Grant Thornton says new Chancellor's pre budget report
hamstrung by predecessor's promises
Thursday 4 October 2007
Today, leading business and financial adviser Grant
Thornton predicts that the forthcoming Pre-Budget Report (PBR) is
likely to set out a plan of action for Chancellor Darling, but the
room for manoeuvre on any major initiatives will be limited,
leading to yet more tinkering around the edges of current tax
policy.
Francesca Lagerberg, Head of Grant Thornton's National Tax Office,
believes that the spotlight was stolen by Gordon Brown in this
year’s Budget when the then Prime Minister in waiting flexed his
muscle for the top job by making a raft of forward looking changes
which will hamper Darling’s manoeuvrability in the Pre-Budget
Report.
“It’s a shame that the new Chancellor has limited breathing space
as he will be keen to show he is not purely Brown's mouthpiece.
However, the issue of whether there will be a general election
could have a significant bearing on the environment in which the
PBR is delivered. In the absence of a general election, I expect a
Report which will be littered with promises for action and
consultations, without real immediate change. However, that does
not mean it will be dull. Darling has already stated he wants to
put tax simplification on the agenda so he will want to show that
this is more than empty words."
Perhaps the most explosive item in the Pre Budget Report could
prove to be the Government reaction to the husband and wife victory
in the Arctic Systems Ltd case. Immediately after the House of
Lords ruled in the taxpayer's favour, the Government issued a
statement to say it would legislate to over-turn the outcome.
Lagerberg notes: "All eyes will be on the Chancellor to see if he
says anything more on income-splitting. If the Treasury decides to
use a sticking plaster approach and rush out legislation it could
lead to significant burdens on small businesses which would put the
IR35 rules into the shade and lead to great complexity for
taxpayers.
"In addition we can expect some statement on the future of business
asset taper relief and there may well be moves towards a carrot and
stick approach on green taxes with increases for some and new
incentives for going green as well," says Lagerberg.
She continues, "Elsewhere, the fiscal screws are wound too tight
and it will be a case of Darling steering the course already set by
his colleague in Number 10."
Change in the wind for non-domiciles?
Despite the Conservative’s proposal to charge non-domicilies a
one-off charge of £25,000, Grant Thornton does not expect the new
Chancellor to take the bait and make any dramatic changes to the
tax treatment of this group in the PBR. However, the new team at
the Treasury has already stated that this issue is on its
radar.
Tax partner, Ian Luder, believes Darling will signal his intentions
on the issue by refreshing the ongoing consultation – the
longest running Treasury review in history – and, if willing,
tinker with some legislation at the fringes.
Luder comments: “The Government has not signalled on the
non-domicile issue so it would be surprising to see any great
legislative changes in this Pre-Budget Report. However, the rules
on remittances are out of step with personal banking trends,
specifically, the growth of current electronic and online
transactions. These rules may therefore be updated for the 21st
Century.
"What's more, it's now almost a year since the Gaines Cooper case
on residence, and it would be very welcome if the Revenue were to
issue new guidance in this area (currently set out in leaflet IR20)
which can be relied on. IR20 is on its last legs. Will we see
residence tests added to statute?
Tweaking around the edges would not necessarily take all the heat
out of the issue, but it would kick the issue into the long grass
for a while and allow Darling to collect his thoughts before
definitely taking a policy decision on this issue.”
Overhauling CGT for UK assets
Luder believes the Chancellor has an ace up his sleeve with regards
to capital gains tax (CGT) rules on UK based assets. At present, an
individual's residence (and domicile) status determines the CGT
liability along with where the assets are based. There are
circumstances where UK assets are sold but no CGT is due. Luder
believes that change is afoot which would bring the UK in line with
many of its European neighbours.
Luder says, "It's too early for Darling to be taking a hatchet to
the non-dom rules, but there’s a quick win available in that he
could charge CGT in line with the 'situs' rules on property. This
would mean making UK based property liable to UK tax irrespective
of the owner’s residence domicile."
"He can dress this up as bringing the UK into line with its
European neighbours who charge CGT based on the situs rules, gain
some extra revenue for the Treasury and be seen to be dealing with
perceived ‘unfairness’ of the non-domicile rules without ruffling
too many feathers," says Luder.
For example, all UK homes would become liable to UK CGT
irrespective if they are owned by offshore entities. Luder predicts
that such a move would result in individuals' reviewing the
elections of their private principle residence which could help
avoid CGT.
Inheritance tax due for progression?
There’s still much that can be done with Inheritance Tax (IHT) says
Francesca Lagerberg. It is traditionally lambasted as preventing
funds passing down through the generations and the tax-take for IHT
is increasing as more individuals of modest means are drawn into
its net. Since 1997/98 IHT yield has increased by some 135% (£2.3bn
on £1.7bn collected in 1997/98) and is projected to collect £4bn in
2007/08 thanks to the previous Chancellor not raising rates in line
with property prices.
Despite IHT being ripe for change, and the Conservatives saying as
much by pushing the nil-rate threshold up to £1 million and
exempting the family home, Lagerberg does not believe that
Chancellor will make any big moves in this area: "The last few
years have seen some avoidance rules being introduced in relation
to IHT, such as the pre-owned assets regime. However, despite Brown
thinking it was due an overhaul he never went for radical change
and his successor is likely to follow suit."
However, Darling could score with the grey vote by introducing a
'sibling exemption' on main residences along the lines of the
spousal exemption. Citing the Burden sisters' case at the EU Court
in 2006 (where two cohabiting sisters faced the prospect of having
to sell their home to pay the IHT on the first death of either of
them), Lagerberg says the Chancellor could make vote winning
headlines with a move which would have negligible cost.
“IHT is a distressing tax and Darling will not want to preside over
a Treasury that is seen to be throwing pensioners out of their
homes when forced to pay IHT. It would make sense to offer a
sibling exemption that would roll-over the IHT charge until the
death of the second sibling. This would enable people like the
Burden sisters to remain in their family home for as long as they
wished."
The Nil Rate Band exemption has been set up to 2010 although
Darling could make a mark by offering a further small increase.
Furthermore, Lagerberg believes the Chancellor could look to
introduce progressive taxation bands, as seen with income tax on an
individual’s assets, say, 10% or 20% on the bulk of assets of
modest estates and 40% on assets above £500,000. For example there
could be 0% tax on the first £300,000, 20% on following £200,000
and a top rate of 40% rate for anything over £500,000. For
individuals with estates in the £300,000 - £500,000 bracket, it
would halve their IHT bill.
Lagerberg says the main issue here is that people in this wealth
bracket are unlikely to have a large amount of liquid assets with
which to pay the IHT bill and by halving the potential liability
within this bracket from £80,000, to £40,000, the likelihood is
increased that there will be liquid assets available to pay the
liability.
Self-employed couples and family businesses under the
hammer
Following the Arctic Systems case
(Jones v Garnett) heard in the House of Lords this year, the
Treasury will be taking a close look at family owned businesses as
it perceives it is losing a substantial amount of income tax from
the way these arrangements are structured in 'non-commercial'
situations. There has already been a statement to this effect where
the Government has said it wants to close down the ability to
'income split'.
The key issue is how the Government will be able to implement any
change. Senior tax partner, Mike Warburton, says that the most
likely change will be the abolition of ITTOIA 2005 section 626
which is the legislative exemption in the so-called settlements
rules.
“Section 626 concerns the tax exemption of outright gifts between
spouses which are not caught by the trust rules. In 1989, Labour
proposed to remove that exemption giving the Revenue the ability to
treat these sorts of gifts as tax avoidance. It didn't fly then,
but the Government has appetite for change in this area now and the
Chancellor could simply announce this move at the PBR and merely be
enacting a previous Labour recommendation,” argues Warburton.
Warburton continues: “The nub of the issue here is that HMRC
perceive income splitting as tax avoidance, but the reality isn't
that pronounced. The average family business conducts its business
around the clock, whether the family members are picking up the
phone or discussing business matters over the kitchen table. So
it’s notoriously difficult for the Revenue to assess these
operations with the basic rules as they are and I fear that life
may get a whole lot harder for businesses set up in this way under
Labour.”
Climate change - Individuals let off the hook as Labour
flexes its green muscle at business
No longer can the Government sit idle on climate change. Although
the previous Chancellor pledged to take action on the UK's carbon
footprint through the tax system, small tax measures introduced or
modified over the past 10 years have seemingly done little to curb
UK pollution.
Maurice Fitzpatrick, a senior tax manager, expects that there will
be minor increases in Airport Passenger Duty and the like, but that
Darling may look to impose his authority on green matters by
increasing taxes and tax breaks available to industry thereby
instigating - hopefully - a faster decrease in UK carbon
emissions.
Fitzpatrick says, "Joe Public is fed up with continual tax
increases that purport to climate change initiatives. Airport
Passenger Duty has done nothing to greenhouse emissions and many
believe a waste tax is merely a revenue-raiser rather than a
targeted initiative to make any dent in the UK's carbon emissions.
For this reason, and perhaps to carry favour with voters, Darling
is expected to turn to industry to take responsibility towards the
climate. There is a raft of possibilities available to the
Chancellor, but to be sure, he will use the VAT system to great
effect, possibly levying higher VAT on products with excessive
packaging."
"On the other side of the coin he needs to make sure there are
enough incentives that encourage individuals and business towards
going green. He should increase access to R&D tax credits on
green initiatives in energy generation, offer further tax breaks to
developers of carbon neutral homes and reduce stamp duty on
individuals who purchase carbon neutral properties."
Fitzpatrick continues, "To put it in perspective, green taxes as a
percentage of total tax yield have actually fallen from 8.1% to
7.1%, or £34.7 billion since the Labour government came to power in
1997. If just 1% of this amount (£34.7bn) had been invested
directly into building wind farms, enough electricity would now be
generated to power a city the size of Sheffield. Action is needed
and Darling may see climate change as an opportunity to start
building his legacy."
Raising personal allowances
The tax credit system remains in an administrative mess and come
April next year, those with incomes between around £5,000 and
£18,000 are set to become reliant on the flawed system in order to
top up their income thanks to reductions incurred from the
abolition of the lower rate of income tax.
Lagerberg believes that raising the personal allowance above normal
inflation would go some way to fixing a problem created at this
year's Budget without admitting that the Government has adversely
affected some people on low incomes. It could also score political
points by rewarding hard working families as a response to the
Tories proposal of returning to a 'Married Couples
Allowance'.
"Raising personal allowances above inflation would be a quick fix
to those who will find the combination of income tax and NIC
changes next April leaves them worse off.. Some of these people
will be falling back on the tax credit system to make up the
difference but not everyone satisfies the requirements to make a
claim. However, the question is how the Chancellor might finance an
above inflation increase. There is the easy approach of funding
such a change through increases in green taxes although the amounts
in question are not small. The Treasury indicated that changing
personal allowances by £100 would cost £650 million in 2008/09 and
£620 million in 2009/10 and changing age related personal
allowances by £100 would cost £75 million in each of 2008/09 and
2009/10. In total, just under £1.5 billion would need to be found
to finance such a move."
Get progressive on Stamp Duty Land Tax (SDLT)
Luder thinks that SDLT is the best weapon the Government has at its
disposal in helping people onto the property ladder and is
surprised that not enough has been done in this area in recent
times to increase help to first time buyers.
"SDLT is a tidy revenue earner for the government," says Luder,
"And it is unlikely that the new Chancellor would do anything to
harm its earning potential which continues to rocket thanks to
hefty increases in house prices."
Luder says the Conservatives proposals to help first time buyers by
exempting properties up to £250,000, means that if Darling does
move on SDLT, he will not want to be open to the challenge that
he’s copied the Tories. Therefore, he could levy SDLT at different
rates according to the value and number of properties any one
individual may have or levy it in progressive slices much like
income tax.
“SDLT could be levied at a reduced rate of 2% on a first house and
then 5% on a second, thereby offering help to first time buyers and
recouping any lost revenue from the 2% rate when the 5% rate kicks
in on the second property.”
”However, if Darling believed that such a move would fail to
encourage enough individuals to take up a second property, he could
provide a nil-rate band to properties under £250,000, then
progressively increase rates at various amounts until imposing a
super rate on properties over £500,000. Much like income tax it
would tax wealthier individuals, but would be fairer in the sense
that only those with higher valued assets were being taxed at a
higher rate."
Despite these possibilities, Luder expects nothing to change come
this pre-budget report as the market is fragile and is best left
well enough alone until it has settled.
And there's more…
Lagerberg notes that there are a number of other measures that are
expected to surface in the Pre Budget Report.
"HMRC is continuing its review of its existing powers. There is
bound to be some reference to the next steps and there has already
been some concern about whether there are going to be more requests
for powers, such as access to personal bank account information,
without any sign of some overarching commitment to safeguards as
could be set out in a Taxpayer's Charter. This could be a real
chance for the Government to show it is keen to put taxpayers’
rights on the agenda."
As for the alignment of PAYE and NIC, the Government has already
stated in past Budgets that it wants to make moves in this
direction.
Lagerberg says, "Work undertaken by Grant Thornton shows that there
are some long and short term measures that any Government might
want to consider to help make it easier for these two areas to move
closer together. However, employers and employees alike are keen to
see improvements in payroll related administrative burdens and this
is where positive steps forward could be made" says
Lagerberg.
The biggest splash possible
Lagerberg says that despite a lack of immediate policy changes
expected at this Pre Budget Report, it is nevertheless set to be
interesting as it comes at a time where there is turbulence in the
financial and housing markets, and predictions of an impending
recession.
"Brown has presided over a strong economy for the best part of a
decade and has pre-spent a lot of the current Chancellor's money.
He has locked in a number of future tax changes such as cuts in the
larger corporate tax rate and the starting rate of income tax, and
increases in the nil-rate band for IHT. Add to that the
possibility of a recession, the housing market cooling off and
worries about excessive debt and instability in world's financial
markets, it's almost as if the PBR might be like watching an old
Hollywood western where the grizzled veteran thrusts the reigns of
a speeding carriage to a fresh-faced, up-and-coming star and asks
him to make good of his lot. Darling has quite an act to follow but
limited scope with which to proceed."