The Chancellor’s “Kitchen Sink”

Introduction

 

In a recent report by Oxford Economics we are told that:

 

 “We suspect the new chancellor will ‘kitchen sink it’, getting all the fiscal bad news out early on. 

 

This will allow her to announce corrective measures to return the public finances to a sustainable path and blame it all on the failings of her Conservative predecessors”.

 

Indeed, we are told that after moving into number 11, Reeves claims to have discovered the equivalent of dry rot in the public finances.

 

Of course, such surprise is barely credible. But if this will be used as cover for throwing the kitchen sink at the next budget (expected in October), then it begs one question…

 

Rachel, what’s in your sink?

 

[Just for fun, of course]

#1 Capital gains

 

Having ruled out increases in income tax, National Insurance and VAT, CGT stands out like the sorest of sore thumbs.

 

The main rate of CGT tops out at 20%. This is well below the top rate of income tax or 45% (plus NICs if earned income).

 

The rate is slightly higher for sales of residential property – which is now 24%… having been 28% until Jeremy Hunt’s budget earlier this year.

 

Could Reeves throw the kitchen sink at this by equalising the two?

 

If she did, this would be straight out of the Green Party manifesto.

 

One issue with equalising the two is that, at present, gains that are purely as a result of inflation are taxed. So, there’d really need to be a re-introduction of indexation relief (like back in the good old days – I still have 162.6 etched on the brain!)

 

However, as it happened, I am not sure that she will go quite this far. But we might seen the top rate going up to, say, 25% or 30% along with a tweak of some of the reliefs (see below).

 

Rumours of a rate raise themselves have the effect of generating revenues by accelerating decisions to, say, sell businesses trying to get ahead of the changes. 

 

Indeed, I suspect there are many conversations happening in accountancy offices  up and down the land on this.

 

“Sell now, before rates go up.”

 

Kerching.

#2 Double dip on death

 

One technical issue I’ve seen bubbling away is the CGT uplift on death.

 

This is the slimmest of silver linings that, although you’ve carked it, your CGT issues are solved. The beneficiary of the assets inherits them at (broadly) the market value at death.

 

Ordinarily, this might sound fair enough if those assets have been taken into account for IHT purposes. Why tax a gain if they’ve already paid 40% on the full value of the asset?

 

I would find it hard to believe they would say that you need to pay IHT on an asset on death but there would be no CGT uplift.

 

As such, I would suggest that, if this change is made, only assets which escape IHT on death – perhaps because they qualify for BPR – should lose the CGT benefit. 

 

For example, if a child inherits the shares in the family business free of IHT, it does not seem unfair they also inherit the historic gain (a bit like the donee following a holdover relief claim).

 

A more practical consideration is that IHT is easier for an estate to deal with as it is simply imposed on the market value of the asset at death. But CGT is charged on the gain. What if the executors don’t have the acquisition and enhancement costs of the asset in question?

#3 Pruning reliefs

 

The kitchen sink approach might well include a bonfire of tax reliefs.

 

After all, we can still say we have not raised taxes even if we’ve torched lots of valuable, and expensive, reliefs right?

 

Let’s have a fish around in the murky dishwater.

 

BPR

 

The FT recently reported that a 68 estates, all with business assets worth more than £5m, claimed BPR on the estates totaling £1.8b. This represents a comfortable majority of all BPR relief claimed in 2020/21.

 

This is likely to be because they represent stakes in unquoted, high value businesses which can qualify for 100% relief.

 

For some sitting on the left, this might be bad enough. Tax reliefs benefiting the richest in society and all that.

 

But, for those who are frothy of mouthed already, it will get worse.

 

The thing is, BPR is not simply restricted to shares (or other interests) in family businesses or trading companies in which the deceased (or transferor) were actively pursued in.

 

Rather, the relief extends to baskets of shares in many (but not all) of the companies listed on the Alternative Investment Market (“AIM”).

 

Eh, but you said unquoted?

 

Indeed, if the company is quoted on Alternative Investment Market (AIM) then it is, well, err, unquoted. Obvs.

 

In the absence of any other requirements, it is therefore possible for a retired person, say Mrs Miggins, to invest, say, £1m of cold hard cash into a basket of AIM shares.

 

After two years (or less if one is investing as ‘replacement property’) then the potential IHT liability of £400k is completely removed once the holding period is satisfied.

 

There is no need to have any involvement in the business. Just ask your financial adviser to pick the shares or the retail product containing them.

 

It is worth noting that not all AIM companies will qualify for BPR as some will not meet another requirement that the company is ‘trading’.

 

For example, a company that is mainly investing or, say, dealing in land will not qualify even if the shares are listed on AIM as they do not meet the trading requirement.

 

Personally, it has always seemed rather strange that a person can obtain an incredibly attractive business tax relief whilst having no involvement or material interest in the business.

 

One might say that investing in a basket of shares on AIM is likely to be volatile experience. This is risk. However, this is investment risk and not business risk.

 

Indeed, in recent years, retail products have emerged trying to protect from this volatility / risk.

 

One could draw an interesting comparison between the case of Mrs Miggins, who gets BPR relief and the substantial curtailing of reliefs for professional landlords who now potentially pay tax on phantom profits if they have leverage.

 

But this is UK tax.

 

So, batsh@t craziness pervades.

 

As such, this aspect of BPR seems highly likely to be floating around in Mrs Reeves’ sink

 

I have previously suggested solution to this.

 

Of course, we don’t understand the extent to which AIM relies on this type of money.

 

Conceivably, removing relief might cause a correction in the market as it becomes less attractive.

 

I am unaware of any figures which try to quantify this.

 

But, even if it does, this seems like an odd distortion as to how passive capital is invested.

 

Why should the AIM generally benefit?

 

Why should some companies on the AIM market – those that qualify as trading companies – when others that are listed (investment companies) do not.

 

Business Asset Disposal Relief (BADR) again?

 

Ah yes, the tax relief formerly known as Entrepreneurs Relief.

 

This relief generally applies to the disposal of business assets – such as shares in trading companies and interests in trading partnerships.

 

However, a couple of years ago, it was whittled down to a shadow of its former self. 

 

The lifetime limit was butchered from £10m to £1m. The holding period and other requirements were tightened up.

 

A husk of a relief.

 

Prior to the changes, ER cost £2.7b a year (ERs previous incarnation, taper relief, was many times more costly for various reasons). The more recent figures are that the more insipid version of the relief is £1.1b a year if one includes the lesser spotted Investors Relief. 

 

The same arguments still circulate that entrepreneurs do not build businesses to get £100k tax saving on an eventual sale.

 

This is a fair point.

 

But many entrepreneurs are, perhaps unsurprisingly, happy to concede that 10%, or at least a chunk being subject to 10%, is a fair amount of tax.

 

Is there a danger that if reliefs are removed and rates go up then there is more sport in looking at other ways of reducing tax? 

 

Even if there is, should we even care?

 

That said, if one accepts that it is appears politically unlikely that Reeves would remove it entirely in her first budget, the potential savings are hardly worth writing home about.

 

R&D?

 

If there has been a purge on BADR because it is seen as expensive and is largely irrelevant at the time our entrepreneur establishes their business then R&D might be susceptible for the same reasons.

 

Historically, it has been difficult to criticise R&D. It made everyone all warm and fuzzy inside.

 

Like a wide-eyed puppy.

 

But if one looks at the same metrics applied to ER, then R&D relief does not shape up well.

 

For the year 2021/22,  the cost (or ‘support claimed’) was about £7.6b a year – quite a bit more than ER. 

 

However, due to changes in the regime, particularly for SMEs, this is likely to fall substantially in more recent years.

 

Secondly, like BADR, I am certain that, in many cases, the availability of relief is not a prime mover in the claimant investing in innovation.

 

Indeed, a historical feature of this regime has been around people having to be told they qualified for relief (and, too often, spuriously so).

 

In addition, it won’t help that a material proportion of relief often leaks into the hands of claims companies charging contingent fees. 

 

We have seen some tightening of the R&D purse strings more recently. HMRC, having followed its usual arc of going from the sublime to the ridiculous in policing claims,  is making a right dog’s dinner of enforcing the regime. It claims that an extraordinary £1.1b is claimed in error or as a result of fraud. They will no doubt trumpet the dog’s dinner they have made in recent months has brought down fraud (by grinding the system to a standstill).

 

There is also the question of whether it even makes sense to provide relief for an enhanced deduction for costs incurred on R&D. A deduction was available for 230% of qualifying costs. It’s now been whittled away to 186%.

 

But, bearing in mind the above ‘problems’, might Reeves be tempted to further take the pruning shears to this relief?

#4 Stopping the boats… and private jets

 

In case you didn’t notice, the previous government had a little thing around stopping boats. You might have heard about it from time to time.

 

Of course, this was all about keeping certain people out of the UK.

 

But will Reeves look at charging HMRC with the equivalent of stopping the boats (yachts?) and private jets leaving the UK?

 

A recent report showed a significant net outflow of millionaires from the UK. It appears that the UK is about as attractive as China for millionaires (thought perhaps less chance of disappearing).

 

Again, with the changes slated for non doms (lest we not forget this was the Tories proposal) there will be many soon to be former remittance basis users considering whether they can do whatever they need to do in the UK whilst being non-resident.

 

This feels more likely if Labour do decide to squash existing excluded property trusts when the new legislation sees the light of day.

 

Of course, this will mean these measures raise less moolah than first trumpeted.

 

What might a kitchen sink approach in this area look like?

 

Firstly, it might mean HMRC simply patrolling this fiscal border more tightly. In other words, more enquiries into whether the statutory residence test is being applied properly.

 

Secondly, we might see a tightening of the rules. Effectively, all of the tests in the SRT can be reduced to a day counting exercise. 

 

As such, these thresholds might be tweaked to make breaking residence more difficult.

# 5 Exit tax

 

But, if people are leaving, we might as well throw the kitchen sink at them, mightn’t we?

 

An exit tax would represent a skim on the assets of those leaving the UK.

 

This might be an exit charge representing capital gains tax on unrealised assets at the time of departure.

 

“How very dare you?” I hear you say. Firstly, don’t blame me. But secondly, it wouldn’t be unique.

 

There were huge howls of anguish and gnashing of teeth when Norway announced a tightening of its existing exit tax of 37.8% on unrealised gains following departure from the country.

 

There are a number of other EU countries with exit taxes – including Spain, Estonia, Denmark, France and Germany (albeit none as spicy as Norway’s)

 

As Roger Ver recently found out to his cost, the US has a similar tax on giving up one’s citizenship.

 

This nicely takes us onto the next potential sink…

#6 Copy what the yanks (and Eritrea) do…

 

Famously, the US has citizenship based taxation. So, if you are a US citizen, or, say hold a green card, you pay US tax on worldwide income and gains regardless of whether you are resident there or not.

 

Less famously, the same is true of mighty Eritrea.

 

Of course, escaping such a tax is difficult. One needs to give up citizenship. You’d need another citizenship. You might also even have to pay an exit tax.

 

If Reeves really was committed to throwing the kitchen sink then a model is sitting right there in Asmara (or Washington DC).

 

Eeek!

#7 Wealth tax

 

Don’t we already tax wealth?

 

Of course we do.

 

We tax transfers of wealth in lifetime and death through Inheritance Tax (“IHT”). 

 

We tax the capital return from wealth through Capital Gains Tax (“CGT”). 

 

We tax income returns from wealth through income tax.

 

Further, we also commonly tax property purchases through Stamp Duty Land Tax and also we have (less commonly) the Annual Tax on Enveloped Dwellings (“ATED”) where one broadly lives in a property that has been ‘enveloped’ in a Company.

 

However, we do not have a tax that is simply levied because you have wealth.

 

A report written by the self appointed Wealth Tax Commission (“WTC”) states that the current suite of wealth taxes is “dysfunctional”. 

 

I think describing any aspect of the UK tax system as dysfunctional is pretty polite. So kudos to them.

 

The WTC also set out a paper on a UK wealth tax. It was largely dismissed by the Tories. 

 

But, remember, we’re now talking about life in a post-kitchen sink world.

 

Indeed, the newly formed Kitchen Sink Commission could well like such a proposal. So, let’s see what the WTC said.

 

In their report, the WTC preferred a one-off wealth tax rather than an annual tax.

 

Although at pains to point out they weren’t making any recommendations, the WTC did set out some illustrations:

• – Threshold of £500k of assets per individual over which a wealth tax is payable; and
• – Threshold of £2m of assets per individual over which a wealth tax is payable

 

Based on a rate of 5% (spread over 5 years) the first of these would reportedly raise a stonking £260bn.

 

Plenty enough to cover the £20b kitchen sink shaped blackhole… several times over.

 

In respect of the second of these, then the tax take would be £80bn.

 

A lower amount, but would cover any other fiscal black holes uncovered further down the track.

 

These are huge sums of money. 

 

This is illustrated by what alternative changes might be necessary to raise £250m over 5 years:

• – Raise the basic rate of income tax by 9%;
• – All income tax rates by 6%; or
• – All VAT rates by 6%

 

Gulp!

 

The WTC’s proposal was that it would apply based on a person’s residence. 

 

Importantly, it was proposed that there should be a residence tail such that, if one was resident, say, for 4 out of the previous 7 tax years, then one would be subject to the tax even if one had left by the time it was enacted.

 

Of course, this would limit the ability to take pre-emptive action. 

 

The proposal was that ALL wealth above the thresholds would be taxed.

 

The report is very clear that ‘exceptions’ and ‘exemptions’ should be resisted to keep the tax base as wide as possible.

 

This is a bold (and potentially politically incendiary) proposal. The proposal is that wealth in pensions, main residences and businesses would be up for grabs.

 

Yikes!

 

It is stated in the report that 40% of the UK’s wealth is tied up in pension schemes and, as such, it would adversely affect the success of a wealth tax where this source was excluded.

 

However, this could easily bring in healthy public sector final salary / defined benefit schemes once they have been capitalised. 

 

However, Reeves has previously, explicitly, ruled out a wealth tax. As such, this would be a political bomb. 

 

But…

#8 Are those claims of fiscal dry rot even more sinister?

 

Here, we’ve pretty much assumed that Reeves will honour those manifesto commitments which have left us tiptoeing through the fiscal periphery.

 

But is the whole “it’s even worse than we imagined” schtick simply a cover to allow them to break those commitments? 

 

Someone might say, it would be the adult thing to do. “Our promises were based on half the picture. All bets are now off!”

 

This would, amongst others, allow changes to income tax and NICS – after all, these are the heavy lifters when it comes to raising revenue.

 

It would allow the wealth tax mentioned above. Previously ruled out.

 

This really would be the ultimate kitchen sink…

 

…Bish, bash, Villeroy & Boch!

Conclusion

 

As they say, it’s only when the tide goes out we see who has forgotten their bathing suit.

 

Same applies to kitchen sinks.

 

It’s only when we let the plug out that we see what lurks beneath the surface.

 

The plug will be removed in October’s Budget.