An iron chancellor selects his targets

Labour promised not to raise income tax, but there's more than one way into our pockets. Clifford German looks at the choices

The Chancellor could easily raise the top rate of capital gains tax and inheritance tax above 40 per cent without breaking new Labour's commitment to keep income tax rates unchanged, says Tim Johnson, the winner of the Planned Savings IFA of the year award for 1997 and business development manager for R K Harrison, a firm of independent financial advisers.

Gordon Brown is already under pressure to show his willingness to raise taxes to support his own claim to be an iron chancellor. New rules on Capital Gains Tax (CGT) and Inheritance Tax (IHT) could be introduced within weeks as part of the interim Budget originally planned to implement the windfall tax on excess profits of privatised utilities, Mr Johnson believes.

Relatively few people currently pay IHT or CGT and soaking the rich minority could pay political dividends by placating what is left of old Labour without antagonising new support in middle England. Better still for a hard-pressed chancellor, changes to IHT at least could be made effective immediately.

Inheritance Tax

Apart from raising the top rate on inheritance tax the Chancellor could reduce the starting point for the tax that Kenneth Clarke, the former chancellor, raised to pounds 215,000 only a few months ago. Another specific possibility would be a proximity tax, levying tax at lower rates on lifetime gifts and bequests to children, medium rates on gifts and bequests to other relatives and higher rates on transfers to unrelated people.

Other measures to plug loopholes could include tightening the concession that progressively reduces tax liabilities on gifts made between one and seven years prior to death. Restrictions on so-called interest-in-possession trusts that allow individuals to transfer assets but retain an interest in the income are also a possibility.

Liability to IHT is triggered by death so any changes in the rules could have an immediate effect on tax liabilities. Anyone with taxable assets of around pounds 200,000 might be well advised to seek immediate advice on whether a trust is a suitable vehicle.

Creating trusts is widely perceived by ordinary people as complicated, restrictive and expensive, and only suitable for individuals with liquid assets such as cash and shares, Mr Johnson admits.

But there are a number of insurance companies willing to set up eligible trusts free of charge for investors who invest trust assets with them. Scottish Equitable International is one of several companies which specialise in interest-in-possession trusts.

Capital Gains

The combination of record share prices and a surging housing market is creating potential liabilities to capital gains tax that a Labour chancellor might find too tempting to pass by. Possible measures include the abolition, reduction or freezing of the current annual exempt allowance of pounds 6,500 worth of gains, an increase in the top rate of CGT, and differential rates on long-term and short-term gains, together with the abolition of the indexation allowance on gains made since 1982, which requires increasingly complex calculations.

Legislation is not likely to be applied to gains already realised and that means anyone with large potential gains should consider doing bed- and-breakfast deals between now and the likely Budget date on 10 July. This involves selling assets such as shares and buying them back at a modest cost in dealing charges as a way of fixing a new and higher base for calculating further gains in the future.

Savings

The government is unlikely to want to undermine savings, partly because so many of its new supporters now have substantial assets, partly because the state of the economy requires more savings rather than more consumer spending. Yet only Premium Bonds and Pensioners Bonds are attracting money into National Savings, so a new range of more attractive fixed-rate products and, in particular, a new issue of savings certificates seems an obvious priority.

Tessas And Peps

The Chancellor might also consider raising the limit on the Tax-Exempt Special Savings Account, or Tessa, which has been unchanged on pounds 9,000 since they were first introduced in 1991. Many investors are now up against the limit and cannot invest any more. Tessas have been overtaken by Personal Equity Plans (PEPs). Anyone who has invested the maximum permitted sum every year since they started in 1987 will now have invested pounds 82,200 in assets, which should by now be worth well into six figures.

There is an obvious temptation for an incoming chancellor to increase the Tessa limit and cut the annual PEP allowance or, more likely, limit the cumulative totals any individual can hold. That could be achieved either by capping the total invested or by limiting the annual amount of tax relief on very large PEP portfolios. Changing PEP limits would probably be deferred to the next tax year, but larger investors might still want to take up this year's PEP allowance early. As a precaution against a fall in the stock market they might consider investing in a corporate bond PEP or one of the staggered investment schemes run by the likes of NPI or Fidelity, that PEP the entire allowance up-front before drip-feeding it gradually into the stock market.

Pensions

The Chancellor could also raise revenue by reducing tax relief on pension contributions to the basic rate of tax, so that higher rate taxpayers can no longer enjoy a 40p contribution from the state for every 60p they put into their pension funds. It would be difficult if not impossible, however, to make the change in the middle of a tax year without risking the charge of retrospective legislation.

There is a real possibility that the new government might be tempted to reduce the Advance Corporation Tax rebate, which exempt institutions such as pension funds can reclaim. Cutting the rebate from 20 per cent to 15 per cent would net the Inland Revenue an estimated pounds 600m a year, which in turn could reduce performance of personal pension funds and add 0.5 per cent of payroll costs to final salary schemes. Once again however it would be difficult to make a change before the end of the tax year.

Miras

At current interest rates mortgage interest tax relief is now only worth about pounds 300 a year. If there is ever a right time to abolish it, it is when property prices are rising strongly and if anything there is an economic case for cooling excessive rises in property prices. For practical reasons however Miras too looks safe at least until the current tax year ends in April 1998.

Insurance Premiums

The government has already said it will abolish tax relief on private medical insurance premiums for the over 60s and other changes are possible. The insurance premium tax was raised to 4 per cent last year and the temptation to increase it and/or extend it to life insurance premiums must be very great for a chancellor looking for ways of getting golden eggs without killing geese. Premiums on term assurance, the cheapest form of life assurance protection, have been coming down and could well stand a 4 per cent surcharge, unwelcome though it would be to the insurance industry.