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Budget commentary

17 March 2005 / Mike Truman
Issue: 3999 / Categories: Comment & Analysis , Arctic Systems , Jones v. Garnett
MIKE TRUMAN introduces initial reactions to the Budget from a team of expert contributors

IS THAT IT? My first Budget as editor, and that's it? Here I am, sleeves rolled up, ready to dictate my incisive analysis of complex tax proposals to typesetters who will instantly transform them into slugs of hot metal ready for the roaring press … well perhaps I'm getting a little carried away, but even so — is that it? I expect, at the very least, to get a complete reform of corporation tax to comment on, and what I actually get is a simplification of the rules for employee purchases of bicycles previously provided by their employers.
What's not there is far more interesting than what is. 'I am making no change to the rate of corporation tax' said the Chancellor, signalling at least another year of the non-corporate distribution rules. The Red Book says 'get your comments in by 29 April', and nothing more. Jones v Garnett (Arctic Systems) may be in the High Court, but there's not a word about the settlements legislation in TA 1988, s 660A from the Chancellor.
The same old paragraph on domicile and residence reform seems to be a permanent feature in the Red Book these days — 'still thinking …'; although the Chancellor has finally acted to stop the use of double tax agreements to avoid the temporary emigration rule — Andrew Hubbard has written more on the implications of this below.

Voodoo economics

But there is one Budget measure on which all sides of the House of Commons seemed to be agreed — that first time buyers had to be helped by raising the SDLT threshold. The only argument between the parties was over whether it went far enough or had been introduced soon enough. By contrast, I'd like to suggest that this is going to do nothing at all for first-time buyers, and that it is, as George Bush Sr famously described Ronald Reagan's economic policy (before he became Reagan's Vice President …) simply 'voodoo economics'.
There are fewer homes available for sale than people who want to buy them. Potential buyers compete almost exclusively on price, and there are always some buyers who are paying the very most they can afford, with a maximum mortgage and every last pound they can scrape together.
At the moment, if they can raise £101,000 in total, they will offer £100,000 for the property so that they have the £1,000 they need to pay SDLT. Their offer will be accepted over, say, the £99,000 which is the most that another couple might be able to offer if they are also to find nearly £1,000 in SDLT.
Once the threshold is lifted, and there is no SDLT to pay, the underbidders will now also be able to afford £100,000. So in order to get the property, the people who previously offered £100,000 will now have to offer £101,000, which again uses up all the money they can scrape together. The purchasers are no better off at all — the only thing that has happened is that the price of property has gone up yet again. There, I knew I'd find something interesting to talk about, if only I looked hard enough…

Capital gains tax

By Andrew Hubbard, Director of Taxation at Tenon
Somewhat unexpectedly the Chancellor has taken a good look at the international aspects of CGT. Several well-known and, by now, fairly long-standing capital gains planning arrangements have been blocked.

A happy return?
The UK has what I have always thought of as a fairly odd system of taxing capital gains made by temporary non-residents. It does not tax gains which arise during a year in which the individual is not resident in the UK, but if that individual comes back within five years of departure, gains which arose when he was abroad are then taxed in the year of return. In other words, the gain is taxed in a year other than that in which it arose. However, what happens if the country in which the individual was tax resident during the absence from the UK also taxes the gain, or more importantly has taxing rights, but does not actually tax the gain? How does the double tax relief work?
In the past, the Revenue has accepted that if there was treaty protection in the year in which the gain was realised, that treaty protection also applies when the gain was taxed in the UK under TCGA 1992, s 10A in the year of resumption of residence. The Revenue has now changed its mind about this and will legislate to 'put beyond doubt' its view that the gain is not protected by double taxation relief. Further amendments will be made to s 10A to ensure that a person will not be able to exploit dual residence to escape from a charge by arguing that he was never non resident for domestic (as opposed to treaty purposes) and thus was never within s 10A in the first place.
At first blush this does seem to put an end to treaty-based short-term emigration schemes. The key issue, which is not clear from the press release, is how this change of view will affect those people who have already taken advantage of treaty-based planning. I suspect that a lot of cheap rented property in Belgium will suddenly come onto the market.

Domicile — abolition by the back door?
There is no fundamental reform of the taxation of non-domiciled individuals, but one change will have a significant impact on planning for non-domiciliaires. A person not domiciled in the UK is only chargeable to CGT on the disposal of UK situs assets. It has been relatively easy to create situations where what are economically UK companies are turned into non UK-situs assets, for example by converting the shares into bearer shares and taking them offshore. Under the Budget proposals, this planning will be closed down. But the proposed rules go wider than this. All shares in UK incorporated companies will be treated as having a UK situs, as will all registered debentures (subject to an exemption for municipal and Government bonds). There are similar changes to the situs rules for intangibles such as rights and options. So, for example, a non-situs option over UK company shares will be treated as a UK situs option. From what we can see so far there is no attack on 'genuine' offshore assets, but there are bound to be some marginal cases. What about the UK incorporated companies which also have shares listed on a foreign stock exchange? On a first reading it appears that those foreign listed shares will be treated as UK situs assets. I would anticipate some feverish lobbing by multi-national corporations over the next few weeks to get some clarity on precisely what this change means.
This tightening of the situs rules will have a major impact on the way that non-domiciled individuals structure their holdings in UK businesses, but it is too early to judge whether or not it will have the effect of driving non-domiciliaires into severing all of their business interests in this country.

Stop the world — I want to get off!
Again, this is about exploiting treaty rules for residence. It has been possible by careful timing for trustees to become resident in a foreign jurisdiction for part of the year and to dispose of a valuable asset while resident in that jurisdiction. If that other jurisdiction did not tax the disposal, or charged it only at a low rate, the trust fell outside the UK rules applying to non-resident trusts and at the same time side-stepped those applying to resident trusts. The result was that the gain escaped UK taxation altogether. This will no longer be possible. From 16 March, the UK will have taxing rights on all disposals made by UK trustees in a tax year in which they are resident or ordinarily resident for any part of the tax year. Any foreign tax paid on a gain will be available for credit relief.
Taken together these three changes will have a significant effect on many of the ways in which offshore structures have been used to mitigate CGT liabilities for UK residents.

A small practitioner's view

By Michael Stern FCA
Before I look in detail at some of the surprisingly few unpre-announced tax measures in the Budget, two thoughts on its context. Was I alone in finding a slight contradiction between the generally upbeat tone of the Chancellor's Budget statement — the savaging of the economies of our partners in the EU and the one-sentence dismissal of the euro were particularly welcome, to me at any rate — and his admission that the Budget represented a fiscal tightening: in other words, that we can all expect to lose a greater part of our incomes to taxation in the coming year than we did in the year now ending, and that without imposing any new taxes? Was I alone in feeling my suspension of disbelief slip when he said that he had improved the conditions of hard-working families by making sure that even more of them reached the position where they were being offered more in benefits than was being taken from them in taxes: I wonder if anyone in the Treasury has ever asked a focus group to find out if people would not prefer to keep their own money in the first place rather than have it pass twice through the hands of officials?
I welcome the acceptance of the Hampton Review and its suggestion that inspections should be reduced and better targeted, but I do wonder if there would not be greater relief from regulation if the targeting and risk assessment processes could instead be improved. For too long, practitioners have been under the impression that certain trades of certain sizes in certain areas are readily and frequently subject to inspection, while those who are big enough to be expected to fight back get away scot-free. Will my small corporate client in a cleaning trade stop getting two different inspections a year? Will another client group of expanding businesses stop receiving day-to-day inspection apparently caused by the decision of the business owner to operate from the heart of the run-down council estate where he chooses to live and work? Is not the Chancellor really saying that there will be a greater concentration on the usual suspects, while large scale operators of overseas employee benefit trusts or large-scale employers of relatively low-paid labour will continue to be exempt from PAYE inspections?
The five-year extension of individual savings accounts limits will be welcome to those of my clients who have lost all faith in the pensions industry. The increase to £1,000 in the value of duty-free goods which can be brought into the UK from outside the EU will be very welcome in those businesses whose employees have to travel frequently, but will the employees have to provide a list of all private purchases to the payroll department or company accountant, so that the appropriate entry can be made on form P11D?

Income tax

By Keith M Gordon MA(Oxon), ACA, CTA, barrister
Other than the trailed rise in the stamp duty land tax threshold, this year's Budget offered no obvious direct tax give-aways to lubricate the Government's election campaign.
But the Chancellor's speech did remind us of his Government's apparent commitment to the reduction of the burdens on small business. Such comments must have been of little comfort to those many businesses who are being attacked under the settlements provisions and especially to Mr and Mrs Jones of Arctic Systems who, at the time the Chancellor was speaking, were in the High Court appealing last autumn's decision of the Special Commissioners.
Once one cuts through the spin, this year's clutch of 'press notices' and 'budget notes' does not contain much to excite the typical small business. Where such businesses are owned by members of same-sex couples registered under the Civil Partnerships Act 2004, the settlements legislation will be extended to them if a non-working partner receives a share of the profits. There is no statement that the exemption for outright gifts to spouses will be extended to same-sex partners, but one must assume that this will indeed happen.
The Government has announced an overdue extension to the exemptions on outplacement counselling and the costs of retraining former workers so that part-time employees are also covered. On a similar topic, the Government has announced a review of Statement of Practice SP 4/86 'Payments to employees when in full-time education' notably increasing the tax-free payments from £7,000 to £15,000 per academic year. There is, however, no extension of this to employees who reduce their working hours to take on a part-time course.
There are two provisions in respect of capital expenditure on buildings. One will be a 100% capital allowance on the renovation of business premises, whether owned or let, so that they are brought back into business use. The premises must have been vacant for a year or more and be situated in a designated disadvantaged area. However, one must wonder whether the rules will actually encourage some buildings to be left empty for a few more months to allow the renovation costs to qualify. The other extends the scope of the landlord's energy saving allowance, which allows a deduction against the profits of a property business, to cover solid wall insulation. This latter change takes effect on 7, rather than 6, April 2005.
In short, this year's tax proposals do not appear to be full of pre-election bribes to voters. But what about the
£1 billion that could be used to increase personal allowances by more than inflation? Rather than simplify the tax system, the Chancellor stated he would rather 'hard-working families' pay their tax on the one hand and claim tax credits with the other. What a give-away!

Corporation tax

By Mark Schofield, tax partner, PricewaterhouseCoopers
With the main tax rates left unchanged, was there anything of interest for business? Well yes! There were positive measures for small businesses, with the Chancellor again talking about simplifying the process for dealing with all taxes and general attacks on red tape alongside enhancements to the research and development tax credit regime. This forms part of a strategy to increase innovation and creativity within the UK economy. But, the cancellation of stamp duty relief on commercial property in disadvantaged areas will be a blow to some.
A lot of the measures targeted at individuals in this Budget are going to cost money, so who is going to pay for it? Quicker tax payments by North Sea oil companies will pay for some and for the rest a small hint came in the Pre-Budget Report when the Chancellor predicted a significant increase in corporation tax receipts between fiscal year 2004 and fiscal year 2006. Clearly, a proportion of this should come from the clamp down on avoidance which he has trailed and acted on over the last year.
Following on from the changes in the Pre-Budget Report and subsequent press releases, this Budget contains a number of, some might say, 'draconian' policies to tackle perceived abuse by corporates. Specifically, a number of 'general' anti-avoidance measures have been introduced into our international tax provisions, which impact significantly on multinational companies investing into and out of the UK. Predominantly these are around hybrid instruments, hybrid entities and double tax relief. There is also a significant tightening of the rules on stamp duty.
The big disappointment for this Budget was the lack of any references to the impact of recent and prospective EU tax cases on our tax system. Given the potential fiscal impact of this, increasing tax competition from the new EU entrants and rapidly expanding economies such as China and India, this is a missed opportunity.
Overall, a prudent Budget with targeted measures. From a corporate perspective the long term question is how attractive the UK will be as a place to do business, particularly given the continually changing tax environment. With an overall expected increase in taxes of 16% between fiscal year 2004 and fiscal year 2006, it also remains to be seen whether the numbers add up or whether the Chancellor will have to come back for more.

Trusts, IHT and POAT

By Malcolm Gunn FTII TEP, tax consultant with Haarmann Hemmelrath
First, here is a question for readers to answer. What is the point of TCGA 1992, s 77? In broad terms, this taxes the gains of certain settlor-interested trusts on the settlor. But nowadays all trustees pay the top rate of CGT anyway which is 40%. So taxing the gains on the settlor can only operate to reduce the amount of tax payable rather than to increase it. If the settlor has losses, or a lower capital gains tax rate for the year than 40%, s 77 will produce a benefit. Next question: what is the point of TA 1988, s 660B which broadly taxes the income of certain childrens' trusts on the settlor? But if childrens' trusts now pay the top rate of income tax (40%) anyway, once again s 660B may operate to reduce the overall tax liability.
Actually, s 660B has slightly more use than s 77 as it catches certain bare trusts where the tax rate would otherwise be the basic rate. Otherwise, one begins to see from these two simple questions that the tax regime for trusts is becoming a bit of a mess. A consultative document for certain reforms was published with last year's Budget and discussions have been continuing during the year. It has now become clear that the discussions have got rather bogged down with different viewpoints. This means that only two of the ideas put forward last year are to make it into this year's Finance Act, one being what is to be known as a standard rate band of £500 for all trusts paying tax otherwise at 40%. Big deal, you might say, but apparently quite a few respondents to the consultative process thought that this was worthwhile. The other proposal which is to make it into print is a regime for trusts with 'vulnerable beneficiaries'. Probably the most common example of such trusts would be those set up under a will or under the rules of intestacy for infant children of the deceased. The exact details of the new regime have not been announced but, in the consultative process, the idea was that the terms of the trust would have to give an unconditional entitlement to the trust assets to the beneficiary upon attaining the age of 18. The trustees would not be liable to tax at the rate applicable to trusts, nor would they be liable to CGT. Instead, the trust income and gains would be brought within the self assessment regime in the hands of the beneficiary. This system would operate by means of an election for such rules to apply.
Other matters within the consultative process have been left for attention in next year's Finance Bill.
In the meantime, the good news is that existing rules relating to bare trusts for children are to continue. Although s 660B largely cancels any income tax advantage, the capital gains of bare trusts are not taxed on the settlor, but instead on the infant beneficiary. This remains one of the few advantages to be obtained under the current trust regime.
We should have long before now had the regulations relating to the pre-owned asset regime, but the inordinate delay in producing them is presumably evidence of the practical difficulties which the theoretical regime has produced. What we do know from an announcement by the Paymaster General on 7 March 2005 is that assets will only need to be revalued every five years and will not need to be updated each intervening year for inflation. Having cracked down so hard on the hundreds of thousands of taxpayers who have attempted to escape from what they see as unfair inheritance tax bills, the Government has evidently decided to be kinder this year. Even so, the valuation of private goods and chattels in people's homes will never be an exact science and many people will no doubt feel it to be an unfair imposition to expect them to get valuers in so that they can pay tax on them. Also, who knows how many people without tax advisers are caught by the wide scope of FA 2004, Sch 15 and have not the foggiest notion that they should be paying some tax under this obscure legislation?
Measurement of the benefit in kind will be at the current 'official rate of interest', at present 5%. But bizarrely, if one pays consideration for the use of chattels, commonly something around 1%, payment will trump the 5% charge. Areas such as this bring home the fact that attempting to tax non-existent income without any source is not easy.
Apart from pre-owned assets, inheritance tax is now higher on the political agenda than it has been for many years and the Government has committed itself to increasing the threshold to £300,000 over the next few years. I expect most will say this is much too little and much too late.

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