additional tax revenue seemingly required so other major measures are likely to be needed.
CGT set to increase
RSM said that with CGT rates historically low, an increase seems unavoidable, possibly with immediate effect on Budget Day. This could even take the form of aligning CGT rates with income tax, which would mean a top rate of 45% for those with the highest earnings. Alternatively, the Chancellor could take inspiration from the United States and introduce different CGT rates for short-term and long-term gains, targeting higher rates at those ‘flipping’ assets for profit.
HMRC’s estimates indicate that increasing CGT rates by 10% would likely reduce the overall tax take by £2bn per annum within just three years, as it would discourage taxpayers from selling chargeable assets. If the Chancellor does increase CGT rates, aligning these with income tax rates would therefore appear counter-productive. However, she could accompany rate increases with changes to reliefs to target the impact of the rises. Another option open to the Chancellor to influence behaviours would be changing the current temporary non-residence rules, which enable taxpayers to avoid CGT by leaving the country for five years, making temporary non-residence a less attractive tax planning option.
Scrapping business asset disposal relief
RSM also said the Chancellor could choose to reduce the benefits available to taxpayers from various CGT reliefs. Business asset disposal relief, originally intended to encourage entrepreneurial behaviour by reducing CGT from 20% to 10% on gains on business sales, has become less effective since the lifetime gain limit was reduced from £10m to £1m in 2020. Scrapping this relief could be a simplification, whilst delivering savings of around £1bn per annum.
Carried interest reform
RSM continued that the government has also signalled its intention to make changes to the taxation of carried interest; the return private equity and venture capital fund managers make on successful investments. Carried interest is currently subject to CGT rates with an 8% surcharge, giving an effective top rate of 28%. The Chancellor is considering changes following recent consultation, but may, in the short term, move the effective rate applied to carried interest closer to the highest income tax rates.
Tax hikes on gifts and inheritances
The Chancellor is also expected to target IHT, said RSM, but it is difficult to see how IHT revenues could be significantly increased without an overhaul of the regime and its interaction with CGT, as most IHT arises on death when reliefs may be available to offset the tax charge arising. Having ruled out the possibility of introducing a wealth tax, the Chancellor has left the door open to increasing IHT revenues by withdrawing business relief for AIM-listed portfolios and agricultural relief for owners not actively farming their own land, and/or capping reliefs for other claimants.
Pension reform – too complex to tackle?
Subjecting individuals’ pension funds to IHT on death is another possible change to the rules we might see on Budget Day, RSM predicts. Pension reform could also take the form of limiting the rate of income tax relief on pension contributions, or a reduction in the tax-free lump sum which can be withdrawn during a pensioner’s lifetime. Pension taxation has been a popular topic for budget predictions for more than a decade; however, potential changes are fraught with complexity and political sensitivity, which is perhaps why successive chancellors’ have shied away.
A softer stance on non-doms?
Having previously confirmed the intention to proceed with the proposed abolition of the non-domicile (non-dom) tax regime, there is speculation that the Chancellor may not take as hard a line as originally anticipated. The forecast impact on public finances of a mass exodus of wealthy non-dom taxpayers may have persuaded her to soften the impact of these changes, RSM concluded.
AJ Bell experts have also taken a look at Chancellor Rachel Reeves’ options to plug the £22bn ‘black hole’ identified in public finances, while at the same time attempting to realise the government’s central objective to drive economic growth.
It said some of the options that might be considered by the government include:
• Pensions tax relief, tax-free cash and the case for a ‘Pensions Tax Lock’
• Pensions ‘death tax’
• National Insurance (NI) relief on employer contributions
• State pension ‘triple-lock’
• Capital gains tax (CGT)
• ISA simplification
• Dividend tax
• Inheritance tax (IHT)
• Tax relief on AIM shares
• Income tax
• Business rates
• National Living Wage
Pensions tax relief, tax-free cash and the case for a ‘Pensions Tax Lock’
Tom Selby, director of public policy at AJ Bell:
“Rachel Reeves’ first Budget has been preceded by feverish speculation over whether pensions could be in the firing line as the new government scrabbles to raise cash to plug a supposed £22 billion ‘black hole’ in the nation’s finances. However, having already drawn the ire of retirees by means-testing the Winter Fuel Payment, the chancellor will likely be cautious about hitting older people for the second time in the space of a year.
“Recent reports suggest Reeves has backed away from the idea of fundamentally reforming pensions tax relief by introducing a ‘flat rate’ of tax relief set somewhere between 20% and 30%. This idea always felt like a non-starter, primarily because implementing such a reform would effectively result in millions of ‘working people’ – exactly who the chancellor and prime minister have said they will protect – being hit with tax hikes. Having just settled pay disputes with NHS workers, it is hard to imagine the new government will be spoiling for another fight over public sector pensions.
“The other suggested target on 30 October is pensions tax-free cash, with some suggesting the maximum someone can take in their lifetime – currently set at £268,275 – should be lowered. Any move along these lines would be deeply unpopular and potentially hugely complicated too. What’s more, neither reforms to pension tax relief nor paring back tax-free cash entitlements would likely deliver the substantial in-year savings the Treasury is looking for.
“The level of uncertainty created ahead of the Budget has real-world consequences, with both contributions and the number of people taking their tax-free cash rising in recent months. It is clearly not desirable that some savers feel forced to take decisions based on rumour and speculation rather than their long-term retirement goals. Given one of the key promises made by the new government was to deliver economic stability to Brits, Reeves should use her Budget to nip this issue in the bud by pledging not to make major changes to either pension tax relief or tax-free cash. This ‘Pensions Tax Lock’ would send a clear signal to savers that the goalposts won’t be moved and should give people more confidence to take decisions based on their long-term interests.”
A new pensions ‘death tax’?
Tom Selby, director of public policy at AJ Bell:
“The tax treatment of pensions on death will be viewed by many as low hanging tax fruit ready to be picked. Under existing rules, it is possible to pass on your retirement pot completely tax-free to your nominated beneficiaries if you die before age 75. If you die after age 75, any inherited pension is taxed in the same way as income. Crucially, pensions usually don’t form part of people’s estate for inheritance tax (IHT) purposes.
“This is undoubtedly a generous set of rules and something which could easily be reviewed by the new government. However, as is often the case with pensions, applying any new tax on death – or bringing pensions into the IHT net – would come with substantial challenges.
“The biggest of those would be around how to treat people who have made decisions about their retirement pot based on the pensions death tax rules as they are today. There will, for example, be lots of people who chose to transfer defined benefit pensions into a defined contribution scheme in part because they wanted to prioritise passing money on tax efficiently to loved ones. If all of a sudden that money became subject to a new pensions death tax, those people would, understandably, feel like the rug has been pulled from under them. It is therefore possible a complicated protection regime would be needed to ensure people are not subject to unfair and arguably retrospective tax measures. This would inevitably reduce the money the Treasury could potentially raise from such a move.”
Ending National Insurance (NI) relief on employer contributions?
Tom Selby, director of public policy at AJ Bell:
“Clearly there are no easy choices for Reeves, but NI relief on employer pension contributions could be an appealing target for a chancellor with limited options available.
“This relief currently costs around £17 billion a year, according to the Institute for Fiscal Studies (IFS), and charging NI, even at a lower rate than the standard 13.8% employers pay, would raise significant sums without breaking any of Labour’s key election pledges. Politically, this would also be less risky as it wouldn’t hit voters directly in the pocket – although there is a danger employers will scale back remuneration, including pensions, to meet this extra cost. If the government goes down this road, it will face a difficult balancing act deciding the level of tax that raises sufficient revenue without undermining its central objective of boosting economic growth.”
State pension ‘triple-lock’
Tom Selby, director of public policy at AJ Bell:
“While next April’s increase in the state pension is pretty much bolted on, it would hardly be surprising to hear Rachel Reeves use the Budget statement to re-announce Labour’s commitment to the ‘triple-lock’. UK pensioners are on track to see a sizeable inflation-beating increase to their state pension next year of almost £500, to just under £12,000.
“The government’s commitment to the triple-lock pledge means it’s likely the earnings growth figure of 4% will be used to determine the rise in the state pension next year. And at a time when inflation has fallen back closer to the Bank of England’s targeted rate of 2%, this will give a welcome boost to pensioners’ income in real terms.
“Sticking with its triple-lock promise may help redeem the government in the eyes of UK pensioners. The government is coming under more intensive pressure to ‘U-turn’ on its controversial decision to axe the Winter Fuel Payment for all pensioners, except those who claim Pension Credit. And although the increase to the state pension should help meet next year’s bills, it doesn’t help those who will be living close to the edge of their means this winter.
“The triple-lock guarantee has worked well in the favour of pensioners over the recent past, boosting the state pension by 28% over the last four years. But with the state pension edging ever closer to the frozen personal allowance of £12,570, and the concept of universal payment coming under increasing scrutiny, the government will have to take the bull by the horns at some point to address who should get the state pension, at what age, and how much.”
Capital gains tax (CGT)
AJ Bell pensions and savings expert, Charlene Young:
“Having ruled out increases to some other taxes, capital gains tax (CGT) might appear like an obvious place for the government to make changes and generate more tax revenue. The most radical option is equalising CGT rates with income tax – which would represent a huge tax increase for investors. The Institute for Fiscal Studies has called for reforms to go further – and for an end to the exemption on death – arguing that the current system actually discourages productive investment. The CGT allowance has been slashed in the past two years as former chancellor Jeremy Hunt sought to balance the books, but that doesn’t rule out further tax increases.
“However, it may not be the cash cow that many think it is. The government’s own figures show that a big increase in CGT rates could backfire and actually lead to lost revenue for the government. For example, raising both the lower and higher CGT rates by 10 percentage points, to 20% and 30% for non-property gains, would result in a total loss of £2.05 billion for the Exchequer by 2027/28. That’s because while the rates are higher, investors would be expected to change their behaviour to mitigate paying the tax.
“CGT being wiped out on death also creates an incentive in some cases to hold onto assets so they are taxed as part of the estate under IHT, potentially paying less or no tax. But if the government scrapped this tax break, there would likely need to be some allowance made to account for inflation. Otherwise people who have owned investments for a very long time would be severely punished.
“One option is to raise the rate of CGT for higher rate taxpayers back to 28% from April 2025. This would be relatively simple to implement and puts it back to the higher rate introduced by George Osborne in 2010. It also narrows the gap between income and investment gains, but not to the extent of taxing them equally at rates of up to 45%. Waiting until April 2025 rather than implementing a hike on Budget day could also bring forward sales investors were already considering.
“It would also be a logical second step to the changes already in progress. Private equity fund managers receive a share of the funds’ profits as carried interest in a personal capacity. Carried interest is taxed under the CGT regime at 28%, rather than as salary income, but the government has already set the wheels in motion to treat and tax it as income, despite calls that it could dent the competitiveness of the UK private equity industry.
“An alternative would be to get rid of some of the CGT tax breaks for businesses, where business owners selling their company benefit from a lower rate of CGT. Raising this rate from 10% up to 20% to equalise it with standard CGT rates is estimated to generate £710 million for the government by 2027/28 – but it’s clearly not a move that will be popular with entrepreneurs.”
ISA simplification
Tom Selby, director of public policy at AJ Bell:
“At a time when government is facing significant fiscal constraints and little by way of ‘good news’, ISA simplification offers the opportunity to announce a consumer-focused reform that will benefit investors and the wider economy. As a first step, the government should combine Cash and Stocks and Shares ISAs, the two most popular versions of ISAs in the UK, reducing upfront choice complexity and creating a more flexible system in which consumers could move easily between cash savings and investments.
“HMRC data suggests there are around three million people in the UK with £20,000 or more invested in Cash ISAs and no money invested in Stocks and Shares ISAs. If just half of that money was invested for the long term, an additional £30 billion of investment would be unlocked.
“Given around half of ISA assets on AJ Bell’s platform are invested in UK companies or UK-focused funds, domestic firms should disproportionately benefit as a result, with the potential for additional retail investment to deepen liquidity and support higher valuations for UK businesses.
“Steps could also be taken to improve the attractiveness of the existing Lifetime ISA. Helping people onto the housing ladder is a clear priority for the new government and the chancellor should iron out the kinks in the design of the Lifetime ISA to make it as attractive as possible to would-be homebuyers.
“Most obviously, the 25% early withdrawal charge, which effectively acts as a 6.25% exit penalty, is deeply unfair and punishes those for whom a change of circumstances means they can’t pursue their homeownership aspirations. Reducing this to 20%, so it simply aims to return the upfront government bonus, would be a simple, low-cost reform that benefits younger people.
“Government should also consider increasing the minimum property purchase price, which currently stands at £450,000, to reflect house price inflation since the LISA was introduced seven years ago.”
Dividend tax
Dan Coatsworth, investment analyst at AJ Bell:
“The previous government has already cut dividend tax allowance to the bone, going from £5,000 to the current £500. The big question is whether Labour is prepared to go any deeper.
“HMRC is expected to collect almost £18 billion from dividend tax in the current tax year so it is already a meaningful source of revenue. While slashing the allowance, perhaps to £250, cannot be ruled out, the new government would be incredibly unpopular with investors if it reduced the dividend allowance any further.
“Another option would be to raise the rate of dividend taxation, although there’s only so much room for manoeuvre with tax rates on dividends already very close to matching income tax rates for higher and additional rate taxpayers.
“The government will likely tread carefully here. Labour wants to encourage investment into the UK stock market and create a more vibrant place for British businesses to access growth capital. Therefore, taking even more of investors’ returns as tax could mean shooting itself in the foot.”
Inheritance tax (IHT)
AJ Bell pensions and savings expert, Charlene Young:
“Often cited as the UK’s most hated tax, despite only being paid by a small proportion of the population, the chancellor could set her sights on raising money through IHT. At 40% it’s already one of the highest tax rates, so it’s unlikely we’d see a headline rate increase. What’s more likely if Ms Reeves did want to change this tax is cutting allowances or whittling away certain reliefs to increase the amount some estates pay.
“A couple leaving their main residence to their children could potentially shelter a £1 million estate from inheritance tax, thanks to both the nil-rate band and the residence-nil-rate band – but either of these could be cut. Another option is taking a red pen to the reliefs given to businesses or to gifting rules – although these aren’t overly generous anyway.”
Tax relief on AIM shares
Dan Coatsworth, investment analyst at AJ Bell:
“Abolishing tax relief on owning certain AIM-quoted shares could be high up the list of ‘easy wins’ for Rachel Reeves. The Institute for Fiscal Studies said in April that abolishing IHT relief on AIM stocks would raise £1.1 billion in the 2024-25 tax year, rising to £1.6 billion in 2029-30. There is an argument to say the system is outdated and hard to defend.
“Business property relief legislation came into force in 1976 for family firms passed down through generations so that inheritance tax bills wouldn’t put a privately-owned business into liquidation. It was subsequently expanded to include holdings in businesses quoted on London’s AIM stock market following concerns that such investments were harder to sell quickly than shares on London’s Main Market. While AIM stocks are typically smaller in size versus ones in the FTSE 350 index, it’s fair to say that liquidity has improved since the junior market launched in 1995.
“Scrapping the tax relief on AIM stocks could backfire. Principally, it goes against the government’s efforts to support UK business growth. Without the tax benefit, investors might rethink why they are holding certain AIM stocks, leading to a sell-off in small caps just at the point where investors are starting to show more interest in the UK market. That could pull down valuations and accelerate UK takeovers if more companies are trading cheaply.”
Income tax
AJ Bell pensions and savings expert, Charlene Young:
“While the chancellor pledged in the election campaign not to raise the rate of income tax, that doesn’t preclude extending the current freeze on thresholds, which is tantamount to raising tax by the back door. It was a tactic used by the Conservatives to raise taxes on working households, with rising wages at a time of high inflation providing a super-charged stealth tax on earnings. The effect is muted somewhat when wage rises are lower, which is to be expected as inflation comes down, but it’s still an easy way to boost tax revenues.”
Business rates
Danni Hewson, head of financial analysis at AJ Bell:
“Keeping high streets thriving and preventing further boarded up holes in the heart of our towns and cities will likely have at least made the chancellor’s to do list.
“The letter from a host of well-known retailers asking the chancellor to consider cutting business rates while the promised reform to the system goes through its laborious cycle has highlighted once again the inequality of a system created in the days before online shopping. But with so many calls on the public purse and similar demands from the hospitality sector to extend current relief beyond March next year, it’s a measure that’s unlikely to make Rachel Reeves’ final draft.
“Labour has promised to be a party which supports British business, but the wait for this first Reeves Budget has felt like death by a thousand cuts.
“Confidence has been eroded and markets have already fired a shot along the Treasury’s bow with lending costs easing up as investors digest speculation that the chancellor will re-write some of the fiscal rules. Even in politics, two years isn’t that long, and no one has forgotten the gilt sell-off that sent markets into a tailspin following Liz Truss’ disastrous mini-Budget.
“This Labour government has an almost impossible task to perform at the end of the month, to deliver enough to reinject confidence back into the country without increasing headline taxes or maxing out the emergency credit card.”
National Living Wage
Danni Hewson, head of financial analysis at AJ Bell:
“Last year’s whopping increase to the National Living Wage has already been cited by many companies as an oversized burden that’s eroded the bottom line. Card Factory, Greggs and Co-op have been amongst the businesses laying out the impact of increased wage costs to their investors.
“While the state pension is tied to the triple-lock and is almost certain to rise by 4% next March, benefits only look at the headline rate of inflation for September, which is expected to come in at 2.2% on Wednesday morning.
“The National Living wage works slightly differently as it will be up to the Low Pay Commission to make its recommendations for 2025, but inflation will be a key factor in that decision making process and after last year’s record increase many employers are hoping for a more manageable uplift this time around.
“However, with Labour’s pledge to create a ‘genuine living wage’ there are plenty of employers waiting nervously for the government’s recommendation which is expected to be outlined by Rachel Reeves in the Budget.
“As expectation mounts that employers may also have to shoulder National Insurance on pension contributions, there will be plenty of businesses reining in expansion plans or considering ways to better harness technology like AI to keep bills down.”
