Our content in this article:
- Value Added Tax (VAT) and Private Schools
- Capital Gains Tax
- Income Tax Thresholds
- Non-UK domiciled individuals – Reform of ‘Non-Dom’ Taxation
- IHT to include the reform of BPR and APR
- IHT Thresholds
- Changes to IHT treatment of Pensions
- IHT BPR and APR
- SDLT rate increase for Second Home Owners and Companies
The issue of non-doms (broadly speaking people who live in the UK but whose permanent home is elsewhere) was covered (103 pages of draft legislation on the abolition of the non-dom regime being published) together with good news (to a degree) about the length of time during which inheritance tax ("IHT") will continue to apply to long term residents who leave the UK.
There were other key points including IHT reliefs are to be changed to include caps on the amounts than can be relieved under both Business Property Relief ("BPR") and Agricultural Property Relief ("APR") (with effect from April 2026), Capital Gains Tax ("CGT") rates are to be increased and an unexpected change with the 2% increase in the Stamp Duty Land Tax ("SDLT") surcharge for people buying buy to lets and second homes.
Much has been made of the ‘black hole’ in the UK’s finances that Labour is saying they inherited from the Conservatives. It remains to be seen whether the measures announced by the Chancellor will make much of a difference in terms of addressing the shortfall. Below we set out and discuss the main points and changes that specifically apply from a private capital/client perspective:
Value Added Tax (VAT) and Private Schools
The Government had announced on 29 July 2024 that VAT would be charged at the standard rate of 20% on school and boarding fees for school terms starting on or after 1 January 2025. The measure was confirmed in the Budget. VAT will not be added to fees charged for classes where all children are below compulsory school age. In addition, it was confirmed that business rates charitable rate relief will be removed from private schools in England from April 2025 through the introduction of new legislation.
The measures announced in the Budget confirmed that any pre-payments of fees or boarding services made on or after 29 July 2024 that relate to terms starting after 1 January 2025 will also be subject to VAT at the standard rate.
These measures will have significant impact on private schools, with not only an additional tax cost, but a new administrative burden. There will also be an impact on local authorities and devolved governments if they fund any private school places as these places will also be subject to VAT. However, the Government has said these authorities will be able to reclaim this VAT from HMRC or the Government will increase the funding to where the authorities fund a pupil's place at a private school because the pupil's needs cannot be met in the state sector. HMRC issued guidance on 10 October 2024 in relation to the charging and reclaiming of VAT on goods and services related to private schools.
HMRC has indicated that VAT will be chargeable on the total value received, including amounts paid by parents and external bursaries, and will cover all goods and services provided by the school. The guidance covers where education is supplied with other elements such as school meals and transport, welfare services, bursaries, grants, charities and supplies provided in classrooms or closely related to the supply of education. There is also guidance on schools buying in travel services and operation of the Tour Operators Margin Scheme.
Some schools have already indicated that the removal of the VAT exemption and changes to charitable business rate relief, together with the increased employers' national insurance contributions, will result in severe financial difficulties with the possibility of school closures, especially for smaller specialist and religious schools. In addition, concerns have been raised by boarding and international schools with many warning international pupils schools will not attend without financial support.
While the addition of VAT to fees is disappointing for many schools and parents, we have also been considering whether there will be any benefits for schools, and specifically whether schools will be able to make claims to recover VAT input tax they incur, not only on new capital projects but also on historic capital projects (generally those incurred within the last 5-10 years) and to recover pre-registration input tax.
HMRC's guidance confirms that there will be the possibility of belated recovery of VAT in respect of earlier capital projects and also recovery of input tax on goods and services purchased prior to VAT registration. HMRC anticipates that private schools are likely to be making both taxable and exempt supplies and so will fall within the partial exemption rules and any associated recovery will be subject to these rules. Capital expenditure recovery will be subject to the Capital goods School rules and the partial exemption rules where applicable.
What is clear is that the VAT charging and recovering position of private schools will be complicated and private schools, like other commercial businesses, will be subject to the full breadth of the VAT legislation and will need to review their own individual positions and take proper advice. There may be some opportunities for schools to consider its fee structures and specifically what goods and services are covered by the fees to maximise their VAT liability and recovery positions.
Capital Gains Tax
An increase in the rates of CGT paid by individuals and trustees (to include personal representatives dealing with the administration of a deceased person’s estate) was widely expected, given that the Government was silent on it in its election manifesto. CGT is paid on any gain arising on the disposal of capital assets, subject to certain exemptions, such as for your main home, and an annual £3,000 allowance.
The lower rate of CGT has increased from 10% to 18%, and the higher rate of CGT has increased from 20% to 24%. The rate of CGT that applies to Trustees and Personal Representatives has increased from 20% to 24%. These rates now match the CGT rates for disposals of residential property. The rate increases take effect from Budget Day, and so apply to disposals on or after 30 October 2024. We expect that there are plenty of relieved sellers who completed their sales late on 29 October.
Sellers should note that the Government will introduce anti-forestalling rules that apply to unconditional, but uncompleted contracts, that were entered into before 30 October 2024. To benefit from the "old" rates of CGT, parties to such contracts must prove that:
- They did not enter into the contract for sale and purchase for the purpose of taking advantage of the rules that deem a disposal to occur when a contract becomes unconditional, rather than at the date of completion; and
- if the parties are connected, they must be able to demonstrate that contract was entered into for commercial reasons.
There will also be changes to the CGT reliefs of Business Asset Disposal Relief (“BADR”) and Investors' Relief (“IR”). The rates of CGT applicable to both reliefs will increase from 10% to 14% from 6 April 2025, and then to 18% from 6 April 2026. The lifetime limit for IR will also be reduced to £1 million for all qualifying disposals made on or after 30 October 2024, bringing IR in line with BADR.
The increase in rates of CGT is, on the face of it, not as dramatic as expected. Prior to Budget Day, there was speculation that the increases could go as far as equalising the CGT rates with the rates of income tax, i.e. up to 45%. The Office for Budget Responsibility forecasts that this package of changes will raise an additional £90 million this tax year rising to £2.5 billion per annum by 2029/30 – this is due to the fact that a relatively small proportion of the population (369,000 people in 2022/23) pay CGT. Together with the other major tax rises announced in the Budget, CGT is likely to be viewed a just one of a number of tax rises in the biggest tax-raising Budget since 1993.
The anti-forestalling measures set out above should be considered carefully. Sellers should take advice if they are unsure whether their pre-Budget sale falls within the old CGT rates, and also if they are considering a capital disposal during the remainder of this tax year.
Income Tax Thresholds
Income tax thresholds for England, Wales and Northern Ireland will be increased in line with inflation from April 2028. The thresholds are currently frozen until April 2028 (a policy announced by the previous Government in the Autumn Statement in 2022). The last increase to the threshold for basic and higher rates of income tax was in April 2021. This commitment will end the practice known as "fiscal drag" from April 2028 whereby the tax receipts are increased by virtue of increasing numbers of people being "dragged" into either paying income tax or paying a higher rate of income tax. The fiscal drag will still be a factor until then.
Non-UK domiciled individuals – Reform of ‘Non-Dom’ Taxation
The Government is moving ahead from 6 April 2025 with its existing plans (inherited from the previous Government) to abolish the existing "non-dom" tax regime for those tax resident in the UK, but domiciled abroad.
We have discussed these proposals in more detail here and the new "Foreign Income and Gains" ("FIG") regime, according to the recent Budget, will mostly be introduced as expected.
As expected, the Government intends to build on the previous Governments proposals by scrapping the "soft landing" of the 50% reduction in foreign income subject to tax in the tax year 2025 to 2026.
The new regime will only apply to income and gains arising after 6 April 2025. Former remittance basis users will still be subject to UK tax on non-UK income and gains arising before then and remitted to the UK. The government is seeking to drive a significant repatriation of wealth into the UK by applying this as a reduced rate of 12% for the next two years and 15% for the year after that.
Further, and potentially more materially for many existing non-doms, the Government is moving ahead with its plan to replace the existing non-dom inheritance tax system with a residency based system. Individuals will be subject to UK inheritance tax on all assets (UK and non-UK) if they are tax resident in the UK for at least ten out of 20 years prior to death. From 6 April 2025, the Government also intends to remove the inheritance tax exemption for certain non-UK property settled in trust while the settlor was a non-domicile. This could make some existing trust arrangements ineffective.
These changes amount to a fundamental change to how the UK's residency rules work for individuals and will have a large impact. It will simply no longer be possible to live in the UK long term and accrue large untaxed gains offshore. It remains to be seen whether the temporary repatriation facility will drive wealth into or out of the United Kingdom on a net basis.
The Government's proposals are complex and detailed and more complexity can be expected once draft legislation is introduced. Anyone currently living or intending to live in the UK who is not already domiciled here, should take detailed advice on their tax affairs and the DWF Tax and Private Capital team is well placed to assist.
IHT to include the reform of BPR and APR
It was anticipated that the Chancellor would make fundamental changes to IHT in the Budget. There were no changes to the rules around lifetime gifts, taper relief rates or capital gains tax on inherited assets as had been widely expected. Nevertheless, the changes which were announced were significant and has been predicted that as a result of the changes the number of families paying IHT will double by the end of the decade.
IHT is a deeply unpopular tax. Many people resent paying it because it is essentially a tax on income and gains which have already suffered tax and therefore people see it as a form of double taxation. Whilst the existing thresholds and the headline rate of tax remain the same, this measure will nevertheless result in more people being dragged into the IHT net. According to the Chancellor, only 6% of estates currently pay IHT on death, but that is up from 4% not so long ago as a result of increased asset values and rising house prices and IHT allowances which have not kept pace with inflation. According to HMRC, the amount of IHT collected between April and August this year was £3.5 billion, which is £0.3 billion higher than in the same period last year, and the total IHT take for the tax year 2024-2025 is predicted to be £8 billion.
IHT Thresholds
The current IHT thresholds/nil rate bands will remain in place until 2030. The Transferable IHT Nil Rate Band (the unused IHT nil rate band that can be transferred from a pre-deceased spouse’s estate), the IHT Residential Nil Rate Band (RNRB) and the Transferable IHT Residential Nil Rate Band (TRNRB) will continue to be available when a house is inherited by direct descendants. There will continue to be a claw back of the RNRB at a rate of £1 for every £2 where the net value of an estate exceeds £2million.
The current IHT Nil Rate Band is £325,000. The TNRB can be up to £325,000 (depending on the unused percentage that is available for transfer). The RNRB is currently £175,000. The TRNRB can be up to £175,000 (depending on the unused percentage that is available for transfer).
Changes to IHT treatment of Pensions
From 6 April 2027 onwards there will be changes to the IHT treatment of pensions that are inherited – broadly speaking:
- Unused pension funds will become part of an estate for IHT purposes and be liable to tax.
- Any IHT due on pensions will be paid from the pension fund itself.
Currently, pensions held in trust fall outside the scope of IHT and these changes will undoubtedly a) increase the number of estates that are liable to IHT; b) act as a disincentive to some people from accumulating wealth in a tax-free manner within their pension; and c) generally crack down on pensions being used for tax planning purposes (as they currently are).
Most UK pensions schemes are discretionary schemes so that, under the current rules, when a person dies any unused pension fund or lump sum death benefits in their scheme do not form part of their estate for IHT purposes. This means that pension scheme members can pass on these funds to their nominated beneficiaries after their death free of IHT. When the beneficiaries access the pension fund, they pay income tax at their marginal rate if the member died age 75 or over. If the member was under the age of 75, there is no income tax to pay unless it is a lump sum taken more than two years after death.
However, the Chancellor has announced that with effect from 6 April 2027 all that will change. Any unused pension funds will be included in the value of a person's estate for IHT purposes and to the extent that the available IHT allowance is exceeded potentially be taxed at up to 40% unless left to a surviving spouse or civil partner. This is regardless of whether an individual dies before or after the age of 75.
If on death a person's assets and any unused pension funds exceed the available IHT allowances, an IHT charge will arise which will be apportioned between the individual's estate and the pension fund.
The pension fund trustees will apparently be expected, within six months of death, to calculate the IHT payable on the pension fund and to pay it directly to HMRC from the pension fund. This is to prevent withdrawals being required (and possibly taxed) to pay the IHT. The Government has launched a consultation on how this change will work, as experts have already warned that it will be a complicated process to administer.
What is left after the payment of IHT can then be paid to the nominated beneficiaries. However, if the scheme member dies over the age of 75, the beneficiaries will still be subject to income tax at their marginal rate, potentially resulting in a double charge to tax due to the interaction between IHT and income tax.
The measures reverse the decision taken by George Osborne in 2015 to exempt pension funds from IHT. The Government said that the aim of the measures is to make the IHT system fairer and to prevent pensions being used as a tool for IHT planning as they are currently.
Combined with the continued freeze on IHT thresholds, the measures will significantly increase the IHT burden on taxpayers with relatively modest estates but substantial pension savings who have, until now, expected their pension savings to be outside the scope of IHT. It is also likely that the measures will result in a significant number of estates being pushed over the £2m taper threshold causing the £175,000 residence nil rate band to be withdrawn.
It is also likely that the measures will lead to a change in taxpayer behaviour by encouraging taxpayers to withdraw funds from their pension during their lifetime, in priority to their non-pension savings, leaving their beneficiaries to inherit their non-pension assets rather than suffering income tax on withdrawals from the pension fund. The measures may also encourage taxpayers to withdraw funds from their pension in order to make more generous gifts during their lifetime.
IHT BPR and APR
Significant reform of BPR and APR has been announced. Changes and points to note as follows:
- There will be an extension to APR (from 6 April next year onwards) to include land managed under an environmental agreement with the UK government, devolved governments, public bodies, local authorities and approved responsible bodies.
- 100% relief to remain on combined business and agricultural property up to a value of £1 million. Qualifying business and agricultural assets worth more than £1 million will attract relief at 50% equating to an effective rate of IHT of 20%, up from 0% currently.
- The changes do not affect assets which already qualify for APR or BPR at 50% and these assets will not use up any of the £1 million allowance.
- The £1 million allowance will effectively be a lifetime allowance covering an individual's estate on death, failed gifts in the 7 years before death and lifetime transfers into trust. Any unused allowance will not be transferable between spouses.
- The £1 million allowance will apply to trusts and there will be a consultation in early 2025 on the detailed application of the changes to qualifying business and agricultural property held within trusts. Where a settlor has settled multiple trusts before 30 October 2024, each of those trusts will have its own £1 million allowance. However, the government has announced that it intends to close this loophole going forward by announcing that, where an individual settles agricultural or business property into multiple trusts on or after 30 October 2024, the £1 million allowance will be split between the trusts, although it is not yet clear exactly how this will work.
- The new rules will also apply to lifetime transfers on or after 30 October 2024 where the donor dies on or after 6 April 2026 to prevent forestalling.
- Reduction in the rate of BPR to 50% on shares not listed on the markets of recognised stock exchanges, eg. Alternative Investment Market shares (again equating to an effective IHT rate of 20%). This change will come into effect from 6 April 2026.
This is a significant reform and the changes will undoubtedly increase the IHT payable by a substantial number of business owners, landowners and farmers. It is a good idea for business owners to now look at and review their succession/tax planning to be sure that their business can cope with the increased IHT liability from April 2026 (e.g. this may mean looking at life insurance when previously they didn’t need to and also tightening budgets to set aside sinking funds). Planning needs to be undertaken as early as possible with there being potential for looking to fragment ownership of businesses and move assets out of a person’s estate (e.g. spreading ownership across the family) ahead of a potential IHT charge on death.
It seems that the best route for planning now may be to examine carefully corporate governance and partnership agreements, family constitutions and potentially bring in family members to hold shares of businesses, thus spreading IHT risk.
SDLT rate increase for Second Home Owners and Companies
The Government announced a 2% increase in the rate of SDLT for second homeowners and company purchasers of residential property.
For transactions with an effective date on or after 31 October 2024:
- Increase from 3% to 5% (above the standard residential rates) in higher rates of SDLT payable by people buying additional dwellings. Transitional rules may apply for instances where contracts have been exchanged prior to 31st October but completion is after that date. It seems clear that the Government is implementing this increase to make sure that people who are looking to move home or purchase their first property have an advantage over landlords, buyers of additional homes and businesses who purchase residential property who will all now pay 5% more in SDLT.
- Increase from 15% to 17% to the single rate of SDLT payable by companies acquiring dwellings for more than £500,000.
From 1 April 2025, there will be an increase of 1.7% in the Annual Tax on Enveloped Dwellings ("ATED") annual charges.
