Update: tax

The past three months would have seen relatively little news in the world of taxation, had it not been for the fundamental changes announced in the pre-Budget report (PBR) on 9 October. In the days that followed the PBR, as the pressure on the chancellor mounted as a result of these mostly unpopular proposals, came the infamous incident of the disappearing discs.

The press had a field day and the chairman of the Board of HM Revenue and Customs, Paul Gray, was forced to resign. This was regretted by many tax practitioners who had thought he was doing a very good job.

Capital Gains Tax

In the run up to the PBR there had been much speculation about the future of the 10 per cent rate of CGT conferred by Business Asset Taper Relief. Specifically, it was thought that this would be withdrawn for the private equity industry, which had been given a rough ride over its apparent tax breaks.

In the event, it was announced that taper relief would be abolished altogether, along with indexation allowance. Thus the allowance designed to exempt from tax inflationary gains, first introduced in 1982, and the taper relief system introduced by Gordon Brown in 1998 will both cease to be available.

Indexation relief had already been frozen as at March 1998, but for assets owned as at March 1982 it was worth an extra 102 per cent of the base cost, so while taper relief grabbed the headlines, the loss of indexation will also have a significant impact for many people.

To compensate for the reliefs being withdrawn, a single CGT rate of 18 per cent would be introduced. The changes will take effect from 5 April 2008, with draft legislation promised before this date. This will potentially more than double the tax payable on the sale of some business assets. The indiscriminate nature of the changes caused uproar in the business community and it is now widely rumoured that a form of retirement relief, perhaps exempting the first £100,000 of gains on business assets, will be introduced. An announcement was to be made on 11 December, but instead Alistair Darling simply told us he needed more time to think things over. However, we are already seeing an acceleration of business sales as vendors seek to take advantage of taper relief. Unfortunately the credit crunch and the uncertainty in the wider economy mean that the timing is far from ideal.

Meanwhile, advisers continue to plan for ways to secure indexation and taper relief without a sale, but find themselves unable to give concrete advice in the absence of the promised draft legislation. Possibilities include:

• transfers between spouses;
• incorporation; and
• transfers into trust.

In addition it is understood that HMRC are considering allowing deemed disposals to be made for 2007/8 to enable indexation and taper relief to be 'banked'. The downside of course is that would produce a CGT liability payable on 31 January 2009 (albeit at a lower tax rate) without any cash proceeds.

People who have already sold business assets, but have taken deferred consideration in the form of shares or loan notes, may find that their tax position has changed for the worse. In some cases they may be able to make an election by 31 January 2008 to crystallise the gain in 2007/8, thus securing business taper relief, but they really need to see draft legislation to know whether this is the best option.

There will be winners as well as losers under the new rules, including owners of investments which do not qualify for taper at the business rate, especially if they have only been owned for a short time. Those who have deferred gains, for example through the Enterprise Incentive Scheme, may also find that tax deferred at a 40 per cent saving will crystallise in the future at 18 per cent.

The run-up to 5 April looks like being a particularly busy time.

Domiciled outside the UK

In the eyes of the public at large, the thought of many of the super-rich paying tax at only 10 per cent was bad enough. Then it turned out that many of them were domiciled outside the UK and, quite possibly, paid no tax here at all. Politically, this is a tricky issue. Not only do foreign entrepreneurs who choose to base themselves in the UK bring their substantial spending power here, they also include some important donors to the major political parties.

Nevertheless, with an autumn general election looking a distinct possibility the Conservatives decided to grasp the nettle at its party conference. They proposed a minimum tax charge of £25,000 per annum for foreign domiciled individuals who chose to pay tax on the remittance basis '“ under which they are only taxed on foreign income and gains to the extent that they bring the money into the UK.

Only days later, the government announced in the PBR that a fixed charge of £30,000 would apply with effect from 6 April 2008, where individuals who were not domiciled in the UK had been resident here for seven years. Thus an issue which had been in the 'too difficult' drawer for many years was suddenly addressed. Further proposals included the withdrawal of the personal allowance for individuals opting for the remittance basis, and some tightening of the rules defining and quantifying remittances.

Again, we were promised draft legislation. This is still awaited, although a consultation document was issued on 6 December. This suggests that some 4,000 people are expected to pay the charge, and that possible changes to the proposals may include:

• withdrawing the seven-year grace period;
• reducing the charge from £30,000 to £25,000;
• increasing the charge for those who have been resident here for ten years; and
• withdrawing the remittance basis for those who have been resident for 17 years (this would mirror the deemed domicile rules which already exist for inheritance tax purposes).

The proposals also include a clarification of the rules regarding residence for tax purposes, with days of arrival in and departure from the UK both to be treated as days spent here. It is to be hoped that this is the first step in a wider overhaul of the residence rules, which are at present an uncomfortable mixture of often contradictory case law and custom. A modernisation and codification would be most welcome, provided of course that a sensible level of debate and consultation takes place first.

Inheritance tax

IHT seems to have a public profile out of proportion to its relatively small '“ albeit growing '“ contribution to the public purse. The Conservatives knew its announcement that if elected they would raise the threshold at which IHT became payable to £1m '“ so that 'only millionaires' would be liable '“ would be immensely popular. The response to this in the PBR was a proposal that the nil-rate band (currently £300,000 but promised to rise to £350,000 by 6 April 2010) would be transferable between spouses or civil partners, which would mean that a couple with a combined estate of up to £700,000 could escape a charge. It is proposed that this will apply where the second spouse dies after the date of the PBR, and may therefore benefit families where the first death occurred many years ago.

Of course, this outcome was already achievable if a couple organised their affairs carefully, typically by including a nil-rate band discretionary trust in their wills. It is therefore a relatively inexpensive proposal.

Generally, couples who already have tax-efficient wills do not need to change them. However, in future a simple will leaving the entire estate to the surviving spouse on the first death will often suffice.

Income shifting

Having lost the Arctic Systems case, the government announced its intention to bring forward new legislation to attack 'income shifting'. In essence this concerns the sharing of income through a company or partnership where a person who is the principal breadwinner saves tax by allowing another, typically their spouse, to enjoy a share of the income. This intention was confirmed in the PBR and in December a 36-page Consultative Document, including draft legislation, was issued. Unfortunately while there are no doubt a number of cases where 'income shifting' is used purely as a tax-saving ploy, the vast majority of family partnerships and companies are much more complex affairs. One person may sometimes possess the technical skills, or work longer hours, but others will contribute in other ways, and be exposed to identical levels of stress and financial risk.

The idea that such arrangements may be neatly categorised so that one partner may be allowed to justify, say a 20 per cent profit share but no more, is fanciful.

We are in danger of producing a situation where HMRC are granted oppressive powers, enabling them to crack down on those they perceive to be abusing such structures, while the majority of family businesses must complete their self-assessment returns in good faith but knowing that they may face an uphill task in proving that their quite legitimate arrangements are not caught by these proposals.

UK residence status

Another case on this subject was heard, this time before the special commissioners. Lee Barrett stated that he had left the UK to live abroad on 5 April 1998 and had not returned permanently until 7 April 1999. Consequently, he claimed to be non-resident for the year ended 5 April 1999.

The HMRC booklet IR20 suggests that a person leaving the UK for a 'settled purpose', staying away for a complete tax year, and visiting the UK for less than 91 days, will be considered non-resident.

However, a prudent tax adviser would not advise a client to rely on this: IR20 is only a guide, each case must be viewed on its own facts, and substantial potential tax liabilities require a cautious approach.

Unfortunately, Barrett was unable to substantiate his departure and arrival dates, in addition to which entries on his bank statements indicated that he was in the UK on 6 and 7 April. Furthermore, he had not established a base outside the UK to support his claim to have ceased to be UK resident. His partner and family remained here.

He would therefore be regarded as UK resident for the year ended 5 April 1999. (Lee Barrett, SpC 639)

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