Tax anomalies that keep experts awake at night

“The Office of Tax Simplification has closed”, states a simple message on the gov.uk website. Its closure was announced in 2022, when Kwasi Kwarteng was chancellor. Instead of the separate arm’s-length body: “Tax simplification will be embedded at the heart of the tax system as a core HM Treasury and HMRC priority.” It was a bold ambition, but hardly achievable.

The UK tax code holds the title of the world’s longest. It’s longer than all the Harry Potter books combined. For complexity bordering on the absurd, we can look to IR35 status, with broadcaster Adrian Chiles facing a fourth tribunal hearing this week in a decade-long case; or the Jaffa “it’s a cake not a biscuit” VAT case of 1991.

For those longing for simplicity, the main parties’ manifestos, which were published this week, offer little comfort. Very little of what’s proposed is aimed at righting where one part of the tax system affects another part. Richard Murphy, professor of accounting practice at Sheffield University Management School, calls them “tax spillovers”— “the ways in which the tax system undermines itself”. 

Spillovers can be positive, but are often negative — some can also be open to abuse. For example, here’s a simple one: corporation tax for companies with profits under £50,000 is at 19 per cent; and the basic rate of income tax is at 20 per cent, so there’s an artificial incentive to form a company and reduce your tax liability.

Labour has backed down on its plans to reinstate the lifetime allowance for pensions, an anomaly in the sense that it was difficult to reconcile the government’s auto-enrolment pension ambitions with capping investment growth on pensions. But the lifetime allowance is not even top of most tax experts’ lists of exasperating anomalies.

Most lose sleep over the income tax “traps”. Clare Moffat, pensions expert at Royal London, singles out the child benefit tax charge and the personal allowance trap.

The child benefit high income charge comes into play as soon as a parent earns £60,000. But two parents earning £59,999 each don’t pay it.

The Conservative party says that, if re-elected, it would increase the income threshold from £60,000 to £120,000 — but the problem doesn’t exactly go away. “Moving the threshold up just reduces the number of people caught,” says Andrew Parkes, national technical director at Andersen, a tax consultancy. “But for those who are, their tax rate increases when it is already over 50 per cent: arguably more unfair.” 

Then there’s the personal allowance trap. In England and Wales, a 60 per cent rate of income tax doesn’t officially exist, but it is hiding in plain sight for people earning between £100,000 and £125,000, as their tax-free personal allowance (currently £12,570) is gradually withdrawn. Higher earners have a simple solution to retain both child benefit and the personal allowance. “Someone with £110,000 income who makes a £10,000 pension contribution would retain their personal allowance so would get 60 per cent relief on the pension contribution,” says Gary Smith who works in financial planning at Evelyn Partners. But not everyone earning at this level can afford to make the additional pension contributions.

The disparity between capital gains tax (CGT) and income tax is another bug bear, with some experts pleased to see the Liberal Democrats include in their manifesto the alignment of CGT with income tax rates. “If you can disguise income as capital, straight away there’s an issue,” says Christopher Thorpe, technical officer at the Chartered Institute of Taxation.

It’s the weird world of inheritance tax planning that throws up some of the most bizarre anomalies

Take “carried interest”, a share of profits earned by general partners of private equity, venture capital, and hedge funds, paid if a fund achieves a specified minimum return. Thorpe says: “In 1987, the government agreed this would be taxed as capital but it’s an anomaly, it should be taxed as income.” A Labour government is likely to treat this as a performance-related bonus that should be taxed as income.

But it’s the weird world of inheritance tax (IHT) planning that throws up some of the most bizarre anomalies.

If you die before your 75th birthday, pension funds can be paid to your beneficiaries tax free. As a result, many financial advisers have a strange duty to tell clients not to draw down on their pensions before that age if they can help it. “Is it too young? Some people are still working at age 75,” says Thorpe. “I’m not planning to die before age 75 to take advantage,” says Murphy.

Many say it doesn’t make sense to give an IHT advantage to Aim shares, when other quoted company shares are fully chargeable. There’s no obvious benefit to the economy, except perhaps that it’s led to a niche sector of wealth managers specialising in managing Aim portfolios that 80-year-old clients can use for “quick” IHT planning.

Meanwhile, campaigners find it strange that a government keen to nurture share ownership to the point of introducing a UK Isa hasn’t thought of scrapping stamp duty on UK shares. Sir Douglas Flint, chair of asset manager Abrdn, says: “Removing stamp duty on UK shares and UK-domiciled investment trusts could provide a significant boost to UK share ownership . . . as well as supporting the competitive positioning of UK capital markets.”

Others choose the inexplicable loophole in relation to young people’s Isa contributions. Until they’re 16, a child can only put £9,000 a year into a Junior Isa. But between 16 and 18 they can put £20,000 into a cash Isa and £9,000 into a Junior Isa. Do that for two years and that’s £58,000 available to shelter from tax. Smith says: “We use this a lot for grandparents putting money aside for school fees.”

With so many of these loopholes still open, it shows that tax simplification is a long way from being embedded into the institutions of government. The experts say fixing some of these anomalies could raise funds too. So whichever government we have after July 5, please conduct a tax spillover analysis after the election.

Moira O’Neill is a freelance money and investment writer. Email moira.o’neill@ft.com, X: @MoiraONeill, Instagram @MoiraOnMoney