Big tax changes on way in coalition's new plans

• David Cameron and Nick Clegg hold their first joint press conference in the No 10 garden. Picture: Getty

Basic details of the initial plans were laid out in the coalition agreement this week, giving the first insight into the extent to which taxpayers will be affected by efforts to reduce the fiscal deficit.

Investors and low income earners will experience the biggest changes initially, with personal tax allowances and capital gains tax (CGT) lined up for significant reforms. Child trust funds and child tax credits also seem certain to be removed or curtailed under the new administration.

A number of previously forecast measures are conspicuously absent from the initial statements, however. The Conservatives have apparently put their proposed increase in the inheritance tax (IHT) threshold on the backburner – see our Top 10 guide overleaf for tips on mitigating IHT – while the Lib Dem "mansion tax" was also a victim of the coalition compromises. VAT was another significant omission but with the national insurance increase partly reversed it seems certain that VAT will be hiked next year, perhaps to 20 per cent to level it with much of Europe

So while details of the likely changes remain sketchy, certain measures will be implemented sooner rather than later. Here's how the anticipated changes to personal allowances and CGT would affect your finances:

PERSONAL ALLOWANCES

The planned increase in national insurance is to be partly reversed so it will apply only to the contributions paid by employees and not by businesses. This means anyone earning over 20,000 will pay an extra 1 per cent in national insurance contributions from next April.

However that may be offset by increased personal tax allowances, in accordance with the Lib Dem proposal to raise them to 10,000. This would effectively take people with incomes below 10,000 out of the tax system altogether, with the measure possibly funded by raising the basic rate of income tax.

The increase will almost certainly be phased, however, perhaps with an initial rise from the current level of 6,475 (higher for over 65s) to 7,500. Increasing the threshold to 10,000 would cost the government an estimated 17 billion, expenditure it is unlikely to countenance with a looming fiscal deficit to shrink.

If the allowance were increased to 10,000, someone earning 20,000 will save 700, while those on 30,000 should save around 600, instead of suffering a small increase in tax through higher national insurance. It is estimated that a personal allowance rise to 10,000 would benefit anyone earning less than 90,000.

However the impact depends entirely on the extent to which personal allowances are phased in. Neil Mitchell, tax partner in the Edinburgh office of accountants Baker Tilly, said an increase to 10,000 would be "easily achieved" with amendments to the basic and higher rate bands.

"Some combination of increased rates and reduced rate bandwidths could do the trick relatively painlessly and without those on higher incomes benefiting," he said.

CAPITAL GAINS TAX

CGT will almost certainly be hiked in the new administration's first Budget. If the link between CGT and income tax is restored – as expected – basic rate taxpayers will pay 20 per cent, higher rate taxpayers 40 per cent and those earning over 150,000 will pay 50 per cent tax on gains above the annual allowance, currently 10,100.

Exactly when the change takes effect is open to speculation – it could be from emergency Budget date, backdated to the beginning of this tax year or from next April. Neil Whyte, tax partner at PKF accountants and business advisers in Edinburgh, said retrospective legislation was unlikely.

"On the positive side, if the change is not imposed retrospectively, there is now a brief window of opportunity for individuals and trustees," said Whyte. "Depending on your personal circumstances, realising latent capital gains on non-business assets so that you pay tax on those gains at only 18 per cent could save you a lot of tax."

Consequently there is likely to be a surge of investors crystallising gains on long-standing gains while the 18 per cent window remains open. Jason Hollands, director at F&C Investments, said: "One strategy open to them will be to 'bed and Isa' these holdings, ie to sell them and repurchase within an individual savings account so that they utilise current annual CGT exemptions and incur any additional tax liability at the 18 per cent rate while future returns will be ring-fenced from the taxman altogether."

Investors can also take advantage of the annual 10,100 gains allowance before CGT is charged by spreading out the disposal of assets over different tax years. Married couples can use both their allowances to reduce tax by transferring assets into each others names without it being considered a sale. Similarly, any losses not previously declared can be carried forward to offset any gains, provided HM Revenue & Customs is made aware of the losses.

It is unclear if a rise in CGT would be accompanied by indexation, which is not mentioned in the coalition agreement. This was available on CGT prior to the move to the flat rate in 2007 and allowed investors to reduce gains by the degree of inflation while the asset was held. If CGT were increased without an inflation-based allowance thousands of investors would see their tax bills more than doubled, according to Fidelity International.

Gary Shaughnessy, UK managing director at Fidelity International, said: "If the coalition government goes back to a marginal income tax rate without reintroducing the indexation allowance, this could act as a significant disincentive to future investment in this country."