New Chancellor George Osborne is itching for next Tuesday. He'll be announcing his first Budget and, rather grandly, has termed it an emergency Budget. There have been plenty of indications and leaks about what he will be proposing, not least with regard to increasing capital gains tax. But does the prospect of cutbacks and tax increases mean you should move fast and make changes to your personal finances now?
Yes, says independent financial adviser Martin Bamford of Informed Choice. "The most urgent priority is making pension contributions, if you are a higher rate taxpayer and had planned to make contributions at some point during this tax year anyway," he says. "There is a high probability that higher rate income tax relief on pension contributions will be abolished or scaled back even further in the Budget, so making these contributions now makes real sense."
The existing system of tax relief for pension contributions was shaken up by the last government's plans to cut the amount of relief given to high earners. The coalition Government is unlikely to scrap the plans – which are due to come into force next April – but may revise them to reduce their perceived complexity.
"In the interests of simplification and saving revenue, it is possible that the Government will repeal the complex rules that are due to take effect from 2011/12 onwards," says Lisa Macpherson, national director of tax at PKF Accountants. "The pensions industry and many others are suggesting cutting the annual limit for qualifying contributions, from the current £255,000 level to perhaps £50,000. At this lower level, giving tax relief at the individual's highest rate, even if that is 50 per cent, would cost the Government less than giving only basic rate relief on a contribution of £255,000."
There has been widespread media coverage about an expected increase in capital gains tax, but should that be a concern? Not to most taxpayers, according to TUC general secretary Brendan Barber. "The vast majority of taxpayers never come into contact with capital gains tax as they are simply not wealthy enough to buy and sell the assets that bring capital gains," he says. "CGT is the tax dodger's tax of choice and is used by the wealthy to pay less tax. If the Chancellor is serious about us all being in this together, he should implement in full the Liberal Democrat proposals on CGT."
In short, the Lib Dems hoped to increase capital gains tax to the same rate as income tax. So higher-rate taxpayers would pay 40 per cent CGT. It does seem likely that the Chancellor will adopt the measure in some form, despite a concerted campaign by the financial services industry and high earners to persuade the new Government to scrap the idea. But it was less than three years ago that CGT was charged at 40 per cent, so a return to that level should not come as a shock.
The people who should be concerned about the expected rise are private investors, second home owners and entrepreneurs with several assets. The question for those taxpayers who may be affected by the potential higher rates is whether they should act now, and realise assets at the current 18 per cent that capital gains tax is charged at.
"Until we get the details in the Budget on 22 June it's all speculation," says David Kilshaw, head of private client advisory at KPMG. "But we would urge anyone considering disposals before then to seek advice as soon as possible."
However, he warns that there could be risks in taking action before next Tuesday. "These include that tax may be paid earlier than if no action had been taken; that the tax liability may have been lower if action had been deferred until 22 June 2010; and that the desired tax result may not be achieved because new legislation makes it ineffective," Kilshaw says. "So it's important to decide whether to take action in the light of these risks."
Martin Bamford also advises people to do nothing right now. "We are not advising our clients to realise capital gains," he says. "While we expect to see the rate of CGT increased in line with income tax rates and the annual exemption reduced, there is a good chance this will apply from the start of this tax year. This could mean those investors who have rushed to dispose of assets will face a hefty tax bill," says Bamford. "You should never let the tax tail wag the investment dog, so selling investments quickly is a foolish strategy."
Having more immediate impact on us all could be an increase in VAT. The widespread view is that it could rise to 20 per cent, and could be introduced as soon as next weekend. "It would be a massive surprise if there was no announcement of a significant VAT uplift on Budget day," says Stephen Herring, senior tax partner at accountants BDO. "On current projections VAT is anticipated to bring in £78bn for 2010-11 and a rise to 20 per cent could add up to a further £11bn. Given that the Chancellor is unlikely to have an opportunity to raise VAT again this parliament, he may be tempted to raise the rate even higher with a promise to reduce it once the deficit is under control," he warns.
On that basis is it an idea to rush forward major purchases to save the potential extra 2.5 per cent of tax? It's an extra £2.50 on every £100 you spend on VAT-able items so if you've been delaying buying that £1,000 HD TV, it could make sense buying it now to potentially save £25. On the other hand, speeding to the shops to rush to buy something that you haven't researched properly could mean paying over the odds in your haste.
In other words, making snap decisions based on changes that might or might not happen could be a costly mistake. "The most important thing ahead of any Budget is to understand your personal financial situation and have a clear plan," says Bamford.
And if you really want to buy an HD TV, read Martin Hickman's Consuming Issues column.
*Increasing VAT from its 17.5 per cent rate to 20 per cent in Tuesday's Budget could trigger a sharp rise in inflation, potentially putting the recovery at risk, warn accountants UHY Hacker Young.
A jump in VAT could mean high-street prices climbing by more than 2 per cent as retailers are likely to pass on the increase to consumers. But higher VAT won't just mean higher prices, it could hit businesses and lead to another recession.
"A VAT hike could push up prices on the high street by around 2 per cent, which would have a very significant impact on inflation," says Simon Newark, VAT partner at UHY Hacker Young. "Higher inflation could trigger interest rate rises, risking the spectre of the 'double-dip' recession."
He predicts that a VAT increase will exacerbate cashflow problems for businesses and could also reduce the capacity of banks to lend. For businesses which cannot reclaim VAT such as banks, it will directly hit their bottom line. Given the weak state of the banking sector and the ongoing reluctance of banks to lend to small companies, a VAT hike could further reduce lending to the small business sector."
Even businesses which can reclaim VAT will suffer. Higher VAT will eat into cashflow, which could push some businesses into insolvency, Newark warns. He says charities will also suffer as a raise in VAT will add to their costs and reduce the funds for charitable projects.
But with the Government needing to reduce the deficit, raising VAT to 20 per cent would bring in between £11bn and £12 bn a year. For that reason, and for political expediency, the anticipated rise in VAT is likely to become a certainty on Tuesday, says Newark. "The Chancellor realistically only has once chance to get away with it by blaming the previous administration, and that is now," he says.Reuse content