Budget Analysis 2007

Following the Chancellors Budget speech on 21 March 2007, the Finance Bill 2007 was published, running to over 300 pages of proposed legislation. This usually passes through Parliament during the summer and ends up in its final form as the Finance Act 2007 in July 2007.

 

The Paymaster General Dawn Primarolo  commented on the Bill’s publication as follows:

“The Government is committed to creating a modern and fair tax system, which promotes long term investment and environmentally sustainable growth, encourages and rewards work and savings and supports and strengthens families. Today’s Finance Bill introduces important measures to promote fairness, maintain the U.K.’s competitiveness and tackle tax avoidance and fraud”.

 

The Finance Bill consists of 113 Clauses and 27 Schedules, which together with the explanatory notes runs to over 800 pages. In the interest of brevity I have only selected parts which I consider may be of interest to readers, rather than attempt to cover every detail.

 

In broad terms the underlying themes in the Bill are to:

 

1.         Encourage environmentally friendly activity.

2.         Discourage and penalise HMRC perceived tax avoidance.

3.         Encourage HMRC perceived genuine activities.

4.         Give additional powers to HMRC.

5.         Encourage on-line communication with HMRC.

  

 

The first batch of clauses makes some alterations to income tax, corporation tax and inheritance tax, bands and rates.

 

As far as income tax is concerned, the rates remain unchanged, being principally 10%, 20% and 40%, whilst the bands of tax have been increased by about 4%, so that the first £2,230 of income is taxed at 10%, the next £32,370 is taxed at 22% and the balance at 40%. This is effective from 6 April 2007.

 

As far as corporation tax is concerned there are no changes for 2007 to the main rate, but from 1 April 2008 the main rate of corporation tax is reduced from 30% to 28%. This fully bites once annual profits reach £1.5 million but reduces the marginal rate of tax, once profits reach £300,000. Conversely, the rate of tax applied to the first £300,000 profits is going to increase from 19% to 20%, this time with effect from 1 April 2007. Again this will reduce the marginal rate of tax for profits over £300,000 up to £1.5 million. There are plans for the lower rate of corporation tax to increase by 1% a year, so that by 1 April 2009 this will be 22%.  This will mean that by then there will be less difference between how company profits are taxed with regard to the level of those profits, which benefits higher profit companies against lower profit companies.

 

The taxation of business profits in the corporate structure at lower levels has therefore changed around, compared to 3 or 4 years ago, when there was a 0% rate in place for the first £10,000 profit. This in itself at that time, encouraged significant incorporation of businesses – over 1 million companies in fact and tax savings were made. This has now been completely reversed and whilst it does not make significant differences to reasonably profitable businesses as to whether they should be incorporated or not, it does call into question how one can plan one’s business when the rates are moving so much. To date there appear to be no changes in relation to the taxation of dividends, both on extraction from the company structure and in the personal hands of the investors. We will have to wait and see whether this is changed in the future.

 

Finally, the inheritance tax nil rate band has been increased by just under 8% from £325,000 to £350,000 with effect from 6 April 2010, whilst the basic rates of inheritance tax remain unchanged at 20% for lifetime transfers and 40% on death.

 

 

With effect from 21 March 2007 the balancing adjustments in relation to industrial buildings allowance and agricultural buildings allowance have been withdrawn. It is planned that the writing-down allowance available currently at 4% per annum will be reduced at the rate of 1% per annum, through to 2010/2011, so that these allowances will be fully withdrawn by that time. The Chancellor’s view was that these allowances have been available in the U.K. in some form or other since 1945 and were initially introduced to encourage industrial development after the end of the Second World War. They also principally encourage development of new buildings and therefore by their withdrawal, the Chancellor may be hoping to encourage the re-generation of existing buildings.

 

From 1 April 2007 the first year allowance of 50% for small businesses on most plant and machinery continues and the 40% first year allowance for medium businesses on most plant and machinery continues. However, it is proposed that from 1 April 2008 there will be a new 100% first year allowance for most plant and machinery, but limited to £50,000 per annum capital expenditure, whilst the writing down allowance each year, currently at 25%, will be reduced to 20%. Therefore if a substantial capital investment is being considered, it looks as if it is likely that this should be done sooner rather than later, to attract the current 40% and 50% allowances on the bulk of the expenditure.

 

From a date to be announced, the research and development tax relief has been extended to companies with up to 499 employees and turnover under €100 million, or a balance sheet under €86 million.

 

There are a number of measures affecting direct taxes on various activities. These include the usual beer, cider, wine, cigarettes, cigars and tobacco duties, all up approximately 3½%, whilst there are significant increases in gaming duty and the introduction of a new remote gaming duty levy, in connection with internet gambling. Of particular interest to all will be the increase in fuel duty rates, increasing between 4% and 35% with effect from 1 October 2007 and the changes in vehicle excise duty rates, with increased rates for the highest polluting vehicles, whilst for the lowest polluting vehicles rates are frozen or reduced, with effect from 22 March 2007. Air passenger duties have been doubled for various destinations, with effect from 1 February 2007, whilst aggregate levy will increase by 22% from 1 April 2008, and landfill tax will also increase by between 14% and 33% from 1 April 2008. The principle of encouraging environmentally sustainable growth continues, with the proposed introduction of corporation tax relief on the cost of energy saving items installed in residential properties, let by corporate landlords, to be similar to that available currently to non-corporate landlords. The date for this has yet to be announced, subject to state aid approval being received. This affects items such as loft, cavity wall, solid wall, floor, hot water system installation and draught proofing. Up to £1,500 per property income tax relief is currently available and will be extended to companies in due course. It is proposed that the income tax relief is available up to 5 April 2015. This theme continues with the introduction of stamp duty land tax relief for new zero carbon homes, available on the  first purchase of new homes, duly certified as carbon zero homes, with the date that it is to apply yet to be announced.  Also from 6 April 2007 any income received by an individual, from the sale of surplus electricity, meeting certain criteria will be exempt from income tax, in order to encourage domestic regeneration.

 

There are a substantial number of Clauses concerned with this, in various guises. The first significant area concerns managed service companies, where companies have been specifically set up for individuals to principally work for third parties, their income to go into the managed service company, and to come out to those individuals as dividends, thus avoiding National Insurance. This is being done on a reasonable scale and will affect approximately 240,000 people. The managed service companies were set up to avoid principally the operation of PAYE, such that the net income of the individual increases, compared to an employment status. From 6 April 2007 all payments received by persons in respect of services provided through managed services companies, are to be treated as employment income, if not already treated as such. This puts all those individuals back on an employment status basis, such that there should be no advantage in using managed service companies in the future. There is also legislation which transfers any PAYE debts arising to certain individuals principally connected in any way with the operation of the managed service company. This legislation is not intended to affect employment agencies. There have been no changes in the legislation in relation to IR35 companies, which are principally companies operating in a similar fashion, but only involving typically one or two people. HMRC continued to fight such selected IR35 cases, though to date their success rate has been very low.

 

There is also further anti-avoidance legislation involving restrictions on trade loss relief for non-active partners in trading partnerships, excluding Lloyds Underwriters and qualifying film expenditure and extensive tax avoidance legislation proposed involving financial arrangements.

 

There is a clause which affects the controlled foreign companies rules, which normally tax a U.K. company where it has diverted profits to a controlled foreign company, to try and avoid U.K. tax. These rules can be dis-applied where a U.K. resident company can demonstrate that the controlled foreign company has a genuine business in another E.U. state.

 

With regard to vehicle excise duty and exempt vehicles, there has been a redefining of agricultural vehicles in modern terms, to ensure that true farm vehicles continue to be exempt, whilst others are not.

  

There are a significant number of measures affecting life assurance companies, general insurance, Lloyd’s insurers and Friendly Societies, mainly of a simplification nature.

 

There have been changes to the venture capital schemes qualifying rules for companies who seek to qualify under these schemes, which principally have reduced the size of such companies, increased the excluded activities and extended the time that monies can be utilised in the activities of the venture capital company.

 

The benefits that a donor may receive before gift aid is denied, in respect of payments made by individuals and companies, have been doubled with effect from 6 April 2007.

 

The pre-owned assets income tax charge introduced on 6 April 2005, which can be elected out of, had a time limit on it, but this has now been lifted with effect from 31 January 2007.

 

Life assurance premium contribution relief, which was introduced on 6 April 2006 has been abolished from 6 December 2006, though it remains effective if a policy was taken out between 6 April 2006 and 5 December 2006. This poses the question of why it was introduced in the first place.

 

These have been increased, for example the Police and Criminal Evidence Act 1984 can now be applied to all HMRC matters and National Insurance matters, including in Scotland and the ability of HMRC to use search warrants where necessary can now be executed in Scotland, when it is endorsed by a Scottish Court. There are also certain cross border powers which will be introduced. All these measures are to be introduced on a date to be announced.

 

HMRC are encouraging the increasing use of this and have been doing so for some years. They have introduced incentives to file on-line under the PAYE arrangements but have no plans to continue with these incentives beyond 2008/09, or extend them to other taxes, whilst over a period of years, making it almost compulsory to file on-line for other taxes. The first system that is being brought into on-line is self assessment (SA). This will affect tax returns from 6 April 2007. The filing date for on-line returns will remain at 31 January 2009 in normal circumstances but for filing by paper, the return date will be brought back to 31 October 2008, thus an incentive to try and file on line.  This will affect personal tax returns, trustees tax returns and partnership tax returns. It is anticipated that as time goes on, filing on-line will be extended to VAT and corporation tax. Mandatory on-line  payment is also to be introduced to all HMRC taxes and again in connection with this, if payment is made by cheque, only once that cheque has cleared  HMRC’s account is it treated as having been received, whereas payment on-line should be immediate. To encourage earlier filing, the time HMRC have to normally enquire into tax returns which currently runs from 31 January each year for 12 months, will now be linked to the date that the self assessment return is received by HMRC. The actual date for this to be effective is to be announced but this would encourage earlier filing, compared to the position currently where there is no advantage to file early in terms of enquiry time limits. This whole area of on-line communication will, in the long term, provide savings for HMRC and prevent the double entry of information both by the tax payer and by HMRC.

  

From 1 April 2009 it is proposed to change the system of penalties to principally apply right across a number of taxes and to break these down into three different categories. First of all the careless error, which has arisen due to a person’s failure to take reasonable care, will attract a maximum penalty of 30% of lost tax. Secondly once the error becomes deliberate and unconcealed, in other words a person makes no arrangements to conceal the error, there is a maximum penalty of 70% of tax lost. Once the error becomes deliberate and is concealed, by for example false evidence to support an inaccurate figure, the penalty rises to 100% of tax lost. Mitigation of such penalties is available by pro-active cooperation and disclosure and helping HMRC to correct the error. Although this has similarities to the current penalty arrangements, it appears to potentially increase penalty levels and applies across a wider range of taxes. How this mitigation will work in practice remains to be seen.

 

This was a Budget that principally honed in on HMRC powers, HMRC communication, and green measures, as well as making one or two adjustments to taxation rates and reliefs available to businesses. It definitely encourages environmentally related activities, both within business structures and for individuals, but does little to encourage investment, other than in an environmentally friendly way. It is as always, an opportunity for HMRC to introduce yet more anti-avoidance measures and will add another substantial tome to the existing mountain of tax legislation, which businesses and individuals are subject to.

 

The views expressed herein are not necessarily shared by Lentells Ltd. The material is published without responsibility on the part of Lentells Ltd or myself for loss occasioned by any person acting or refraining from action as a result of any view expressed therein. Should you have any specific queries in relation to the Budget, please email myself on nigel.gamblen@lentells.co.uk  or if you are an existing client of Lentells Ltd, contact your usual person within the company.

 

4 May 2007