Prepare now for potential rise

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Alec Stewart

With only 49 days until the new Chancellor, Rachel Reeves, delivers her first Budget statement, we await what is expected to be a “painful” announcement. Detail as to where this pain will be felt is not yet known, however, there have been assurances that income tax, National Insurance and VAT will remain untouched.

This dramatically narrows the number of taxes which seem likely to rise, particularly as it is felt that those with the broadest shoulders “should bear the heavier burden”. With other taxes safeguarded, capital gains tax (CGT) and inheritance tax (IHT) will struggle to hide from the inevitability of increases.

All of this offers a small window of opportunity to reconsider how assets/investments are held and enjoyed. Unlike so many other countries, the UK has always enjoyed the predilection for drawing primarily on income, and making sure that capital is preserved at all costs, which possibly comes with a sense of being a longer-term “custodian”.

When it comes to assets like land and buildings, this may be the only option – it is difficult to receive an income from land and pocket any growth in capital value at the same time. However, other assets, such as stocks and shares, should not offer the same dilemma. For too long, many have held their investments, taking only the dividend income whilst watching the capital grow. This ignores two crucial truths:

1. Dividend tax rates, on income, are higher than CGT rates (and the annual exemptions lower). Therefore, the traditional “capital custodians” who are focussed exclusively on drawing income year on year have been doing so at increasingly disadvantageous tax rates;

2. This approach remains out of step with the rest of the world where markets (larger than those of the UK) invariably offer very little by way of dividend income. Other markets and investors have commonly understood the impact of taxation on overall or “real return” for investors. Furthermore, one must assume that those encouraged to retain the capital and live off the income are happy to invest in the narrower sectors that offer dividends, possibly excluding the much larger, highly diversified and potentially profitable, investment areas enjoyed by the rest of the world.

As the Budget looms, some should ponder on whether the “income taking/capital custodian” approach offers the best outcome.

Who benefits from the traditional approach? Possibly the financial markets and advisers who take a percentage of the capital on an annual basis? Certainly the tax authorities which levy the higher rates of dividend tax for many, and await a larger tax uplift with IHT on the capital (or, at the very least, an uplift in CGT on the gain as anticipated in the Budget).

For many, now might be the time to reconsider how they really benefit from their assets. With CGT rates so much lower than those levied on income it might be a good time to crystallise the gain. Custodians wishing to pass assets on to future generations might consider extending their generosity by passing assets with lower future tax bills. Admittedly, this could create a tax liability in the short term, but any liability now is likely to be much less than that in the future.

It may also encourage some to wean themselves away from a ‘focus on income generation’, to one of overall real return (ie, a mixture of capital growth and income, after tax and costs), offered by a broader and, frankly, larger market. Of course, it is always possible that tax rates may go down, but as any investment mantra tells us, things are likely to go up over the longer term.

Murray Beith Murray LLP Private Client Partner, Alec Stewart, is a solicitor in Scotland & England/Wales and is authorised to provide financial advice.

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Murray Beith Murray LLP is at 3 Glenfinlas Street, Edinburgh EH3 6AQ