Labour

1. "Closing the Carried Interest Loophole"

One of the policies contained in the NPF Policy Document (the Labour Party's policy document prepared in advance of, and then approved at, the Labour Party Conference in October 2023) is the proposal to "scrap the carried interest tax loophole enjoyed by a small number of private equity fund managers". While not featuring heavily in speeches at the Labour Party Conference, it has been repeated on several occasions since, most recently in the Q&A with the Shadow Chancellor after their Labour Business Conference on 1 February 2024.

As an initial point, it could be argued (pretty strongly) that "loophole" is not a fair term to use. First, the taxation of carried interest in the UK has been reviewed and adjusted on multiple occasions over the years, and the resulting regime is not simple and is intended to balance encouragement to asset managers to base themselves in the UK with a reasonable level of taxation. It does not, despite the press comment, simply result in CGT. Income flowing to carry holders (for example, coupon on debt securities or dividends paid by investee companies) is taxed as income in the usual way. Further, capital gains are already taxed at a higher rate than ordinary UK capital gains (28% vs 20%), and that rate is not in international terms hugely generous (it is probably more the combination of the CGT treatment and the non-dom rules that is unusual) – many jurisdictions have either different regimes or favourable practices for carried interest, for example the rates for carried interest include 28.5% in Germany, 26% in Italy, 30% in France and 15% in Ireland. So, the rates applied are not out of kilter with international comparisons. And there are a number of further safeguards already baked in – so, there is no deduction for acquisition costs on the relevant capital assets (so it is really a tax on capital receipts not on capital gains); and there are special rules to tax as income both shorter term holdings (and a 40-month holding period is needed) and disguised management fees. So, definitely not a loophole in the sense of exploiting an unintended gap in the rules – these are considered, balanced rules, which are comparable to other jurisdictions.

However, it is right that the Government should consider from time to time whether the balance between the benefits arising from alternative asset managers locating in the UK on the one hand and a fair tax burden on their activities and investments on the other. The tax raised by this change is slated in the NPF Policy Document as partly funding a major upgrade of mental health services in the UK, an area crying out for further funding; but worth noting also that the Labour Party envisages this raising less c.£440 million, not a huge amount in the scheme of the overall tax take.

So, if Labour does consult on next steps for the taxation of carry (and as noted above the Shadow Chancellor suggested on 1 February 2024 that the party did intend to) then what options are available to them? There are quite a few, but a few of the more obvious options would be the following:

  1. Deem all carried interest as "employment related securities" regardless of whether the holder is an employee (as opposed to, for example, a partner in an LLP). This would ensure that all grants of carry are subject to employment tax (and NICs) on acquisition, but would not necessarily result in increased tax when returns are realised on the carry if that carry was acquired early in the life of the Fund. As a result, this feels like it may not achieve the political objectives of the Labour party;

  2. Treat all capital returns on carry as income, from either employment or trading. This would require significant, and far from straightforward to draft, changes to the law, and would be materially out of step with all major comparator economies. There has been much comment on the risk of asset managers moving their (ultimately, quite mobile) businesses out of the UK. It would, however, most clearly achieve the political messaging, albeit conflicting very badly with the otherwise pro-business stance being put forward by the Labour party in recent months;

  3. Adjust one or more of the existing regimes mentioned above – for example, by extending the holding period before it is treated as a capital return or by making the conditions to be treated as a carried interest more stringent (such as, with minimum investment requirements). The danger of these sorts of changes is that may leave a Labour Government at risk of having adjusted rather than closed the perceived "loophole";

  4. The simplest change would be to retain the current regime but to increase the rate from 28% to some higher rate, to be determined as part of the post-election discussions and reflecting the international comparator regimes. Taken with the changes to the non-dom rules, this may raise a material amount of tax subject to lost tax through behavioural change. This would also be easy to implement (as there is a ready-made regime, understood and applied by HMRC and taxpayers), and a very limited requirement for changes of law so fast to introduce. It could also, in principle, have different rates applying to gains up to (one or more) thresholds. If a change is to be introduced, this approach seems to us the most nuanced and balanced approach that could be taken; and

  5. Clearly, the simplest answer would be to retain the existing regime while a new Labour Government considered, with the full resources of the Government machinery at its disposal, what the right and balanced answer to the treatment of the sector is, and allowing any consequences from removing the non-dom regime to be determined before concluding whether further change was required. As noted above, the UK carry regime is not an outlier in international terms and it is to be hoped that a proper consultation process would ensure all the consequences of a change are fully considered.

2. Business Tax Roadmap

In recent months, the Labour Party has placed significant emphasis on appealing to business as being a safe pair of hands. This included the Labour Business Conference in London on 1 February 2024, in which Rachel Reeves said she wanted "to set out today what a pro-business Labour Government will mean in practice". There have been a number of announcements, at the February event or going back to the October 2023 Labour Party Conference, including the following:

  1. a new "fiscal lock", enshrined in legislation requiring that significant and permanent tax changes must be accompanied by OBR forecasts, under a "Charter for Budget Responsibility";

  2. a commitment to publish, within 6 months of forming a government, a business tax roadmap, which will set out Labour's plans on business tax for the duration of its first Parliament;

  3. the intention to replace business rates with "a fully costed and funded system of business property taxation"; and

  4. several pledges on elements of the business tax landscape that will not change – in particular, a cap on the rate of corporation tax at (the current rate of) 25% and a commitment not to remove the full expensing and the annual investment allowance.

3. Reform of Non-Dom Tax Rules

Another high profile Labour proposal relates to the tax regime applying to non-domiciled individuals ("Non-Doms"). These are individuals who are resident for tax purposes in the UK, but (broadly – the rules are complicated and based on case law) whose permanent residence is overseas.

The UK currently has a generous Non-Dom regime, by international standards, although a number of jurisdictions have moved to introduce similar systems (discussed below). Non-Doms are currently able to reside in the UK and pay tax on their income or gains only if it is either UK source or is "remitted" into the UK – they do not pay UK tax on their unremitted foreign income or capital gains. There are also inheritance tax benefits to Non-Doms, as they do not generally pay IHT on worldwide assets. The rules allow individuals to claim the status for up to fourteen years (in a twenty year period). From years seven to fourteen, the Non-Dom is required to pay the annual remittance basis charge which ranges from £30,000 to £60,000. Once an individual has lived in the UK for fifteen years in the last twenty they lose their Non-Dom status and become deemed domiciled in the UK. The result of this is that their worldwide income is subject to UK IT and CGT, and the IHT rules can apply.

The UK's Non-Dom regime is relatively generous when compared with the regimes of similar economies such as Canada, Japan, France and even to some extent, Italy. For example, the length of time you can be a Non-Dom is longer, fifteen years versus the shorter periods of Canda, Japan and France; and in terms of the cost to remain subject to tax on a remittance basis, £30,000 to £60,000 (only kicking in after seven years), this is less than for example the c.£100,000 each year in Italy.

Speculation that Labour would move to repeal or replace the Non-Dom system has been strong for a long time. This has only increased given the political impact of a Tory Prime Minister being married to a very wealthy Non-Dom. Originally, Labour proposed to abolish the Non-Dom regime; characterising the regime as a tax loophole for wealthy individuals.

However, in more recent months, the suggestion has been that Labour would significantly reduce the benefits of the Non-Dom regime or replace it with a more modern (and narrower) alternative. This is in response to fears that entirely removing the system would be uncompetitive from an international perspective and would damage the wider economy. The Shadow Chancellor, Rachel Reeves, has stated on several occasions that Labour intend to 'replace [the non-dom regime] with a modern scheme for people genuinely living in the UK for short periods.' This would also be consistent with the stated purpose of the Non-Dom regime is to attract international individuals to work, invest and spend their money in the UK. Reeves has said that Labour are looking at Non-Dom regimes in jurisdictions such as Canada, Japan and France. All three jurisdictions offer less generous tax benefits than the UK, for example by having a shorter period for which the benefits are available.

A new 'clear, simple and modern system' could benefit individuals claiming Non-Dom status by removing the complexity and uncertainty of the current system. Changes could be softened by the introduction of 'grandfathering provisions', which means applications submitted before a certain date continue under the old regime.

Current speculation in the press anticipates that a Labour Government would reform the current system to allow individuals to claim Non-Dom status for up to four years before they pay full UK tax.

There are a number of knock on effects which could arise from a change in the Non-Dom rules: one of the key knock on effects of a change to the Non-Dom rules would be the impact on IHT. Currently one of the main benefits of being a Non-Dom is that your worldwide assets would not be subject to inheritance tax. For those who have very large estates and who are domiciled in jurisdictions with more favourable rates this can be an enormous benefit of the UK Non-Dom regime. Another perhaps less publicised knock on effect of changing the Non-Dom rules is how it might impact some holders of carried interest. Where Non-Doms, holding interests in overseas carry funds, receive income from the funds they have the option to not remit those gains and not pay UK tax.

4. VAT on Private Schools

The Labour party have proposed to end the VAT exemption on fees for private schools if they win the next general election. Currently schools can benefit from an exemption from VAT by two means, the first is under the general exemption for the provision of education by eligible bodies and the second is by qualifying as a charity and obtaining the VAT exemption for charities.

Ending these two exemptions may be simple enough but, VAT is a complicated area of tax law with several intricacies which could significantly impact the amount of revenue the measure returns. The Institute for Fiscal Studies ("IFS") estimates that removing tax exemptions from private schools would raise £1.6 billion a year in extra revenue (after allowing for input tax deductions, VAT on boarding fees and exemptions for specialist provisions).

The tax consequences of the change are not straightforward. This is in part down to VAT being a tax on the value added to goods and services, which is achieved by requiring the supplier of a good or service to account to HMRC for the VAT (known as output tax), but the supplier being able to reduce the amount that they owe to HMRC by the amount of VAT they have paid when receiving goods or services (input tax). A supplier making exempt supplies will see some or all of its input tax recovery limited, so the removal of the VAT exemptions for private schools may result in a better input tax recovery position. The interaction between output tax and input tax can create some strange results with taxpayers sometimes able to obtain material credit for their input tax relative to their output tax. While current modelling from the IFS estimates that private schools would achieve an effective tax rate for VAT purposes of c.15% it is arguable that this is reflective of the current system which is yet to consider how it might organise itself to be the most tax efficient that it can be. Further consideration may need to be given to the potential availability of large refunds where large capital expenditure has been undertaken in the previous ten years.

Another difficulty a Labour Government would face is ensuring that the legislation ending the exemption for private schools is sufficient. This is necessary to ensure that schools cannot split out their services in a way which reevaluates the cost of teaching and accentuates the cost of other services which are VAT exempt such as after-school care and accommodation. Doing so in a way which does not accidentally capture childcare or special needs services provided by state schools or within communities may prove to be very challenging and could have disastrous consequences if it led to a rise in the cost of those service more generally.

A Labour Government would also need to give considerable thought to what anti-forestalling measures it included. Anti-forestalling measures are designed to prevent a taxpayer taking advantage of a period before a measure comes into effect to mitigate unreasonably the impact of the upcoming measure. For example, many schools already give parents the opportunity to pre-pay school fees, to help families and schools to manage the future costs. Would any changes include anti-forestalling measures to prevent schools offering arrangements where parents pay in advance (and under the current VAT exemption) for education, and thereby save VAT on the fees? If so, when could such an anti-forestalling begin from (now, the date of any manifesto announcing the measure, the election day or the date that legislation is first put forward for the change?) bearing in mind fairness and principles around not having retrospective taxation?

An interesting assumption made in the IFS paper is that a reduction in the number of pupils in private school education resulting from the VAT changes (and therefore not paying VAT on the fees under the new system) may not lead to a net reduction in VAT raised by the change, on the assumption that if parents have additional cash as a result of not paying fees (and VAT on those fees) for private school, they are likely to spend it on other things generating VAT receipts. This may be true but the IFS do not seem to have considered that the reverse may also be true – for families needing to find additional cash to pay for private school, there may be a corollary reduction in other (VATable) spending?

5. Other Measures

Alongside the measures proposed above, the Labour Party has proposed a number of other measures but without as much detail as to what the changes may be. These include:

  1. the Shadow Chancellor responded to the changes made by the Tories last year on the Lifetime Allowance for Pensions by saying a Labour Government would reverse these changes. This would not be a straightforward thing to do, so it may be that the counter-measure would be to reduce the amounts that can be taken as tax-free lump sums and perhaps also to limit the inheritance tax benefits of pensions (as pensions currently can be passed on to beneficiaries tax-free);

  2. The Labour party has long been an advocate of the windfall tax, leading the initial calls for one to be implemented, and long been a critic of how the Conservative party implemented it. Since its inception into UK law the Labour party has criticised the scheme as it only applied to profits made from extracting UK oil and gas rather than extending to other activities like refining oil and selling petrol/diesel on forecourts. The Labour party also criticised the availability of tax deductions which allowed them to deduct 91% of capital investment costs.

    In response Labour is proposing to increase the total tax rate from 75% to 78% and extend the time period which the scheme will run for by two years. The Labour party has shelved plans to backdate the windfall tax on oil and gas producers to the start of 2022 which may have eased some tensions between the party and the industry.

    There has been immediate backlash since the announcement of the intended extension and increase in the windfall tax. OEUK warned that the proposals could cost as many as 42,000 jobs in the sector and given the windfall tax was introduced to tax the increased profits resulting from higher energy prices associated with the Ukraine war questions over its justifiability may arise as prices and profits return to more normal levels.

  3. alongside discussions in relation to pensions, other IHT "loopholes" pointed to by Labour include questioning whether the AIM exemption for shares and securities (part of the business property relief rules) is too broad or should be capped, and whether agricultural property relief for farmers is sufficiently tailored to be available for "real farmers". Removal of either seems unlikely but narrowing is certainly possible; and

  4. at the Labour Party Conference, they announced that they would "raise stamp duty paid by foreign individuals, trusts and companies when they buy UK residential property", although there is limited further information as to how this might operate.

Conservatives



6. Inheritance Tax (IHT) reforms?

Ahead of the Autumn Statement in November there was a lot of press speculation that Jeremy Hunt would include cutting inheritance tax in his plans. Despite no mention of inheritance tax at the Autumn Statement, rumours persist that IHT may be cut or scrapped ahead of the 2024 election.

Despite inheritance tax only being paid on an estimated 4% of deaths, it remains a tax that appears to be generally disliked by the public. A YouGov poll in September 2023 indicated that 61% of Britons consider inheritance tax to be unfair, with a common theme in follow-up polling being that the tax is perceived to represent 'double taxation'. This does suggest that scrapping or cutting inheritance tax might be a vote winner for the Conservative party at the next election, even though the tax currently only impacts a relatively small number of people.

Recent press speculation has suggested that the Government has cooled on the idea of announcing cuts to inheritance tax at the forthcoming Spring Budget, with the focus seemingly now on possible cuts to income tax or NICs. Instead, it may be more likely that the scrapping of inheritance tax, or a more full-scale reform of the tax, becomes a manifesto pledge for the Conservative Party going into the election.

7. Income Tax & NICs

Following the cuts to National Insurance Contributions (NICs) that were announced at the Autumn Statement in November, speculation in the press is rife that there may be further cuts to taxes on income in the forthcoming Budget (on 6 March). A headline grabbing cut to income tax had been rumoured, but any such cut would not be easy to fund.

A further cut to NICs at the Spring Budget may be more likely, particularly given that the cost of cutting employee NICs is cheaper than cutting income tax because NICs are generally not paid by individuals who have reached the State Pension age. HMRC estimate that a 1p cut to the main rate of employee NICs would cost c.£4.6 billion in 2024/25, as compared to c.£6 billion for a 1p cut in the basic rate of income tax.

The cuts to NICs that were announced at the Autumn Statement, and any further cuts to income tax or NICs that are announced in the Budget, should be balanced against the expectation that personal tax thresholds will continue to be frozen. For many taxpayers, the effect of this "fiscal drag" will offset the benefit of any cut in the headline rate of tax, resulting in an increase in their tax burden. The continued freezing of personal tax thresholds was projected by the OBR in November to raise a combined £44.6 billion tax revenue for the Government in 2028/29. This was an increase of £13.6 billion on the OBR's March 2023 forecast (as a result of higher and more persistent inflation than expected). For context, the OBR estimated that the cuts to NICs that were announced in the Autumn Statement would reduce tax receipts by £10 billion by 2028/29.

8. Business Taxes

Following Labour's recently announced plans to cap corporation tax at the current rate of 25%, and to maintain full expensing for capital expenditure, there is seemingly not much difference between Labour and Conservative policy in relation to business taxes. In this context, it will be interesting to see whether the Chancellor announces any new business tax measures in a bid to distinguish the Conservatives Party's offering from Labour.

The Chancellor's biggest tax policy announcement for businesses at the Autumn Statement was the permanent adoption of full expensing, allowing companies to claim a 100% deduction for capital expenditure in the year in which it is incurred. This was billed as "the largest business tax cut in modern British history". For more detail, read our Autumn Statement 2023 briefing. Businesses will be listening out for any update at the Budget as to whether or not full expensing will also be extended to cover leased assets (which are currently excluded).

The current expectation is that the Chancellor will not have the same headroom to play with at the Budget that he had in November, so the scope for further tax giveaways to businesses may be limited, particularly if priority is given to cuts to income tax in a bid to win over voters. Instead, there is likely to be a continued focus on policies to drive investment and growth, in line with the policies announced at the Autumn Statement.

9. Stamp Duty

Is a stamp duty exemption for 'downsizers' on the cards?

A January 2024 report from the London School of Economics and University of Sheffield, sponsored by Lord Mandelson (Labour peer) and Lord Heseltine (Tory peer) recommended using SDLT and a "little creative thinking from the Treasury" as a tool to encourage better use of the existing housing stock. The recommendation (which has been suggested by a number of institutions previously) is to incentive downsizing, especially among the elderly, by waiving SDLT for downsizing 'elders' to encourage them to move to suitable housing and increase the supply of larger homes. Whilst this policy hasn't been adopted by either party, it feels like something that could appeal to the 'grey wall' Conservative voters and is unlikely to cost a material amount in lost SDLT revenue (it may even increase SDLT revenue if it stimulates more house moves). There have been recent calls from the "One Nation" group of Tory MPs for the Chancellor to adopt this policy at the Spring Budget.

SDLT can also be used as a tool to stimulate the housing market generally, as shown by the stamp duty holiday brought in during the pandemic. If this is the aim, some would argue that incentives aimed at the earlier stages of the property ladder have more impact (e.g. no stamp up to £500k). Reducing stamp lower down the ladder makes it easier for first time buyers to buy which in turn increases demand in the market, making it easier for existing house owners to sell, and so on, creating a ripple effect up through all stages of the property ladder.

Reform to stamp duty on shares?

It is being reported that the City is putting pressure on the Chancellor to scrap stamp duty on shares – a charge levied at 0.5% on the transfer of shares in UK companies (subject to certain exemptions). There is concern that the charge makes the UK's capital markets, in particular the main market of the London Stock Exchange, less competitive than some of its rivals. The tax brings in around £3.3bn each year, so any cut here would likely have to be viewed as an investment in reviving London's capital markets, thereby contributing to longer-term growth.

These calls for reform come at the same time that the Government is due to provide an update on proposals to modernise stamp taxes on shares, following a consultation process that was conducted in Summer 2023. For more information on the proposed reforms, see our legal briefing on this topic. An update on these proposals is expected in 2024.

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