Tax + School Fees: A Tough Equation

The new chancellor, Rachel Reeves, yesterday confirmed the introduction of VAT on school fees, alongside other initial fiscal changes. This is aimed to fill the fiscal ‘black hole’ and will inevitably be addressed through tax rises…

It has been confirmed that 20% VAT will be charged on school fees from January 2025. This will apply to core education and boarding costs but not to ancillary services including school meals. With immediate effect (as of 29th July 2024), VAT also applies on advance fee payments covering school fees from 1st January 2025 as an anti-forestalling measure. We do not expect VAT to be claimed for advance school fee payments made before the announcement, however, it may be argued in legislation that VAT should apply if such payments are to cover applicable services from January 2025 onwards, regardless of when such payments were made. This is not only a challenge for parents, the vast majority of whom already struggle to pay for school fees (which last year rose by 8% on average) but will also likely impact schools given that a large proportion of their costs is for staff, and therefore not VAT reclaimable. Private schools will also have relief on business rates removed from April 2025, if the legislation is passed.

We anticipate that there will be further tax rises introduced in the Autumn Budget, set for 30th October 2024. Labour does not plan to increase income tax rates, national insurance or VAT, and they inherit frozen tax bands which remain in place. These bands have pushed more individuals into higher tax brackets, particularly as earnings have attempted to keep pace with high inflation. The focus is likely to be on general ‘wealth’ tax rises which may cover increases to capital gains tax, inheritance tax and possible changes to the tax relief offered on pensions.

There has been talk of a flat rate of pension tax relief for years. Currently, pension contributions receive tax relief at the individual’s marginal income tax rate of 20%, 40% or 45%. The reason for the tax relief is to encourage pension contributions and to ultimately manage the state burden for an ageing population. Should a flat rate of tax relief be introduced, 30% for example, this could substantially reduce the Treasury’s tax relief cost. Although this would be beneficial for those in the 20% bracket, it would be less attractive for those in the 40% or 45% tax brackets and would likely discourage higher earners from maximising pension contributions. This could also create problems for public sector defined benefit pensions.

Another option could be a removal of the long-standing pension 25% tax-free lump sum available from minimum retirement age. Again, changes here would conflict with the incentivisation to pay into pensions and would likely necessitate a hugely complicated transitional arrangement as rule changes come into effect. The maximum tax-free lump sum has now been capped at £268,275, the new ‘Lump Sum Allowance’, and so those with larger pension pots are already being squeezed here.

The capital gains tax (CGT) allowance was cut aggressively by the former chancellor. There remains speculation that CGT tax rates could be increased and aligned to income tax rates. Any increases here would need to be introduced sensibly to avoid a rush for the sale of assets at current tax rates, which would put downward pressure on valuations. There would also be a greater onus on using tax-efficient ISAs and pensions to shelter from CGT.

With a long-term rise in asset prices and frozen inheritance tax (IHT) allowances – the £325,000 nil rate band has been in place since 2009 – more estates are captured by IHT. There was no mention of IHT in Labour’s manifesto. However, this doesn’t rule out the possibility of changes to the regime which could adjust exemptions or the rate of applicable tax. Pensions have not been subject to IHT for a decade and could be on the new chancellor’s radar.

We are watching developments closely. Do get in touch if you would like to review your financial planning.