Grant Thornton calls for clarification and certainty in
the 2007 budget
7 March
2007
Today, leading business and financial advisers Grant Thornton
predicts that the forthcoming Budget is likely to be 'steady as it
goes' as the Chancellor seeks to display his credentials as Prime
Minister in waiting. However, Grant Thornton also highlights that
there are many unanswered questions that need resolving to keep
UK's economy on track.
Francesca Lagerberg, Head of Grant Thornton's National Tax Office
comments, "In what is sure to be Gordon Brown's last Budget as
Chancellor, he will be seeking to reassure the country that he is
the man to take over from Tony Blair as Prime Minister. It is
unlikely that we will see any drastic and unexpected legislation
that would enrage his potential supporters. Last year's Pre-Budget
Report has already set out the key agenda for the Budget on 21
March but the Chancellor should take the opportunity to offer
further clarity on these issues and set in train research to
deliver a better UK tax system."
HMRC Powers and Filing Deadlines
Since the merger of Customs and Excise with the Inland Revenue
there has been a move towards aligning their powers, coupled with a
concern that the former Inland Revenue might expect to enjoy an
increase to the former Customs and Excise levels. To date the
new-look Her Majesty's Revenue & Customs (HMRC) has been keen
to ensure there is no 'power grab'. The Budget is expected to see
criminal sanctions for serious tax fraud becoming aligned with the
Police and Criminal Evidence Act (PACE). Extensive consultations
with industry and the accounting professions over this issue have
been taking place. The penalty regime for incorrect tax returns is
also under review.
Francesca Lagerberg says, "The new penalty regime will be linked
far more to a taxpayer's behaviour. Those who have made every
effort to submit a correct return but have made a simple mistake
should not be penalised but those who do not take reasonable care
could face tougher penalties than under the current rules. We are
hoping to see in the Budget a clear statement on the missing link
in this consultation which is exactly what those penalty levels
will be for those who miss information off their tax returns or
make other such errors."
Anti-avoidance
HMRC is increasingly concerned to target what it perceives
"unacceptable tax avoidance" being implemented by taxpayers. It has
made a number of public announcements that it will have 'stopped'
such avoidance by 2008 - which is less than 12 months away. Will it
use this Budget to keep pushing that agenda along? The disclosure
of tax avoidance scheme regime introduced in 2004 has provided HMRC
with details of how many planning arrangements work and
consequently enabled HMRC to legislate against them.
Planning in relation to the creation of personal capital losses is
likely to be limited by the introduction of Targeted Anti-Avoidance
Rules. The draft form of the legislation is currently the subject
of consultation and a number of serious concerns have been raised
by interested parties. Whether there is the time (and inclination)
for the necessary amendments to be made before the Budget, remains
to be seen.
Francesca Lagerberg says, "We are expecting a raft of detailed
technical changes in the Budget aimed at known tax schemes as HMRC
seek to tighten the screw on those who undertake aggressive tax
planning. Last week's announcement on sideways loss relief relating
to partnerships - which will affect those who have entered into
film partnerships and others - is just one example of how committed
HMRC is to closing down known tax schemes. The issue is whether in
this rush to suppress the resulting legislation will be too wide
and too complex, thus affecting commercial transactions."
Managed service companies
The Budget is likely to include more detail on rules announced last
December in relation to managed service companies (MSCs). The
Government finally lost patience with these entities which it
believes flout existing tax rules. Its solution is that anyone
working within these structures should become a deemed employee,
with the company having to pay the necessary tax and NICs.
The proposals only relate to MSCs and not personal service
companies (PSCs), which are the more traditional structures for
owner-managed businesses. Essentially, the difference between MSCs
and PSCs is that the MSCs are invariably not controlled by the
worker, whereas the PSCs are.
As these rules are expected to come into force from 6 April 2007, a
number of MSC providers may be caught out. Those taxpayers who have
'sleepwalked' into these structures without really understanding
the full tax implications may also have a nasty shock.
Furthermore, proposals issued in February 2007, provide for new
rules for any liabilities to tax and NIC that remain unpaid, due to
the MSC ceasing to trade etc, to be transferred to an appropriate
third party. This could leave employment agencies and recruitment
bureau with an unexpected tax bill.
The use of MSCs has only arisen because of the differentials which
arise in the UK tax system between those who are employed and those
who have operate via a corporate structure.
Francesca Lagerberg says, "The Budget is likely to allude to the
MSC rule changes in a positive light but they are just a sticking
plaster for a much broader issue which arises from the different
tax system that applies to the payment of dividends. A better
overall solution is for the Government to reinvigorate its review
of the taxation of small business and seek better long-term
answers. The type of legislation embodied in the new MSC rules is
fraught with complexity and can lead to unintended consequences.
What is needed is a more radical review that encompasses other
problem areas such as the rules relating to IR35 and employment
status in general."
Relief for first time home buyers
Tax partner, Ian Luder, believes there could be a significant move
in Stamp Duty Land Tax (SDLT) thresholds.
"Much like Inheritance Tax, SDLT thresholds have not kept up with
inflation and the UK's booming property market, and first time home
buyers have been unwittingly caught in its net. SDLT was not meant
to capture the lower end of the market so I would expect that the
Chancellor could offer a nil rate to homes under £250,000 and this
may well be funded in part by introducing a new higher rate of 5%
on homes over £1m. Of course this would then be touted as real help
to first time home buyers jumping onto the property ladder."
Residence and non-statutory guidance
The rules relating to when an individual is regarded as resident in
the UK, and therefore liable to UK tax on income arising here, have
been examined again recently in the Gaines-Cooper v HMRC case. This
highlighted that the useful guidance provided by HMRC in this area,
upon which taxpayers rely, is not enshrined in the legislation.
This has raised concerns as to whether this is sufficient to
provide the clarity taxpayers need as such guidance does not have
the force of law. Despite reassurances from HMRC this January that
its guidance is sufficient, there is concern that something more
concrete is needed than is embodied in statute.
The Gaines-Cooper v HMRC case also examined Mr Gaines-Cooper's
domicile and those domicile rules have been under review for a
number of years now.
Francesca Lagerberg comments, "It is unlikely that we will receive
any proposals concerning changes to the domicile rules. As
non-domiciliaries contribute significant wealth to the economy, the
Treasury is unlikely to rock the boat at the current time, but with
the promise of a review in the background, the future of the tax
rules remains uncertain for this group.
Equally on the issue of tax residence, there is unlikely to be any
political desire to force through any changes at this stage. The
issue of residence and domicile has been under review since 1988
and nearly two decades later we are still not much further on. This
is a tax problem that fits very firmly on the 'too difficult
pile'."
Richard and Judy case
The case last summer of Madeley & Another v HM Revenue &
Customs, heard by the Special Commissioners, focused attention on
official estimates that the Treasury is missing up to £150 billion
in tax revenues. Television entertainers Richard Madeley and Judy
Finnigan claimed that they should be able to offset their agents'
fees against income tax, in the same way that many other
entertainers do. The case centred around the fact that actors,
musicians and dancers can claim agents fees as a legitimate expense
but that other entertainers, sportsmen and authors are unable to
write off the cost of their agents' fees.
Francesca Lagerberg comments, "Since Richard and Judy won their
case against HMRC, other entertainers have been carefully watching
any moves from the Treasury to see if the legislation will change.
As estimates have been made that the Treasury is losing hundreds of
billions of pounds in income tax revenues, we are likely to see new
measures brought in to ensure that the Treasury receives what it
considers is due. It could be that new measures will have far
reaching effects in the entertainment world. For example, many well
loved household names are self employed for tax purposes so any
amendment to rules around the employment status of entertainers
could well affect those in the public eye."
Pensions
As a result of the consultation process surrounding "Pensions
Simplification" an alternative to annuitisation, known as the
Alternatively Secured Pension (ASP), was introduced following
concerns raised by certain religious groups. Although this did not
allow for the payment of a cash lump sum to beneficiaries, it did
provide for residual funds, generally referred to as "left over
funds", being transferred to pension funds of other members.
As a result of anxiety concerning tax leakage, HMRC has sought to
place restrictions on the benefits that could be available from
using ASP. Firstly, this was done by applying Inheritance Tax to
the left over funds passed on to other members. This appears to
have been accepted by investors as a reasonable approach but it
gives rise to some practical issues, particularly for scheme
pensions. At the Pre-Budget Report (PBR) in December 2006 it was
proposed that transfers of left over funds would be treated as
unauthorised payments and subject to tax penalties of up to 70% and
the residual 30% of the fund would then be subject to Inheritance
Tax. With the residual fund then being transferred into the fund of
another member, when that member took the benefits, 75% would be
paid as income and subject to income tax of up to 40%. It could,
therefore, be argued that the overall tax applying as a result of
the transfer is at a level approaching 88%.
In relation to the pension regime Richard Harwood, Client Service
Director and Head of Designated Pensions Specialists, says, "There
is still a significant amount of the pensions legislation that
remains unclear and certain areas really need to be straightened
out. In particular the rules on death and the £1.5 million lifetime
allowance cap need to have further legislation and it is highly
likely that this will be announced on 21 March."
National Insurance Contributions (NIC)
At the time of last year's Budget, we were told that the Government
would conduct a review into aligning income tax and national
insurance and this would be consulted on after the Pre-Budget
Report. This review has yet to happen and although we may hear an
update on progress it is unlikely that Gordon Brown will announce
any radical alignment of the two systems as this would force him to
admit that NIC is in fact a tax, not a contribution. An increase in
the upper threshold of NIC could break Labour's pledge not to raise
income taxes.
Even so, it is possible that a new "super rate" of 2% NIC could be
announced for higher rate earners. However, with more taxpayers
entering the higher rate band owing to fiscal drag, this is likely
to be an unpopular move. Perhaps this is too risky at a time when
Mr Brown is looking to consolidate his position.
Trusts
HMRC has already announced an intention to correct two unintended
consequences of last year's dramatic and unexpected changes to the
trust regime. Grant Thornton hopes that some lessons will have been
learnt. Legislation enacted in haste and without proper
consultation usually requires remedial work in a short period of
time.
This will hopefully prevent any changes to the Inheritance Tax
rules, even though they are ripe for reform and have been for the
past 10 years. For example, many households could be taken outside
the inheritance tax net if a main residence exemption was
introduced, similar to the capital gains exemption for the main
residence. Nevertheless, Grant Thornton believes such reforms
require in-depth consultation and should not be pulled like a
rabbit from a hat on Budget Day.
Dogs that won't bark
It also seems unlikely that the effects of fiscal drag will be
addressed with above-inflationary increases to allowances and
reliefs to correct the impact of previous changes despite the
announcement that the Government has received the highest amount of
income tax in January 2007 since records began in the mid - 1960s.
Grant Thornton questions whether the time is now ripe for the
Government to move income tax thresholds so that they increase
annually in line with earnings rather than at the lower rate of
increase of the retail prices index.
As has been recently highlighted, the Treasury now collects twice
as much income tax revenue compared to before Gordon Brown became
Chancellor, despite a decrease in the basic rate of income tax and
the introduction of the 10% starting rate of income tax. It is
expected that in the 2006/07 tax year, the Treasury will collect
£141 billion compared to £69 billion in the year before Labour came
to power.
Mike Warburton, tax partner, comments, "The UK is now a high tax
society, and ultimately this will damage the economy. The more that
individuals are taxed, the less willing they will be to work and
consequently will have less disposable income which naturally will
have a knock on effect on the economy".
With Gordon's new role on the horizon, headline-grabbing changes
are not anticipated in this Budget, instead tinkering with the
nitty-gritty of the tax legislation seems likely which may not make
for big news but, if badly thought-out, could have an explosive
impact further down the line.