Update: tax

This was the Chancellor of the Exchequer's 11th and probably final Budget. One constant theme throughout all 11 Budgets has been a propensity for tinkering with taxes and tax rates and this was the case again on this occasion.

The rate of corporation tax paid by the smallest companies has varied from zero per cent to 21 per cent since Gordon Brown took over at number 11 and this year sees the introduction of his highest rate yet of 22 per cent. The 10 per cent starting rate of income tax that Mr Brown introduced in 1999 is now to be restricted to investment income and capital gains, but with a corresponding reduction in the basic rate from 22 per cent to 20 per cent.

Many businesses were incorporated in recent years in response to the zero per cent and 10 per cent corporation tax rates and many of those businesses will now be considering whether to dis-incorporate. The clear message is that this government now wants to dissuade small businesses from incorporating partly because of the perception that they can avoid paying National Insurance Contributions in the company environment by rewarding themselves with dividends. The gap between taking the rewards of entrepreneurship and perceived tax avoidance is narrow!

Overall this Budget did little to reduce complexity although there were a couple of notable exceptions:

• In recent years many people have acquired property offshore for holiday or retirement use. In many of these cases the property will have been owned via a company for reasons unconnected with UK tax planning. The result of using this structure was that the individuals found themselves facing UK tax liabilities on benefits in kind on what were essentially domestic arrangements. This practical problem has been recognised and we are promised a change in the legislation next year.
• Hitherto there has been no consistency in the level of penalties charged for errors and misdemeanours. A new tariff of penalties is to be introduced, ranging from 'suspended sentences' for those who have made relatively low level errors to swingeing penalties for those who set out to defraud the system.

In his final Budget, Gordon Brown beat his previous record for the number of Budget Notes. This year's score card was 81 Budget Notes running to 189 pages, in addition to various other publications, thereby leaving a rather large carbon footprint.

Income tax changes

The basic rate of income tax will be reduced from 22 per cent to 20 per cent from 2008/09.

The 'starting rate' of tax (a 10 per cent band for the first £2,230 of income in 2007/08) will be removed from 2008/09 for earned income and pension income but will remain for savings income and capital gains. There is no proposal to change the dividend tax rates.

The age-related personal allowances for those aged 65-74 and 75 and over will be increased by £1,180 in 2008/09 and by inflation or above-inflation amounts thereafter such that by 2011/12 the age-related personal allowance for those aged 75 will be £10,000.

The Upper Earnings Limit, the income ceiling for National Insurance Contributions (NIC) under both Class 1 (employed) and Class 4 (self-employed), is to be increased by £3,900 in 2008/09. In 2009/10, the basic rate band will be increased by a further £800 above inflation. The aim of these announcements is to align the Upper Earnings Limit and the ceiling of the basic rate band.

All of this means that an employee earning up to about £18,600 with no investment income will no longer benefit from the 10 per cent band so will be worse off. The changes complicate an already complex system of rates and allowances and do not tackle certain anomolies in tax rates applying to dividend income.

Holiday property overseas

It is not unusual for UK resident individuals to acquire property overseas and to structure their investment via an offshore company which owns the property.

The main reason for adopting this route was to avoid the impact of the 'enforced heirship' inheritance rules in those countries or local taxes, rather than for UK tax planning purposes. For example, property situated in France is subject to French succession law whereby children are entitled to a share of the property on death. Individuals buying holiday accommodation in Florida are recommended to use anLLC (US equivalent of private company) to protect against claims from visitors injuring themselves on the property whilst non-Bulgarian resident individuals are not able to own land there directly and so structure the purchase through a company.

Under existing legislation a potential tax charge could arise by virtue of the individual obtaining a benefit in kind by their occupation of the property by reference to the market rent of the property for the whole time that it was available for their use.

The government has announced its intention to introduce legislation in the 2008 Finance Bill which will ensure that individuals who have bought a home abroad will not be liable to a benefit in kind charge for any private use of the property if purchased through a company and whose sole activity is the holding of the property for occupation and/or letting. HM Revenue & Customs (HMRC) will also not pursue any tax liability for prior years.

Corporation tax

In order to maintain competitiveness in the UK, there has been some pressure to match other European countries that have reduced their rates of corporation tax.

With effect from 1 April 2008, the main rate of corporation tax will be reduced from 30 per cent to 28 per cent. This will affect standalone companies and companies that are part of a group, with profits above the upper relevant maximum amount (currently £1.5m).

The small companies' rate will increase from 19 per cent to 20 per cent as from 1 April 2007. This will affect companies that have profits chargeable to corporation tax lower than £300,000. It is proposed that from 1 April 2008 the small companies' rate will increase to 21 per cent with a further increase to 22 per cent with effect from 1 April 2009.

The increase is designed to make it less attractive for smaller companies to pay dividends to their shareholders, but the changes do not achieve that objective.

The upper and lower limits used when determining the small companies' rate remains unchanged.

Business tax reform package

The Chancellor announced major changes to Capital Allowances and Research and Development tax credits.

The principal changes are:

• from 2008/09 the rate of general pool writing-down allowances will reduce to 20 per cent;
• from 2008/09 the rate of writing-down allowances on long-life asset expenditure will increase from 6 per cent to 10 per cent;
• there will be consultation in respect of expenditure on plant and machinery. Proposals include from 2008/09:
• A reduced writing-down allowance for fixtures integral to a building at 10 per cent;
• A new annual investment allowance for the first £50,000 of expenditure on plant and machinery;
• A payable credit for losses resulting from capital expenditure on green technologies.

First-year capital allowances for small businesses

The temporary 50 per cent first-year allowance available for small businesses is to be extended for a further one-year period until 31 March 2008. The rate of first-year allowances for medium-sized enterprises remains unchanged at 40 per cent.

There will be consultation on the reforms to the capital allowances regime and the introduction of an annual investment allowance of £50,000 per year from 1 April 2008. This annual allowance may replace the current first-year allowance system.

Managed Service Companies (MSCs)

From 6 April 2007, MSCs (sometimes known as 'umbrella' companies or 'composites') that are used to provide the services of workers to clients in circumstances where, had there been a direct engagement it would have amounted to an employment, will have to apply tax under PAYE to all income of the workers who have performed the client services, other than allowable expenses. From the same date, the workers will cease to be able to regard client premises as temporary workplaces for travel and subsistence expenses purposes. From 6 August 2007 (assuming Royal Assent takes place before then), NIC Regulations will require Class 1 NIC to be applied by MSCs to all income of the workers other than disregarded expenses.

HMRC will have power to impose the liability to account for the tax under PAYE and Class 1 NIC on certain linked third parties in cases where MSCs fail to comply and possess no tangible assets against which distraint might be applied. The third parties concerned would be the MSC scheme provider, those who direct and or control the MSC or MSC scheme provider and associates of and persons connected with the MSC or MSC scheme provider.

The effect of the new legislation is the likely elimination of MSCs, certainly based in the UK, as suitable vehicles for workers seeking to pay tax at self-employed rates on their earnings.

Recognition of stock exchanges

Legislation will be introduced to allow HMRC to designate certain investment exchanges as recognised stock exchanges for tax purposes. Any exchange defined by the Financial Services Authority (FSA) as a Recognised Investment Exchange (RIE) may be designated in this way.

In addition, a definition of whether or not a share is 'listed' will be introduced.

It was feared initially that this measure was designed to remove unlisted status from AIM-quoted shares thus denying them valuable inheritance tax and capital gains tax reliefs. However since AIM is not an RIE, this fear would appear unfounded at the present time.

A beneficial consequence of a change in recognition of a stock exchange is that shares of subsidiary companies which previously did not qualify for approved share schemes purposes may now do so. In addition, such shares may separately qualify for the statutory corporation tax deduction available for most kinds of employee share awards including unapproved ones under Schedule 23 FA 2003.

Tax relief on personal term assurance

For many years it was possible for individuals to take out personal term assurance policies and, provided premiums paid were within certain limits, they were entitled to claim tax relief.

Following the introduction of pension simplification on 6 April 2006 and the introduction of the lifetime allowance '“ £1.5m for 2006/07 '“ it was possible for a short period of time for individuals to take out personal term assurance of up to £1.5m and receive tax relief on the premiums. This was felt to be too generous and as a result all premiums paid on personal term assurance policies will now be outside the scope of tax relief unless the policy application was received by 14 December 2006 and they were taken out as part of a pension scheme by 6 April 2007.

Where the individual is a member of an occupational registered pension scheme, if the insurer receives the application for the policy by 29 March 2007 and it is taken out as part of a pension scheme before 1 August 2007, relief will continue to be granted. It should be noted that tax relief on employer contributions paid by employers will continue.

Alternatively secured pensions

One of the reasons cited by investors for not taking out a pension plan is that they do not like the thought of taking an annuity at age 75 and then dying shortly thereafter, as their hard-earned savings would be absorbed into the annuity pool rather than be passed on for the benefit of their family.

Pension simplification saw the introduction of an alternatively secured pension on 6 April 2006. In very simple terms this allowed individuals to pass on any residual pension fund after age 75 to other members of the same scheme, albeit subject to inheritance tax (IHT).

The Government made it clear that they did not want pension schemes to be used as IHT planning vehicles and they announced changes to the way that residual funds would be taxed under an alternatively secured pension on 6 December 2006.

The changes are now enacted with the introduction of an income tax charge of 70 per cent followed by an IHT charge of 40 per cent on the residue.

The result of this is that any residual pension fund will be subjected to tax at a rate of 82 per cent and only the balance, 18 per cent, will be available for transfer to nominated members of the same scheme.

The A-Day changes led to an increased interest in personal pension planning and the latest changes are likely to dampen that interest significantly.