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Budget 2008 - Tax measures in the pipeline


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Chancellor Alistair Darling has followed his predecessor Gordon Brown in the practice of pre-announcing a variety of tax measures that will take effect following Budget 2008.

Capital Gains Tax - Darling's debacle

In his Pre Budget Report in October 2007, Alistair Darling announced plans to radically simplify Capital Gains Tax (CGT). Unfortunately he also succeeded in making it more expensive for most of those likely to pay it - setting out a flat rate charge of 18%.

In the wake of the 'outcry' from small business, he revised his plan to introduce a 10% rate for small business entrepreneurs up to a cap on lifetime gains of £1 million.

However, this still penalizes more than 270,000 Save As You Earn employee shareholders - almost 16% of the 1.7 million employees who participate in such schemes - according to ifs ProShare, the not-for-profit organisation that supports employee share ownership in the UK.

The current CGT regime means that basic-rate taxpayers who have held shares in their employer for at least two years are liable for a 5% CGT charge on any gains in excess of £9,200. From 6 April 2008, they will be required to pay an additional 13% tax on any gain above the nil rate band.

For entrepreneurs, qualifying gains will be either the disposal of all or part of a trading business carried on alone or in partnership, or the sale of shares in a trading company or holding company of a trading group, provided you own 5% of the company and work in it as an employee or officer.

Is this an embarrassing climb-down by the Chancellor or does it merely reflect a minor change to appease protestors?

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Alistair undone by 'non-doms'

The Chancellor has also been forced to step back from his proposed tax clampdown on resident non-domiciles (non-doms) after warnings that many wealthy foreigners were preparing to quit the UK.

The advantageous tax regime for non-doms has brought an estimated £125 billion in investment and business into the UK. Mr Darling's plan to make them disclose details of their offshore income even if it was not being remitted in the UK had left many considering a new country of residence.

Alistair Darling has now confirmed that these individuals will not be required to disclose any offshore income. However, they will still be liable to pay the £30,000 levy set out in the Pre Budget report. Mr Darling hopes to raise £800 million form the fee.

However, the Chancellor's retreat here may already be too late. According to a survey by Society of Trust and Estate Practitioners (STEP), more than £40 billion of investment could be lost from the UK.

The furore over non-doms highlights an old problem in fiscal policy - the difficulty of taxing the super-rich without having the opposite effect to that intended - ending up making the public purse poorer rather than richer.

Why higher tax rates don't mean higher tax take

In 1978, when the top rate of tax was 83%, the top one per cent of earners paid 11% of the total income tax take. The top 10% paid around 35%. By 2001, with the top rate of income tax at 40% (since Nigel Lawson's Budget 1988) the top one per cent of earners were paying 23% of the total income tax take and the top 10% more than half.

Lower rates of tax lead to a virtuous circle of wealth creation, creating more top earners and a bigger tax take overall. If the tax system becomes too onerous, then the law of diminishing returns kicks in. The rich who can live where they like, will move abroad; the economy attracts less foreign talent; wealth creators become less inclined to create wealth since they keep less of it. The outcome is a falling tax take.

These facts have always been a fly in Labour's ointment.

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Income tax cuts - Brown's last hurrah

It's been a long time coming and, no doubt, will be re-announced with fanfares - Gordon Brown's last hurrah in Budget 2007 was to announce a cut in income tax, taking the basic rate down 2p in the pound from 22% to 20%. However, the measure was not to take effect until 6 April 2008.

It's also not as generous a move as it might appear. Alongside the cut in the basic rate is the abolition of the 10% starting rate of tax, which Mr Brown himself introduced in Budget 1999.

The 10% rate had actually been a Manifesto pledge by Labour in the 1997 General Election which brought the party to power, "Our long-term objective is a lower starting rate of income tax of ten pence in the pound."

Priorities have obviously changed. The abolition of the starting rate will, in fact, mean higher tax bills for some pensioners and young workers on the minimum wage. Although the 10% band covers only the first £2,230 of taxable income its abolition will leave those with incomes between £5,435 and £15,000 worse off. For example, those with an income of just £7,000 a year could see their tax bill rise by an eye-watering 76%; surely not the way to end poverty?

As a sop Mr Brown also announced plans to boost the tax-free age-related allowances for pensioners while those over the age of 25 and in work will benefit from higher Working Tax Credit. Those singletons under 25 and those retiring before 65 appear to have been thrown to the wolves.

How the income tax changes hit pension planning

For the tax year 2008 / 09 there are important changes for contributions paid into pension funds as the basic tax rate falls from 22% to 20%. As a result of the tax cut, you'll get less 'bang for your buck' in pension contributions. A total of £3,600 (gross) may be paid into a pension scheme on which tax relief can be reclaimed irrespective of earnings.

For example, in the tax year 2007 / 08 you may pay up to £2,808 every tax year into a pension plan irrespective of earnings and enjoy the favourable tax advantage whereby for every £78 invested, the Government contributed £22.

However, the basic tax rate will fall for tax year 2008 / 09, which means that pension contributions payable to the pension scheme will equate to 80% of the gross contribution you wish to pay meaning that the scheme will reclaim 20% on your behalf. As a result of the decrease in basic rate tax the £3,600 gross contribution will cost you £72 more in the tax year 2008 / 09.

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Council tax - lowest increase since Labour came to power

Council tax is not a Budget measure but it is still massively affected by central Government decision-making. In fact, one of the main reasons council tax has shot up over the last decade is Ministers' desire to take the credit for launching popular policies like free bus travel, for which cash-strapped local authorities then have to pay for..

In Budget 2006, Gordon Brown proudly declared that people over 60, and the disabled, would be able to travel for free on any local bus across England thanks to the additional funding that he was making available.

The accompanying press briefing quoted Alistair Darling, then Transport Secretary and Mr Brown's successor at the Treasury, at length. "More freedom and more choice for millions of people," he boasted.

The only mention of finance was in the footnote where it was pointed out that the Government was making available funding of "up to £250m". It wasn't enough. Not by a long shot. Such 'grandstanding' leaves councils in an invidious position - either they cut other equally important services in order to honour Government policy or they raise council tax bills further.

What they cannot do, however, is ask Mr Darling for additional funding - the Government will maintain they have made funds available, take the political credit and then look for another initiative without giving adequate consideration to the financial implications.

This year, according to a Times / Chartered Institute of Public Finance & Accountancy poll of local authorities, the average council tax increase in April will be around 3.9%. However, this masks a wide range of figures with 92 councils setting rises above 4% and 12 above 5%.

The typical annual cost for a Band D property will be £1,372 - virtually double where it stood when Labour came to power in 1997. That so many increases are clustered around 4-5% is not a coincidence. Ministers have made it plain that any council passing a rise above 5% is at risk of being formally 'capped' - a declaration that made 5% the informal cap as far as many councils were concerned.

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Business Taxes - Arctic outlook

The full rate of corporation tax for businesses will decrease to 28% but the small companies' rate will increase to 21% and then 22% as of 1 April 2009. Purchases of intellectual property, goodwill and other intangible assets will still qualify for a tax deduction equivalent to the amortisation or impairment loss charged to the profit and loss account; a flat rate of 4% may be elected alternatively.

In Budget 2007, Gordon Brown raised the tax rate on smaller companies but claimed he was compensating for that by raising capital allowances - allowing, so he said, for revenues to be recycled to "legitimate businesses investing for the future". Can we put our faith in the wisdom of the state to know what businesses are "legitimate" or not, or indeed what "investing in the future" might actually mean?

At the bottom of the corporate chain is the attack on husband and wife firms. After being defeated by the Law Lords in the Arctic Systems Ltd case - in an effort to tax dividends paid out to spouses as if they were income, the government is now attempting to introduce a cumbersome set of rules to combat what it calls 'income shifting' that will force couples to assess exactly what contribution each partner makes to the business. Anyone whose spouse answers the phone will have to come up with some way of proving their contribution, or else face a higher tax bill.

The Government's approach is not conducive to effective, sustainable, transparent and robust policy formation, according to the Association of Chartered Certified Accountants (ACCA). ACCA is also worried about the implications for financial confidentially, which is still an issue for some spouses who are not prepared to share their income details.

The Government's proposals will target all jointly-owned businesses, and family businesses in particular: if profits are not shared out in what the tax man sees as a "commercial" way, there could be a heavy tax penalty to pay.

Chas Roy-Chowdhury, head of taxation at ACCA, says, "We are concerned that proposals could bring about the effective end of independent taxation. Whether they want to or not, spouses will need to discuss openly with one another what income and taxes each is attributed in order to ensure they are not caught by the legislation.

"The Government now seems to be proposing a much higher burden of proof and record keeping requirements for family businesses - this is an especial burden for small business. The net result would be that there would be very little additional exchequer gain from this measure, yet it will create significant burdens on small businesses."

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ISAs become easy, at last

New rules on Individual Savings Accounts (ISAs) take effect on 6 April 2008. It's been a long time coming but at last the ISA regime is being made simpler. Each adult will have an overall allowance of £7,200 each tax year. Up to half of this, £3,600, may be invested in a cash ISA.

Your options will be to invest £7,200 in a stocks & shares ISA or invest up to £3,600 in a cash ISA and invest the balance in stocks & shares. There will no longer be all the maxi, mini palaver that has confused people since ISAs were first introduced in 1999.

At the same time, existing Personal Equity Plan investments will automatically become stocks & shares ISAs and be subject to the ISA rules. Child Trust Funds, when they mature, which the first will do in 2020, may be rolled over into ISAs

You will be able to transfer your previous years' cash ISAs into stocks & shares ISAs without affecting your annual ISA allowance. You may also transfer your current year's cash ISA into a stocks & shares ISA provided you transfer the whole amount. Crucially, however, you may not transfer stocks & shares ISAs into cash - perhaps an unfortunate omission given the stock market's recent volatility.

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Driving a harder bargain

Fuel duty is set to rise by 2p on 1 April 2008. However, Mr Darling has been receiving pleas from all sides to scrap the proposed increase which was announced last year by Gordon Brown.

An open letter to the Chancellor published in the Daily Telegraph noted that, "At 50.35p a litre, UK fuel duty for diesel and petrol is already the highest in Europe. Indeed UK diesel duty is double the EU average rate of 25p a litre. The Chancellor now plans to increase this by 2p per litre from April 1.

"Such an increase will generate further serious difficulties for the transport and forecourt industries, business drivers, those dependent on the car, and for businesses or individuals in remote or rural areas with no alternative transport options."

AA president Edmund King added, "Our analysis shows that the Chancellor has already bagged an unexpected windfall of more than £4 billion from motorists and the oil industry in the last 12 months and therefore even if he scraps the threatened 2p per litre increase, he would still be £3 billion better off.

"The record pump prices are already hitting those on low incomes, rural, disabled and many car-dependent motorists, so an extra increase would be unjust, unfair and unnecessary."

Accountants Grant Thornton, say the Government could afford to forgo the increase because a surge in the price of crude oil had delivered an extra £1.2 billion in revenue from North Sea oil operators above that forecast in the Pre Budget Report last October. Mr Darling, who increased duty by 2p per litre in the autumn, is planning another increase in 2009.

Given shortfalls in revenue elsewhere, the calls to scrap the duty increase may fall on deaf ears.

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12 March 2008 © Moneyextra.com

 

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