Inheritance Tax / Capital Gains Tax / Tax / News

What’s happening to UK tax allowances?

As assessment of the Autumn Statement continues, Peter Webb, our Head of Tax Advisory, takes a look at the effects on personal tax allowances for those in the UK tax bracket.

Ahead of the Autumn Statement the Chancellor predicted that “decisions of eye-watering difficulty lie ahead”. And although personal tax rates weren’t increased, most tax bands and tax rates were frozen until 2028. The consequence of this will effectively increase the amount being paid by UK taxpayers over the coming years.

According to the Institute for Fiscal Studies, the tax burden – the amount of tax which will be paid as a result of this Budget Statement – is likely to rise above 37% of national income; the highest it’s been for 70 years. Freezing allowances and tax bands – rather than increasing taxes over several years – is a stealthy way to hike up those bills. Indeed, Rachel Reeves, Shadow Chancellor, described this strategy as “a Conservative double whammy that sees frozen tax thresholds and double-digit inflation erode the real value of people’s wages.”

What effect will reducing the tax-free dividend allowance have?

Jeremy Hunt also took action to reduce the tax-free dividend allowance. This area has experienced particular confusion – in September Kwasi Kwarteng wanted to reduce the tax rates on dividends but we now know the existing rates (which stand at 8.75%, 33.75% and 39.35%) will continue. But that’s not all; rather than dividend allowances being frozen, the amount which can be taken without incurring a tax bill will be reduced by 75% – from £2,000 to £500 by 6 April 2024. The effect can be seen when putting that change into context; if you pay tax at 45% and receive dividends of £2,000 you currently don’t pay any tax at all on those dividends. However, in the 2024/25 tax year you’ll face £590 tax on that £2,000 dividend income.

What about Capital Gains Tax?

Jeremy Hunt said this was a Budget without rabbits – but it was very much a surprise that historically low Capital Gains Tax rates were not increased. In fact, a more duplicitous way to increase the amount of Capital Gains Tax has been designed; by aggressively reducing the annual exemption, the amount of capital gains you can make each year without paying tax is also impacted.

This means that by 6 April 2024 the Capital Gains Tax annual exemption will be £3,000, a reduction of more than 75% over the current exemption of £12,300. Understanding the effect of this is pretty stark:

Consider the sale of a buy-to-let property which would result in a gain of £20,000. Assuming you pay tax at 40% and no other gains arise in the same tax year, the Capital Gains Tax bill would be £2,156. That same event in 2023/24 will result in a tax bill of £3,920, and in 2024/25 the tax will reach £4,760. This represents an increase in tax payable of 121% from the current year.

This simple illustration doesn’t take into account the effect of inflation and the possible increase in value of the assets being disposed of. As a result, there is a real tax “double whammy” here.

What action can you take?

As always there are some steps you can take to mitigate these changes:

  1. Consider diversifying your investments against different tax rules to reduce the risk that these changes may have. For example, if you only invest in assets that produce dividends, the reduction in the dividend allowance over the next couple of years will adversely affect your net investment income – we can provide personal investment services if you require assistance with managing your portfolio.
  2. The reduction in the allowances for dividends and Capital Gains Tax will take effect from 6 April 2023 and will further reduce on 6 April 2024 so it can be helpful to take advantage of the higher allowances now, while they are still available.
  3. Ensure all family members are using their available allowances. Tax allowances are available every year for Income Tax, Capital Gains Tax, Inheritance Tax, dividend income, interest income and for investing in Individual Savings Accounts. Given the changes it’s even more important to ensure all available allowances and lower rate tax bands are being made use of every year.
  4. Capital Gains Tax rates are at historic lows so it may be worth considering whether now is the time to take gains out of your investments, especially given that Capital Gains Tax rates may become a target in the not too distant future.

To discuss any aspect of your tax planning, please contact your nearest office.