Six crazy tax rules brought in by politicians – and why we were saddled with them

Britain’s tax law is full of seemingly inexplicable quirks. Many baffling rules arise from the longforgotten circumstances that prevailed at the time they were introduced. Here are some of the most obvious examples.

1 WHY WE CAN TAKE 25PC OF OUR PENSION TAX FREE

This goes 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, unsurprisingly, it was very supportive. After all, its staff were set to benefit.

When retirement annuities were introduced by the 1956 Finance Act for the private sector, there was no provision for this facility. However, 14 years of commercial pressure to match the civil service scheme eventually prevailed, and by 1970 all schemes qualified. Nigel Lawson, as chancellor, tried to abolish the relief, but failed. He complained that he had faced “the most astonishing lobbying campaign of my political career”.

2 WHY WE HAVE SUCH STRANGE TAX RATES ON DIVIDENDS

In the 1960s, companies financed themselves extensively by borrowing, rather than by raising money from shareholders. This was largely because they received tax relief on interest payments, but not on dividends. This made some companies vulnerable to an economic downturn.

In 1972, the government introduced Advance Corporation Tax ( ACT), which effectively provided companies with tax relief on dividends paid. Following the 1997 election, Gordon Brown announced the abolition of ACT. This policy was to raise £5bn a year from private- sector pension funds by taxing their dividend income, although his poorly informed backbenchers cheered what they thought was the abolition of a tax.

Dividends are still taxed at a lower rate than other income, but the figures are seemingly random: 8.75pc, 33.75pc and 39.35pc. Rates are again too high to prevent the problems identified 50 years ago and history could repeat itself.

3 WHY INVESTMENTS CAN BE TAXED EVEN WHEN THEY MAKE A LOSS

Single- premium insurance policies, frequently referred to as bonds, can offer an attractive way to invest. They allow you to take up to 5pc a year without tax because it is treated as a return of capital. However, if you exceed that amount, the surplus is taxed as income even if the policy has not made a profit.

This draconian treatment arises from the introduction of wholly excessive anti-avoidance legislation and can lead to some very unfair results.

4 WHY YOU GET JUST NINE MONTHS TO SELL YOUR HOME AND AVOID CGT

You have an overlap of nine months after you buy a new home before the sale of your previous one attracts capital gains tax. People need this flexibility when they move because when you buy your new home, it can take a long time to sell the old one.

The grace period used to be three years, which better reflected the practical problems people can encounter. It was shortened following the MPs’ expenses scandal in 2009, when this newspaper exposed the way MPs were using the rule to gain CGT relief on both their London and constituency homes.

5 WHY WE HAVE TO WAIT SEVEN YEARS BEFORE GIFTS BECOME FREE OF INHERITANCE TAX

When IHT was introduced by the Labour government in 1975, there was no time limit for gifts. The intention was that all gifts made in your lifetime, with a few exemptions, would be taxed.

This was not only incredibly harsh for taxpayers, but also created a major headache for the Inland Rev enue, which was required to maintain records for the lifetime of taxpayers.

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.

6 WHY THERE IS AN EXTRA IHT EXEMPTION FOR FAMILY HOMES

This stems back to October 1 2007, when the then shadow chancellor, George Osborne, told his party conference that the next Conservative government would raise the IHT threshold to £1m. “This means we will take the family home out of IHT,” he said. It was a ploy to unsettle Gordon Brown, who planned to hold a snap election, and it worked, because he called it off.

By 2010, the economic situation had changed vastly and Mr Osborne, as incoming chancellor, abandoned his promise and blamed it on his coalition partners. The £175,000 “residence nilrate band” is simply a weak attempt to live up to his original promise.