5 really bizarre tax rules and the reasons why they exist
Following the increase in National Insurance contributions (NICs) in May 2022 and the chancellor’s “temporary” windfall tax on energy firms, taxation has featured heavily in 2022’s headlines.
According to the Telegraph, British taxpayers are paying more to the Treasury than ever before, so much so that the tax burden could reach the highest levels since the 1940s next year.
As a result, you might be inspecting your taxes more closely in a bid to reduce your liability. If you are and would like information on the tax changes of 2022/23, and how financial planners could help you be more tax-efficient, read our informative blog.
If you have been looking at tax rules more closely recently, you might have been struck by two things: taxation is extremely complicated, and there are some very bizarre rules. Some are so strange that you might be left wondering where they originate from and why we still have them today.
If so, read on to discover five of them and why they still exist.
1. 25% tax-free lump sum from pensions
This rule dates back to 1909 and the civil service. At the time, civil servants lobbied for their pensions to have the same perks as the railway pension scheme, which provided a tax-free sum for widows. As the Inland Revenue is a civil service, it was extremely keen to help and so supported the request for parity.
That said, the 25% tax-free lump sum was not granted to private schemes until 1970, when schemes typically started to benefit from the relief.
It’s said that while acting as chancellor, Nigel Lawson tried to abolish it but failed, later saying that it was because he had faced the “most astonishing lobbying campaign” of his political career.
2. Living for 7 years before gifts escape Inheritance Tax (IHT)
In 1975 the Labour government introduced Capital Transfer Tax (CTT), which was exceptionally severe at the time. As all gifts made during someone’s lifetime was liable to the tax, barring a few exceptions, there was no time limit for gifts.
This created a serious headache for the Inland Revenue as this meant it had to keep records for the lifetime of taxpayers. It caused so many problems that HMRC asked the government to introduce the seven-year rule that is now in existence.
This means that if you gift using the potentially exempt transfer (PET) rule, which allows you to gift any amount to anyone, you need to live for seven years for it to fall outside your estate. If you don’t, your estate might be liable to IHT on a sliding scale, depending on how long you lived for and what other gifts you’ve also made.
3. Lower tax rates for dividends
In the 1960s companies typically raised money through borrowing, not from shareholders. One reason companies favoured this was that they received tax relief on interest payments.
Then, in 1972, “Advance Corporation Tax” (ACT) was introduced that effectively provided companies with tax relief on dividends paid out. This made raising money through shareholders a more attractive way for companies to generate funds, until in 1997, when the then chancellor Gordon Brown scrapped ACT.
Today Dividend Tax rates remain below Income Tax rates, although there does not seem to be any reason for this. Following the increase in rates in the 2022/23 tax year, dividend rates stand at 8.75% for basic-rate taxpayers, 33.75% for higher-rate taxpayers and 39.35% for additional-rate payers.
4. Use of family home to help reduce Inheritance Tax
In 2007, George Osborne was shadow chancellor and stated that, if the Conservatives returned to power, they would increase the IHT threshold to £1 million. At the time he said it would “take the family home out of IHT”.
What he had not accounted for was that, by 2010 when he became chancellor, the economic situation had changed vastly thanks to the economic crisis of 2008.
As such he had to abandon his pledge, and instead introduced the £175,000 “residence nil-rate band”, which was effectively a watered-down version of the original promise.
5. You must sell your home in 9 months to avoid Capital Gains Tax
If you buy another home while still owning your existing one, you have nine months to sell the latter before you become liable to Capital Gains Tax (CGT).
As this could result in an 18% or 28% CGT tax bill depending on your tax rate, it could significantly reduce the amount you’re left with after the sale.
Up until the MPs’ expense scandal of 2009, you would have had three years to sell your home, which in a less buoyant market could significantly reduce your chances of facing a CGT liability. But when it emerged that MPs were misusing the three-year rule to benefit from CGT relief on their London and constituency homes, the relief was reduced to nine months.
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As you can see, the British tax system has its fair share of unusual rules. While this could help you reduce your tax liability, care needs to be taken to ensure you don’t accidentally breach them and end up with an unexpected and potentially significant tax liability.
A financial planner could help you better understand the UK tax system, and take into account your wider wealth to ensure you’re as tax-efficient as possible.
If you would like to discuss ways to use bona fide tax breaks and other tax rules to reduce your tax liabilities, please give us a call on 0800 434 6337. We’d be happy to help.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.