Chancellor will find it hard to please business at Budget
Faced with growing unrest from business and the City, the
Chancellor's Budget must allay fears that the UK is becoming
uncompetitive and promote measures to encourage growth, against a
backdrop of an estimated £2 billion overshoot in current year
public borrowing , says leading financial and business adviser
Grant Thornton.
Stephen Quest, tax partner at Grant Thornton, does not hold much
hope for a dynamic first Budget from Darling, but believes UK
business may expect a few treats to help build bridges after the
recent fallout from capital gains tax (CGT) simplification and
non-domicile (non-doms) and residence reforms.
Quest asserts, "The rushed announcement of the changes to
capital gains tax and the taxation of 'non doms', followed by a
major climb down in the face of fierce criticism, means that we are
likely to see a more cautious approach from the Chancellor towards
business taxation in this Budget. After the last few months, the
Chancellor will be largely looking to hold the ship steady."
Quest continues "Mr Darling will be desperate to establish his
credentials as a business-friendly Chancellor. It's going to be a
tough year for business: the economy is slowing and tighter lending
conditions means the frantic market activity from past years has
softened. Within a broadly neutral Budget, we expect to see a
package of measures for start-up funding and growth businesses,
which will be financed by a further clampdown on tax
avoidance."
UK competitiveness
According to Head of International Tax at Grant Thornton, Joy
Svasti-Salee, the UK has gradually slipped behind its global
competitors as a key place to do business.
"The UK has a high corporation tax rate when compared with the
other major European countries. The move to 28% from 30% from 1
April 2008 was a good first step, but the Chancellor needs to go
further, perhaps to a rate of 25%."
"With a 28% corporation tax rate the UK ranks 18th in terms of
competitiveness amongst the 27 European Union Member states. The
average rate for the EU 27 is 24.5%. By aiming towards the EU
average corporation tax rate, Darling would bounce the UK up four
places to 14th which would make it far more attractive to larger
corporates."
Svasti-Salee goes on to say that the UK benefits from being a
less bureaucratic place to do business than France, Germany or
Italy and has also avoided the regulatory overload that has left
the US with excessive regulation and associated high costs.
"The UK tax system needs to imitate the regulatory environment
and become more competitive. The proposed changes to the taxation
of foreign profits, under discussion since last summer and due to
be introduced from April 2009, present a real opportunity for the
UK to move into the premier league."
Heather Self, international tax partner at Grant Thornton, adds:
"Bringing in a dividend exemption system would be a real win for UK
business - but if it is accompanied by detailed red tape, any
advantage will be frittered away."
Simplification of the corporation tax
rate
At Budget 2007, small and medium businesses (SMEs) cried foul at
the increase in their headline rate of tax from 19% to 20% in April
2007 with further movement to 22% by 2009. Their pain might yet be
exacerbated.
"The last few months have been difficult for UK heartland
business," says Ruth Dooley, tax partner at Grant Thornton. "SMEs
were forced to endure a 1% rise in their headline rate of tax in
April last year and the change to an 18% flat rate of CGT for
individuals and unincorporated businesses took everyone by
surprise. If Darling is to follow his simplification agenda, then
his next target might be to align the corporation tax rates of all
companies operating in the UK."
"The outpouring of anger from the SME community would need to be
balanced against the gains of goodwill and associated economic
growth from large business which would look to the UK as a
competitive jurisdiction in which to base its operations. On the
face of it, the loss of revenue from large corporates would not be
balanced by gains from SMEs from this rate change. However, if
companies invest in the UK as a result of a competitive corporation
tax regime, then the change could prove to be self-financing in the
longer term."
Dooley says that a drop in the corporation tax rate would
require short-term measures elsewhere to recoup the lost billions
and that, "A single corporation tax rate would bring about a great
deal of simplification in the corporation tax regime such as
removing the need to consider whether companies are associated when
claiming the reduced rate of corporation tax for small companies
and removing the need to consider transfer pricing in a UK
context."
"Darling has been aggressive in his pursuit of simplification
and the CGT backlash does not seem to have dented his confidence or
ambition. The corporation tax headline rate is an obvious and high
profile measure, and one which could begin healing, to some extent,
his relationship with the City and big business which has been
fractured thanks to the attack on non-domiciled individuals.
However, such a bold move might be too radical for a Chancellor
looking to restore business confidence."
Green taxes about to make a dent on
business
Environmental taxation seems primed to be a key battleground
between political parties, yet fails to deliver at each Budget and
Pre-Budget Report with consecutive chancellors espousing their
green credentials yet doing little with tax policy to help the UK
meet its carbon reduction targets.
Maurice Fitzpatrick, senior tax manager, predicts that this
Budget will be different and says, "Darling will ratchet up green
taxes on UK business not least because it is an area in which he
has room for manoeuvre in terms of providing a boost to the public
finances. I anticipate a 'tax on the polluter' will be used to
encourage companies such as retailers and manufacturers to curb
their use of excessive product packaging. There is growing public
awareness and support in tackling this issue."
Since Labour came to power, green taxes as a percentage of total
tax revenue have fallen from a high of 9.3% in 1997/98 to sit at
their lowest level in ten years of 7.3% of Treasury receipts**.
Furthermore, this has happened at a time when the UK is seeking to
meet its promises under the Kyoto Protocol to reduce greenhouse
gases by 12.5% by 2008 - 2012 and the Government's own manifesto
pledge to reduce carbon dioxide (CO2) by 20% by 2010***.
"The 20% carbon reduction is a 'pie in the sky' target," claims
Fitzpatrick. "The UK Government is going to fall woefully short of
meeting its target of a 20% reduction in CO2 by 2010. Current
reductions in CO2 amount to only a 6.4% decrease on 1990 levels***.
A ramp up or the introduction of new green taxes seems almost
inevitable this Budget."
Property
The UK property market has been hard hit by the credit crunch.
Lenders have been less willing to lend at levels seen previously
and a number of institutional property funds have restricted the
access to funds by investors.
In addition, the Budget (and related Finance Bill) will see the
introduction of revised capital allowances rules (including the new
"integral features" regime). Broadly speaking, these changes reduce
the amount of annual capital allowances which can be claimed in
respect of property, increasing taxable profits, and at least
partially, offsetting the reduction in the main rate of corporation
tax.
Clare Hartnell, tax partner, comments, "This change will affect
all occupiers of property and increase their annual tax bill. Real
Estate Investment Trusts (REITs) will find that at a time when
borrowing is harder to secure, the reduction in capital allowance
rates will increase the amount of cash which they must distribute
to shareholders leaving them with less funds to reinvest in the
business."
It was announced in Budget 2007 that industrial buildings
allowances (IBAs) would be phased out. However, there has not been
sufficient detail provided on a timely basis about the new rules to
enable business to take reasonable decisions based on sensible
expectations of how the rules affect them. Given that the new rules
come into force from 1 April 2008, detail in this area is long
overdue.
On a more positive note the introduction of legislation allowing
Property Authorised Investment Funds access to a similar tax regime
to that afforded to REITs (i.e. broadly moving the tax point to
investors) will enable them to compete in the retail investment
market on a more equal footing.
Other issues
There are a number of other issues which require clarification
in this Budget.
1) Capital gains tax changes will also affect corporates
Although the introduction of a flat rate of 18% relates to the
taxation of individuals, there are also wider implications for
corporates.
Favourable tax breaks are available for companies who
incentivise their employees with company shares. However, the new
CGT regime that comes into force on 6 April 2008 is likely to
increase the CGT payable by these employees when they come to
dispose of their shares. We wait to see whether the Chancellor will
provide any additional relief for the participants of these schemes
to encourage companies to continue using the initiatives.
2) Missing trader intra-community fraud (MTIC)
MTIC fraud, or carousel fraud as it is commonly referred to, has
not attracted the same levels of controversy in recent months, but
the authorities' hard line stance against those caught up in such a
carousel means that they remain on a collision course with innocent
businesses.
3) Corporation tax simplification - being
"associated"
In terms of simplifying corporation tax, a change is expected to
the rules for calculating the rate of tax when companies are
"associated". Companies can be treated as associated when
shareholders in different companies are partners in a partnership.
Despite HM Revenue & Customs' stance against film partnership
structures, there is strong pressure to review the impact on
taxpayers being treated as associated with entities to which they
have little real linkage. There is a limited existing concession
but it is hoped that changes will be announced at this Budget.
One simplifying measure might be to tax commercially-linked
companies on a consolidated basis. This would simplify claims for
loss relief as there would be an automatic offset and remove the
need to consider transfer pricing between companies based wholly in
the UK.
The regime for taxation of chargeable gains has a number of
provisions aimed at ensuring tax is only levied on gains realised
when an asset is disposed of outside a group. Grant Thornton
expects this regime to be simplified to align the tax outcome more
closely to the economic effect for the group.
Quest says, "The rules for offsetting gains and losses within a
group has been a bone of contention for sometime owing to the
inherent complexity. Likewise with the associated company rules.
Business processes have moved on and the regulation governing them
is finally catching up."
Quest concludes, "Given the wave of changes which the Chancellor
has already announced, it is clear that more can be expected in
this Budget. A lot of aggravation has been caused by a lack of
notice. In order to avoid a repeat episode, the Chancellor would be
well advised to provide greater information or defer their
introduction. Business requires certainty and the Chancellor will
not want to further sully his track record."
* Table A3.1 Estimated costs of principal tax expenditures and
structural reliefs, Budget 2007
**Government accounts (table 1.2), latest available 2007
***Defra, January 31 2007