By Lesley Davis, partner in the private client team at law firm, Shakespeare Martineau

The unprecedented levels of financial support that the Government has provided during the pandemic has been welcomed by many. However, these last few months will have left the Treasury with a huge budget deficit, and it may need to turn to taxes to recover. So, what are the likely focuses and how will any changes impact the public?

In order to make a tax hit more palatable, the capital taxes are the most likely to be targeted. Specifically, this would include inheritance and capital gains tax (CGT), which are often associated with wealthier individuals who can afford to pay more, although this is not necessarily the case. Parts of this legislation are also relatively straightforward for the Government to change. Any alterations could be quickly pushed through Parliament, allowing the deficit to recover sooner. In fact, the Government has already tasked The Office of Tax Simplification with conducting a full review of CGT, which can only mean that changes are on the way.

Both inheritance tax and CGT have a number of areas that could be hit. For inheritance tax, this includes the nil rate band, the potentially exempt transfer exemption, and spouse exemption on death.

Normally, no inheritance tax is charged if the value of a person’s estate is less than £325,000 – known as the nil rate band. However, the Government could choose to reduce this, making fewer people exempt. For example, if the nil rate band is lowered to £100,000, then this could impact a great many more people, not just the very wealthy.

Another aspect of inheritance tax that could end up impacting those of average wealth is the potentially exempt transfer exemption. Currently, people can make as many gifts over £250 as they would like without incurring any tax liabilities, but as soon as a gift of over £250 is made, then a seven-year clock begins.

This seven-year clock works on a sliding scale. If a person dies within three years of making a gift of over £250, then 40 percent tax must be paid on the gift. Should they die after seven years, then zero percent tax is payable. The more years that pass, the less tax that must be paid. Removing this seven-year system, or increasing it, would lead to a large amount of extra tax for many people.

Although probably a last resort, spouse exemption on death could also be altered in some way, whether it be removed or restricted. At present, any gifts between a married couple or those in a civil partnership are exempt from inheritance tax. If this relief is removed, then on the first death of the couple, the house might have to be sold in order to pay the inheritance tax, potentially leading to the surviving person becoming homeless. This would obviously be a tough sell for the Government, but it is a possibility.

Qualifying business property and agricultural property also currently enjoy a full exemption from inheritance tax on death. These exemptions could easily be removed causing a variety of issues for those wishing to transfer land to the next generation.

CGT is another likely target. It refers to the tax paid based on the increase in value of an asset from when a person bought it to when they sold it.

An increase in CGT may seem strange at present, as it is unlikely that people’s assets will be increasing in value. Nevertheless, as we come out of this economic crisis, assets will begin to grow in value again and the increase in CGT would start to make an impact. However, this decision could cause a stagnation of assets, with people unwilling to sell them or pass them on to avoid the high levels of CGT.

There is also the option of removing CGT uplift. Currently, a person who has inherited an asset only has to pay CGT calculated from its value on the date of the deceased’s death to the day they sell it. Removing CGT uplift would mean the receiver of the asset would have to pay CGT from when the deceased originally acquired it instead. If this was in the 1970s, for example, then this would lead to a considerable amount of tax to be paid.

However, there are ways to plan ahead for any changes to the capital taxes. One option is to make lifetime gifts now. Alterations are unlikely to be retrospective, so if people are planning to leave an asset to their children anyway and can manage without it, then it is wise to gift it now. This would also help in terms of the seven-year clock, as if the Government do remove or lengthen it, then it will have already started running.

Creating a will that allows executors and trustees to move with any changes in tax legislation is also advisable. By leaving a more fluid will alongside a letter of wishes that asks for legislation to be considered after death, it is ensured that assets can be treated in the most tax efficient manner.

Another sensible option is to set up a family discretionary trust using the current nil rate band. Married couples and civil partners have £325,000 each, so can create a £650,000 trust, which they would not have to pay tax on now. This can be used to support the next generation if people don’t yet want to give assets outright, whether that be due to the receiver’s age or their circumstances.

There is no doubt that the Government will have to recover the budget deficit somehow, and the capital taxes are an obvious place to start. However, no matter what individuals choose to do to prepare for this, they should seek out guidance from a professional first. An expert can objectively review the situation and assess what is right for the family, allowing them to act efficiently before the capital taxes are hit.