PBR predictions: hard-nosed revenue raising masked by feel-good give-aways

It is clear that whichever Government is in power next year it will need some hard-nosed revenue-raising policies to give a chance of paying off the massive budget deficit.

However, in the forthcoming pre-Budget report the present Chancellor may be tempted to hold back some of the worst news and instead offer some feel-good headlines on give-aways to specific parts of the community.

“On the eve of a difficult election, the Government needs to find a chunk of extra money that doesn’t upset too many voters. So we must expect tax increases and spending cuts with high earners bearing the brunt,” said Richard Mannion, national tax director at Smith & Williamson, the accountancy and financial services group.

“We could see further increases in income tax for high earners, windfall taxes on the financial services, a rise in capital gains tax so that it narrows the gap that is developing between the top rates of tax on income and capital gains, and plenty of anti-avoidance on tax arrangements.

“We might also get a small rise in corporation tax for small companies, National Insurance could be ratcheted up to target those on very high earnings and the salary sacrifice regime could also come under attack,” continued Richard.

“This could add up to some painful tax increases, but the Chancellor should recognise the fragility of the economy. No one can be sure we have reached recovery-mode and he should moderate any revenue-raising ambitions accordingly, ” added Tim Lyford, head of corporate tax, also at Smith & Williamson.

Further details of possible changes introduced as part of the PBR are outlined below:

Income tax – increases to some rates

We have already been warned that a new 50% top rate of income tax will apply from 6 April 2010 on taxable income over £150,000. A new rate of income tax might be considered for incomes over, say, £100,000pa, moving from 40% to 42% or even 45%. This would bring in extra funds but would attract little criticism from the majority of the electorate. 

CGT – up

It is only right that gains on long-term capital investments are taxed at a lower rate than income. However the decision to move to a flat-rate system in 2008 is now looking rather strange as the differential between CGT at 18% and an income tax top rate of 50% is encouraging taxpayers to seek out ways of re-designating income as capital.

Consequently the CGT rate on short-term gains could be increased from its current flat rate of 18% to an individual’s marginal rate of tax to make it less attractive to reclassify income.

VAT - up

Although the standard VAT rate returns to 17.5% on 1 January 2010, there could be further increases in the pipeline.  A rise could be on the cards for 2011 to, say, 20%. Bearing in mind that the average rate of VAT in the EU is almost 20% and that each 1% increase brings in about £4.5billion, the Chancellor must be sorely tempted. However, any VAT rise immediately pushes up inflation.

NICs - up

A further option for today’s cash-starved government might be to accelerate some of the NIC increases already announced. People earning over the relevant threshold (currently £43,875) pay 1% on all additional earnings. We have been warned that this will rise to 1.5% with effect from 6 April 2011; so having already softened us up the Chancellor may feel inclined to bring forward this increase to 2010.

Similarly, the rates of NIC for high earners (say, those on over £150,000pa ) could be ratcheted upwards. The only problem, is that this would be viewed as yet another disincentive to working in the UK by ‘non-doms’ who represent a highly mobile and frequently highly-skilled international work force.

Corporation tax – increase for small companies

 An increase in corporation tax for small businesses from the current 21% to 22% was announced a couple of years ago, bringing it closer to the rate for larger companies (currently 28%), but this was delayed because of the recession. Given that any firm making a loss during the recession will not have paid corporation tax, we assume that the government may be planning to bring in the increase this time around when companies are more likely to be in a taxpaying position.

However the Conservative Party has recently stated that it hopes to move towards a standard corporation tax rate of 25% and a small companies rate of 20%, so the current Chancellor may feel obliged to match Mr Osborne. 

It is likely that any announcement here would take the form of an aspiration to reduce the rates in the future rather than a promise to do so immediately, given the country’s desperate need to bolster tax inflows at the present time.

Salary sacrifice - under review

Although HMRC seems to have had an off-on relationship with salary sacrifice, this could be one area to come under scrutiny.

Numerous employers have set up salary sacrifice schemes whereby staff forego an element of salary in return for a tax or NI-efficient benefit such as child care vouchers or pension contributions. With the employer paying for these directly, both the employer and employee save on NICs or tax – which cuts the government’s tax-take. 

However, we could see the government restricting the tax relief on these benefits for higher earners in the same way as they are already planning to restrict tax relief on pension contributions for those earning £150,000 or more. Such a move could affect those in salary sacrifice schemes covering eg free lunches, child care vouchers, car parking, cycle to work schemes.

Windfall taxes – new areas

With some of the banks announcing profits again, the financial services would be an easy target for a new windfall tax. Such a move could be of electoral appeal, but would further reduce the attractiveness of the City of London as an international financial centre.

Green measures

To help car manufacturers and promote the use of ‘greener’ cars, we could see greater tax breaks on energy-efficient company cars.  We might also see an extension of capital allowances for environmentally friendly assets.

Anti-avoidance – tighter controls

Rules introduced in 2004 require designers of contrived tax avoidance schemes to disclose their schemes to HMRC at the outset and this enables government to take swift action to close any perceived loopholes in the tax law.

The Financial Secretary to the Treasury has already announced that the PBR will contain yet more measures to shut down reported tax schemes. The danger area here is that HMRC, the Treasury and Ministers are increasingly blurring the lines between contrived avoidance and routine tax planning and there are concerns that the government might consider legislation to stop people accelerating any dividends or bonus payments before the new higher tax rates apply from 6 April 2010. 

Support for entrepreneurs and smaller businesses

We would welcome any easing of the rules on Venture Capital Trusts and the Enterprise Investment Scheme. The conditions as to the size and value of companies which can qualify for investment under these schemes have been made much more restrictive over the last few years.

There is a difficult balance for the Treasury to strike in this respect : encouraging investment in small private companies in difficult equity and debt markets, whilst ensuring the UK does not fall foul of the EU State Aid provisions.

We expect to see the Business Payments Support Service to be formally extended to partnerships, bearing in mind that the cash flow effects of the recession will be with us for some time yet.

[Background on EIS / VCTs. From 6 April 2006, the reduction in the ‘gross asset’ test reduced the size of companies which could qualify for investment under VCTs and EISs meant fewer companies were eligible to raise funds under the Venture Capital Trust or Enterprise Incentive Scheme. The revised upper limit for the ‘gross asset’ test fell from £15m before investment and £16m immediately after to £7million before investment and £8 million afterwards.]

For further information, before or on the day of the budget:

Richard Mannion – National Tax Director – 020 7131 4252/mob 07799 761326
Tim Lyford – Head of Corporate Tax – 020 7131 4213
Inez Anderson – Employment Tax and Incentives Director 020 7131 4919
Hannah Dobson/John Voyez – VAT directors 020 7131 8138/020 7131 4285

PR queries:

Kate Harrison - 020 7131 4228
Jess Koslow - 020 7131 4264
Matt Rowe - 020 7131 4550

Disclaimer

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

Note to editors

Smith & Williamson is an independent professional and financial services group employing over 1,500 people. The group is a leading provider of investment management, financial advisory and accountancy services to private clients, professional practices and mid-to-large corporates. The group operates from offices in London, Belfast, Bristol, Glasgow, Guildford, Salisbury, Southampton, and Worcester.

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