Taxing times

Even before the Covid-19 crisis, the personal tax landscape was facing an overhaul. Now, that's almost guaranteed. Financial planners have a challenge and an opportunity ahead of them
by Paul Bryant


Pre-Covid-19 political events in a number of countries saw wealth taxes, capital gains taxes (CGT) and inheritance taxes (IHT) enter mainstream policy discussions. But as governments all over the world contemplate how they will pay for pandemic spending, tax changes have moved closer to implementation.

Here we examine possibly imminent changes to the tax landscape, and how financial planners might react, or even prepare in advance for them.

A jump to the left

As 2019 unfolded, in the US – traditionally one of the strongest proponents of low taxes, small government, and encouraging and celebrating wealth creation – the wealth-tax debate moved out of far-left political fringes and into mainstream politics.

Two of the highest-profile Democratic Party presidential candidates, Bernie Sanders and Elizabeth Warren, both featured significant wealth taxes prominently in their manifestos. Sanders proposed a charge of 1% on wealth above US$32m, increasing in increments to an 8% charge on wealth above US$10bn. Warren's proposal was to charge 2% on wealth above US$50m, and 6% above US$1bn.

Later in 2019, the UK also saw the tax debate shift in a similar direction in the lead-up to a December general election. And the noises came from all political sides.

The Labour Party promised to raise income taxes on those earning more than £80,000 per year (although it didn't specify a rate) and alluded to raising CGT rates as well. Its 2019 manifesto states: "We will end the unfairness that sees income from wealth taxed at lower rates than income from work." The Liberal Democrats had a similar CGT policy. And the Conservative Party promised to cut tax breaks such as Entrepreneurs' Relief (a reduction on CGT when selling a business) – which it has subsequently delivered upon. Strict clampdowns on tax evasion and avoidance were a near-ubiquitous theme.

Following the election, in February 2020, there were even reports that the Conservative Party was seriously looking into introducing a 'mansion tax' – a tax on the value of high value homes.

Now, in mid-2020 in the wake of eye-watering spending by both the UK and US governments on fighting and reducing the impact of Covid-19, some of the tax ideas of Sanders, Warren, Labour and the Liberal Democrats are lingering, even though they lost their respective political races.

According to Michael Goodman CFP®, founder and president of New York-based Wealthstream Advisors, there is an "extremely high likelihood" that taxes for the wealthy in the US will rise, regardless of which party secures a majority in the November elections, because Covid-19-related programme costs need to be covered. "There is no other way to pay for the trillions of dollars, and to cover lower-than-expected tax revenues – payroll taxes are going to be lower than budgeted as a result of increased unemployment, decreased working hours, or people taking pay cuts," he says.
James says that personal taxes, seen by governments as "low-hanging fruit", are likely to bear much of the burden of paying for this deficit

Michael predicts realistic scenarios in the US of personal income tax rates rising for higher earners; the difference between CGT and income tax rates reducing or being eliminated; and increases in estate (inheritance) taxes. James Mohide, senior tax manager at CISI-Accredited Financial Planning FirmTM Paradigm Norton, sees a similar situation playing out in the UK because of the "huge jump in the country's budget deficit". The Office for Budget Responsibility's recent estimates, released on 14 July 2020, state the direct impact of new policy measures on the budget deficit in 2020/21 to be £192.3bn.

James says that personal taxes, seen by governments as "low-hanging fruit", are likely to bear much of the burden of paying for this deficit. According to the HMRC tax and national insurance contribution (NIC) receipts for 2019/20 (as of May 2020), UK tax receipts totalled £635bn, with the largest contributors being income tax at £194bn (31% of the total), NICs at £143bn (23%), VAT at £130bn (21%), followed by a big drop down to the £61bn (10%) received from corporation tax.

But James thinks two of the smaller contributors to personal tax receipts – CGT and IHT, which contributed £9.9bn and £5.1bn in 2019/20 respectively – are most likely to see changes, as opposed to income tax, NIC, or VAT, because the UK additional (top) rate of income tax is already at almost 50% (45% plus 2% NIC). He believes this is the level "at which you start walking through a political minefield – people don't like the notion that they are taking home less than the exchequer." Plus, he adds, standard rate VAT is "reasonably high" by international standards, with the temporary cuts announced in July for the hospitality sector seemingly demonstrating that an upwards trajectory appears unlikely.
"I can see the government targeting a substantial increase in revenue from inheritance or gift taxes in the coming years"

Echoing Michael's thoughts regarding the difference between CGT and income tax rates reducing, James says that raising CGT in the UK appears an "easy win" because of the "disparity between income tax rates and CGT rates, and with the current government already having reduced Entrepreneurs' Relief, it certainly shows that CGT tax reform is on the agenda". James continues: "This is likely to pique the interest of financial product providers and planners, with the CGT deferral relief available on Enterprise Investment Scheme subscriptions, and reinvestment relief available for Seed Enterprise Investment Scheme subscriptions, becoming much more valuable against the backdrop of potential CGT rate increases. But there are of course investment risks to consider here."

With regards to IHT, James's other likely candidate for reform, he says: "I can see the government targeting a substantial increase in revenue from inheritance or gift taxes in the coming years. It also looks like there is some political will behind this. Just look at the level of detail in the January 2020 All-Party Parliamentary Group (APPG) report Reform of inheritance tax." Mansion tax could also be a consideration, he adds, but ultimately there is a lag here with actual tax receipts.

The APPG report offers some insights into how these reforms might pan out. It recommends replacing the current IHT flat rate of 40% and system of reliefs, with a 10% (possibly increasing to 20% for estates over £2m) rate payable on lifetime and death transfers, replacing the concept of potentially exempt transfers with a £30,000 annual gift exemption. The report says: "The key principle is that it should be low enough for the tax to be broadly based without the need for complex reliefs. A flat rate gift tax with fewer reliefs would be simpler, more broadly based, lead to less avoidance and ensure the UK's competitiveness in attracting wealthy people to live (and die) in the UK."

Financial planners respond

Despite having views on the most likely changes to taxes, both Michael and James stress that there is simply no way to know for sure and that financial planning cannot be based on predicting these changes.

Mike Aitken, chair of Magus Private Wealth, a UK wealth management and financial planning firm, echoes this warning. He believes that building in speculative changes to taxes into the firm's financial planning process is unrealistic, as there are many variables built into a financial plan already. "Do I factor in a 2%, 5% or 10% income tax increase? When do I do this? Do I make a guess about a future CGT rate? It just doesn't make sense to do this, so we tend to use the tax environment as it stands today, and then adapt our plans when changes are actually made," he says.

But tax 'diversification' is certainly a strategy financial planners use to respond to this challenge. Mike says: "It's a bit like an investment portfolio, which you want to be diversified to spread risk. You also want to be diversified from a tax perspective. This entails investing assets using different tax 'wrappers', such as individual savings accounts, general investment accounts (GIAs), pensions, offshore bonds and the like."

One of the advantages of doing this is that clients are not heavily impacted by a sudden change to one tax rate or rule. This is a big risk in some cases, particularly with CGT, where (in the UK at least) changes often come into effect the day after they are announced.

Another is being able to quickly 'turn up' or 'turn down' the relative use of these wrappers as their tax advantages or disadvantages change. Mike says that GIAs are relatively tax-efficient, as they're taxed at CGT rates, so can play a part in the tax-free CGT allowance. However, he says, offshore bonds were popular (pre-April 2008) as some income fell within a tax-free allowance, therefore delaying paying income tax, in some cases after retirement, when most people fall into a lower tax bracket.

Michael Goodman says that because of the uncertainty in the tax environment in the US, this tax-timing element of diversification has become very important – a strategy he calls 'laddering out your risk'. This is particularly relevant when it comes to retirement accounts – most commonly 401(k) plans (similar to workplace pensions in the UK), and individual retirement arrangements or IRAs (similar to self-invested personal pensions or SIPPs in the UK).

He describes the above retirement accounts as buckets of pre-tax dollars, with tax only being paid on withdrawals. But with such a high likelihood of future tax rises, there is an argument in favour of 'accelerating' tax payments if income is likely to increase by withdrawing more than the minimum required from these accounts, effectively locking-in today's tax rate on those withdrawals.

In the UK, trusts are a tool that financial planners often use for IHT planning. But, says James, over the past decade or so, these have faced increased scrutiny, from both a tax perspective (they are usually subject to tax at the additional rate) and a compliance perspective (with the introduction of the Trusts Registration Service).
"Some have found the stay-at-home experience positive and are keen to stop work earlier"Despite this, James says, "They can still form part of an effective tax planning strategy including where business assets are settled into the trust, nil rate bands are used, or where protection and control are a key issue." For example, if a parent wants to transfer assets to a child, but doesn't want them at risk, such as may be the case in a divorce, they could be held in the trust and not in the personal capacity of the child. Similarly, if the parent isn't convinced the child will be a responsible custodian of the assets at that point, they can be held in trust with the child as the beneficiary but 'controlled' by more responsible trustees.

James continues: "Planners should also be mindful of the additional administrative costs of running a trust, and the make-up of assets within the trust, as these can quickly absorb tax savings."

Robert Reid CFPTM Chartered MCSI, managing director of UK-based Syndaxi Financial Planning, says that the Covid-19 crisis has resulted in a unique period of opportunity for financial planners, as clients want to plan more in-depth than previously. He says that pre-Covid-19, it was difficult to get clients to engage with issues such as tax wrappers and IHT planning, but now he is seeing a change in engagement. Lockdown, he says, may have given some people a glimpse into their retirement, and beyond.

He explains: "Some have found the stay-at-home experience positive and are keen to stop work earlier. So, we might field questions about if more efficient tax planning can help them do that. Others have been bored stiff at home and realised a sudden transition from working to retirement won’t suit them. That leads to a different conversation about exactly what they want to do in semi-retirement, what the financial implications are, and what the optimum financial (including tax) plan might be."

Dangerous potholes

Robert says that taxation is something his firm always looks at with clients. However, he expresses caution, too. "As financial planners, we need to be very conscious that what we do is financial planning, not full-on taxation advice, and we should certainly not stray unintentionally into the grey area of tax avoidance." He stresses that legitimate tax planning is getting more complicated to manage, citing disclosure of tax avoidance schemes as one of the things to be conscious of, where persons promoting or providing information about tax planning schemes could be determined to be contributing to tax avoidance. To make matters worse that may only be discovered once they have disclosed details to HMRC.
"If you are doing something that is within the letter but not the spirit of the law, you can be tried in the court of public opinion"

Also, says James, tax planning nowadays is being done in a totally different context compared to ten years ago, when there was a clear distinction between tax evasion, which was illegal, and tax avoidance, which was legal. "We have had a shift towards a position of 'you should be paying a fair amount of tax'. And if you are doing something that is within the letter but not the spirit of the law, you can be tried in the court of public opinion. And that’s not where you or your clients want to be," he says.  

For financial planners, it is going to be interesting but testing times. Clients will face higher tax bills, and possibly be presented with opportunities to cut corners. Financial planners need to be the providers of balance – building tax efficiency into their plans, but not letting the tax tail wag the investment dog.

Seen a blog, news story or discussion online that you think might interest CISI members? Email
Published: 29 Jul 2020
  • Financial Planning
  • Wealth Management
  • US election
  • US
  • Trusts
  • Tax
  • Pensions
  • inheritance tax
  • financial planning
  • CFP
  • capital gains tax

No Comments

Sign in to leave a comment

Leave a comment