The strange history of 5 common UK tax rules

table of wedding gifts

Terry Pratchett once wrote that “Taxation is just a sophisticated way of demanding money with menaces.”

Trying to get your head around the tax laws can trouble even the most mathematically minded. Rules have evolved in all sorts of weird and wonderful ways over many centuries – indeed, there have been three different versions of Inheritance Tax (IHT) in the last 50 years alone!

Some of the current rules can look a little bizarre on first glance. So, here’s the background to five of the stranger tax rules and regulations, and what it has to do with the railway pension scheme and the humble flapjack.

1. The wedding gifts exemption for Inheritance Tax

The modern framework for paying tax on death was established back in 1894. Through various incarnations of Estate Duty it remained broadly intact until 1975 when the Labour chancellor, Denis Healey, introduced the “Capital Transfer Tax”.

One significant new rule under this Act was to establish that there was no time limit for lifetime gifts. The intention was that all gifts made in your lifetime, with a few exemptions, would be taxed.

Considering that this restricted lifetime giving – particularly families passing on businesses – Nigel Lawson introduced a new Inheritance Tax (IHT) in the 1980s.

Section 22 of the Inheritance Tax Act 1984 introduced a specific IHT exemption for “gifts in consideration of marriage” (later amended by the Tax and Civil Partnership Regulations 2005 to also include “civil partnerships”).

This law allowed individuals to gift a certain amount on the event of a wedding (or civil partnership) and for this money to fall outside their estate immediately:

  • £5,000 to a son or daughter
  • £2,500 to a grandchild of great-grandchild
  • £1,000 to anyone else.

Interestingly, despite more than 35 years elapsing since this new law came into force, these amounts have never changed.

2. VAT on Jaffa cakes and flapjacks

Since McVitie’s introduced the Jaffa cake in 1927, Brits have enjoyed the curious mixture of Genoise sponge, orange jam, and chocolate coating.

Did you know that every McVitie’s Jaffa cake is produced in Stockport, and the production line is more than a mile long?

Back in 1991, the humble Jaffa cake found itself at the centre of a court row between manufacturer McVitie’s and HMRC. Under UK law, biscuits covered or partly covered in chocolate are standard rated for VAT (so 20% VAT is payable). However, chocolate-covered cakes are zero rated.

McVitie’s argued that a Jaffa cake was a cake, as:

  • The ingredients were regarded as similar to those of a cake
  • The product hardens when stale, as a cake does
  • The texture was that of a sponge cake.

Despite HMRC’s arguments, McVitie’s successfully argued that a Jaffa cake was a cake, meaning that VAT is not paid on Jaffa cakes in the UK.

A similar issue reared its head in early 2022 – and this time it was the flapjack in the firing line.

A judge ruled that a range of 36 flapjacks manufactured by Glanbia Milk was so full of toppings and extra ingredients that they could no longer be described as traditional flapjacks and were not something anyone could eat at “celebratory functions”.

So, they were judged to be confectionary, and not “cakes”. The judgement is likely to cost the manufacturer millions of pounds because it relates to flapjack sales between 2016 and 2018.

An HMRC spokesperson said: “HMRC accepts that a traditional flapjack can be treated as a cake and zero rated. However, a product that contains different ingredients and, for example, has been developed as a sports nutrition product, falls to be confectionery and is standard rated.”

3. Why you can take 25% of your pension pot tax-free

When you retire, you can usually take 25% of your accumulated pension pot free of tax. But why is this?

This dates back to 1909 when the civil service lobbied for parity with the railway pension scheme, which provided a tax-free sum for widows. The Inland Revenue was asked for advice and, as its staff were set to benefit, supported the initiative.

When the Finance Act of 1956 introduced “retirement annuities” there was no provision for this facility. However, after 14 years of commercial pressure to match the civil service scheme, the rules were standardised and, by 1970, all schemes qualified.

4. The “seven-year rule” for gifts and IHT

As you read above, the Labour government introduced Capital Transfer Tax in 1975 with no time limit for gifts. All gifts made in an individual’s lifetime would be taxed.

On consequence of this was that it was a major problem for the Inland Revenue, who suddenly had to maintain records for the lifetime of taxpayers. So, it was pressure from the Revenue that persuaded the government to introduce the seven-year rule, whereby gifts made more than seven years before death would not count.

A 2019 review by the Office of Tax Simplification recommended that the time should be cut to five years but, so far, the government has been reluctant to reform the tax.

5. Why you only have nine months to sell your home and avoid Capital Gains Tax

If you buy a new home before you sell your previous one, you will typically only have nine months to sell your previous property before Capital Gains Tax (CGT) will be due. If you don’t, you could end up paying 18% or 28% CGT on gains made on your old home, depending on your own marginal Income Tax rate.

The reason the nine-month period exists is that HMRC understand you may need this flexibility when you move because, when you buy your new home, it can take a long time to sell the old one.

Historically, you used to have three years grace – but you have the MPs expenses scandal to blame for the shortened time frame.

The 2009 scandal uncovered that MPs were using this rule to gain CGT relief on both their London and constituency homes, saving a significant sum in tax. Consequently, the rules were changed for everyone.

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Please note

This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.

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