Are U.K. Investors Facing a Double Taxation Shock?

(Bloomberg Opinion) -- The U.K.’s pile of debt has hit a record 2.08 trillion pounds ($2.78 trillion). The cause is the gargantuan effort to mitigate the impact of Covid-19. The issue is how to pay for this largesse.

Because spending cuts are politically unpopular and economically damaging, the government will have little choice but to raise taxes. The question then is, which ones will it target?

There is little scope to raise additional revenue by hiking income tax, as incomes that were barely growing before the pandemic have now been hit hard by lockdowns. Boris Johnson’s Conservative government also made an election manifesto commitment last year to not increase taxes on income.

Another option is raising the inheritance tax. However, the ruling Conservative Party has only recently made good on its 2015 pledge to allow a married couple to leave a home (valued up to 1 million pounds) to their children entirely free of the charge. This allowance was very popular within the party and is unlikely to be reversed.

The heavy lifting will therefore have to be done by taxing assets, especially since property values and stocks have shot up in value in recent years. That has left the capital gains tax squarely in the Chancellor’s crosshairs.

The government’s Office for Tax Simplification has come up with a number of proposals to reform capital gains tax in a detailed report published last month. Its principle recommendation is to apply the same tax rates to both income and capital gains, which could raise what you pay on the latter by a fair amount.

Currently there are a myriad of rates that people pay: For normal assets, the capital gains tax ranges from 10% for basic-rate taxpayers to 20% for top-rate taxpayers. For property sales (not your main home but investment properties), it ranges from 18% to 28% for top-rate taxpayers. Meanwhile, the top tax rate for income is 45%, rising to 47% if national insurance is also considered. 

There’s another proposal being touted that would add additional bite to a hike on capital gains tax.

Currently, any capital gains liability is expunged upon death by an exemption called the “death uplift.” The tax office has proposed scrapping this exemption, so the liability will roll over to whomever inherits the asset. This will particularly affect those getting large, indivisible assets, such as property. These assets frequently have to be sold to pay off any inheritance taxes that come with them. Under the new proposals, such assets being sold would become subject to capital gains tax too. They would in effect be double-taxed.

Take the example of a second home or an investment property purchased many years ago for 100,000 pounds. Its value now is 500,000 pounds, and the owners bequeathed it to their daughter.

If we assume that the new inheritance tax allowance mentioned above has been fully utilized with respect to the main family home, the daughter would still have to pay inheritance tax on this second property, which would amount to 40% of the home’s current valuation. Being somewhat short of cash, she has to sell the house to pay the resulting 200,000-pound bill.

No more death uplift exemption would also mean that capital gains tax was due on the 400,000-pound capital gain on the home’s value. If this tax is raised to match income tax, that would make most of this gain chargeable at 45%, meaning a bill of up to 180,000 pounds. The total tax bill in this case would amount to some 380,000 pounds or 76% of the value of the home. Given different numbers, the double taxation could climb to 85% of an asset’s worth.

Now nobody knows precisely which taxes will be raised and in what combination. However, the tax office acknowledges that applying capital gains and inheritance taxes separately, as in the example above, would be “administratively simpler,” despite potentially producing a much larger bill.

What’s clear is that many people who might be affected by tax hikes are already cashing in their chips. Confronted with the pandemic, a potential double tax whammy and the current strength of the property market, landlords in particular are selling assets. According to the estate agent Savills, property auction sales are up 40% on a year ago. 

What does this mean for you? Well, there is now a hefty incentive to realize a capital gain prior to any rule change. So if you are sitting on a large capital gain, the U.K.’s current stamp duty holiday (a temporary relief from the tax that must be paid on any home purchase) might provide you with a reason to sell before the government gets a chance to act on the tax proposals. 

Meanwhile, if you are mulling a property purchase, it might not be such a terrible idea to bide your time. Once the short-term boom triggered by the stamp duty holiday is over, the tax-driven selling of assets is very likely to push property prices down. And first-time buyers will still get some form of tax relief even after the holiday expires. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Stuart Trow is a credit strategist at the European Bank for Reconstruction & Development. He is also a pensions blogger, radio show host and member of numerous retirement, finance and audit committees.

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