The devil in the detail
First of two articles on the 2004 Budget and Finance Act (tax rates and reliefs, income tax on pre-owned assets)
By the time that this appears in the pages of the Journal, yet another massive Finance Act will have joined the already groaning pages of tax legislation affecting us all. While the final details may have changed somewhat by the time of Royal Assent, there was enough in the Budget and the Finance Bill to inform – if not to entertain. Entertainment was sorely lacking throughout the process. Gordon Brown may have fallen among image makers to the extent that some attempts at humour and levity are made – but his annual stand-up would never readily transfer to another stage.
That of course would be of no concern to our long-serving Chancellor – prudence and effectiveness are the watchwords, as he hopes to carry these across to another part of Downing Street. He may have been rather hoping that this was the last Budget he would have to deliver personally, but even if it is not, it might perhaps mark the end of an era.
For instance, this Budget may mark the last chance to deliver really bad news, if any is coming. A putative Prime Minister could scarcely return with a serious tax-raising Budget, presumably shortly before a 2005 election. Thus if money is needed, as appears to be the case from spending plans announced, it may have to come from borrowing rather than increased taxation.
This means that we are perhaps in a period of relative stability for slightly longer than usual, until after that election has taken place. On the tax front, one exception to this may be in the closing of perceived loopholes, although there we move into definitional problems – one Chancellor’s loophole is another taxpayer’s perfectly correct adherence to the statutory rules.
Bringing in the heavies
While the Government may be constrained in the ability to raise taxes by headline promises on basic and higher rates of income tax, this would not preclude changes in rules on reliefs and exemptions – and also action on what may be perceived as “fringe” taxes, such as the geriatric national insurance contributions or the bouncing baby stamp duty land tax.
On that note, perhaps the most important recent change for large numbers of solicitors is in fact nothing to do with the Budget/Finance Act. This is the announcement that the “light touch” arrangements for stamp duty land tax end on 19 July. Given the importance in Scotland of obtaining an SDLT certificate, it is particularly vital that SDLT forms are completed with great care from now on.
A theme for this year was that that most of the news on taxes, both good and bad, was announced in some shape or form before the Budget. Indeed most of the announcements (principally in the Pre-Budget Report) gave warning of changes to come that turned out to be rather less draconian than might have been feared.
But any optimism, at least about the extent of changes, was laid to rest by the arrival of an astonishing 474 pages of Finance Bill, with much more to come by way of secondary legislation. For lawyers whose work extends to tax (and while they might choose not to believe it, that means most lawyers), more ominous warning appeared in announcements about the recruitment of further staff directed towards attacks on tax evasion – and perhaps for reasons of tone and attitude, the proposed merger of the Inland Revenue and Customs and Excise. The cultural clash between Hector the Inspector and the rather more swashbuckling reputation of at least some parts of Customs might make interesting viewing. But in the meantime, the mainstream tax changes were rather limited.
The basics (and a bit beyond)
Rates and allowances for income tax, corporation tax, capital gains tax, inheritance tax, stamp taxes and the pension schemes earnings cap are set out above.
Income tax and NI rates
These figures demonstrate another theme, that of little change in the basics. Thus things like personal allowances continue to rise, but not by very much. They are tied to (very low) inflation and hence rise much more slowly than earnings. This leads to the phenomenon known as “fiscal drag”, which has nothing to do with Gordon Brown in a tutu (for which great thanks). It involves a steadily growing number of taxpayers falling into the higher tax band. With the difference between basic and higher rate tax at a very high 18% (and 20% if one is making comparisons with savings income), it becomes particularly valuable to try to make full use of allowances and basic rate bands. This point gains further weight from the disappearance of a number of savings benefits – for instance, the recovery of the tax credit on dividends on holdings in PEPs and ISAs is removed from 6 April 2004.
The rate of tax applicable to savings income in section 1A, ICTA 1988, other than dividends, is 20 per cent for income falling between the starting rate and basic rate limits. The rates of tax applicable to dividends are 10 per cent for income below the basic rate limit and 32.5 per cent above it.
The rate of relief for the continuing married couple’s allowance and maintenance relief for people born before 6 April 1935 is 10 per cent.
National insurance rates and thresholds for 2004-05 (see table on right) were announced in the 2003 Pre-Budget Report. But of course the payment of an extra 1% without limit for both employers and employees (and also the self-employed) above the various thresholds is a significant change, and makes income in a form not subject to that impost particularly attractive.
Capital gains tax
The annual exempt amount rises, with indexation, from £7,900 to £8,200, with the trust exemption becoming £4,100. Rates remain tied completely to income and corporation tax rates – perhaps even more so now that the rate applicable to trusts, affecting both income and gains of some trusts, rises to 40%. This affects all chargeable gains for trusts (not merely discretionary/accumulation trusts, as is the case for income).
It also affects the capital gains tax which may be payable by executors, which may increase the need for planning in relation to CGT and executries. Particularly as house prices have risen so sharply, this may be an issue which needs to be looked at very carefully when executry assets are to be sold or transferred to beneficiaries.
Rates for trusts
As announced in the Pre-Budget Report, from 6 April 2004 the rate applicable to trusts will be 40 per cent and the Schedule F trust rate on dividends (and similar income) will be 32.5 per cent. (This does not however apply to liferent trusts.) The change is a significant one and may require careful planning to minimise tax, particularly when dealing with beneficiaries whose own marginal rate is less than that suffered by a trust or executry. This change is immediate, but a further raft of changes in trust taxation can be anticipated in the next few years, following consultation on this issue. Further changes will be reported as and when they are implemented.
More on income tax
In a much-trailed move, a new relief is introduced for a wider range of employer supported childcare. Employees will be able to receive up to £50 a week of childcare, tax- and national insurance-free, where their employers contract with an approved childcarer or provide childcare vouchers for the purpose of paying an approved childcarer. However, this does not come into force until 6 April 2005.
Scale charges are to be introduced for the private use of company vans, but an exemption is to be introduced for emergency vehicles which are taken home.
Jointly owned shares
If a husband and wife own shares in joint names, there is a conclusive presumption that the income is received in equal shares. This is to be removed and the couple will be taxed in the proportions which they actually own.
This may lead to confusion, in particular when there has been donation between the couple.
Venture capital reliefs
Important changes are made, in both directions, in the extensive reliefs available for approved venture capital investment.
For VCTs, the rate of income tax relief goes up to 40% (from 20%); but the important CGT deferral relief is to be removed. The annual investment limit doubles to £200,000.
The enterprise investment scheme limit also rises to £200,000 and there are some technical improvements in relation to the repayment of loans.
There is a range of changes in connection with groups of companies.
Community amateur sports clubs
A new measure will double the corporation tax thresholds for registered CASCs. As a result, CASCs will be exempt from corporation tax on profits derived from trading, if their trading income is less than £30,000 and on profits derived from property, if their gross property income is less than £20,000. CASCs that do not exceed these thresholds will not have to complete a tax return on an annual basis.
This is a useful measure allowing members who incorporate relief for pre-incorporation losses against income from the company (or from a limited partnership).
Income tax on pre-owned assets
Although there were the usual pre-Budget apocalyptic threats of massive changes to inheritance tax, these did not really come to pass. However, a much watered-down version of anticipated rules in pre-owned assets is to be brought into force.
Instead of changing the reservation of benefits rules to keep up with the various schemes designed to avoid them, it was announced in December 2003 that there will be an annual charge to income tax under Schedule D, Case VI on the use of assets which were formerly owned. This was met with much squawking, screeching, and stamping of tiny feet about how UNFAIR it all was. Some of it clearly wore down the Chancellor, because the threat looks to be much diluted.
It cannot be stressed too much that this charge, despite being essentially aimed at IHT avoidance devices, is very much a stand-alone tax and it is not intended that it be dovetailed into the IHT legislation – although there are considerable overlaps. Indeed, the Revenue came out and said that people affected will be:
“People who have entered into contrived arrangements to dispose of valuable assets, while retaining the ability to use them. The main purpose of arrangements subject to the charge is to avoid inheritance tax.”
The charge will come into effect from 2005-06. It is to be applied to the benefit people get by having free or low-cost enjoyment of assets they formerly owned (or provided the funds to purchase). It is to apply in appropriate circumstances to both tangible and intangible assets. Broadly following the model of the benefit-in-kind charge on employees, the rules will quantify an annual cash value for the benefits enjoyed by a taxpayer: this will be treated as an addition to their taxable income, subject to a de minimis threshold, and a set-off for any amounts made good by them for the benefit.
The key change made following the consultation was a vast expansion of the exclusions – the new charge is not to apply to the extent that:
- the property in question ceased to be owned before 18 March 1986;
- property formerly owned by a taxpayer is currently owned by their spouse;
- the asset in question still counts as part of the taxpayer’s estate for inheritance tax (IHT) purposes under the existing “gift with reservation” (GWR) rules;
- the property was sold by the taxpayer at an arm’s length price, paid in cash;
- the taxpayer was formerly the owner of an asset only by virtue of a will or intestacy which has subsequently been varied by agreement between the beneficiaries; or
- any enjoyment of the property is no more than incidental, including cases where an out-and-out gift to a family member comes to benefit the donor following a change in their circumstances.
More generally, the rules for tangible assets will mean that former owners will not be regarded as enjoying a taxable benefit if they retain an interest which is consistent with their ongoing enjoyment of the property. For example, the proposed charge will not arise where an elderly parent formerly owning the whole of their home passes a 50 per cent interest to a child who lives with them. But transfer between unmarried couples may cause particular difficulties.
The de minimis threshold has been set at £2,500 per year. If that is relevant in any particular case, the fact that it is an annual amount may cause difficulties of valuation – particularly if the “benefit” is near to that limit.
The Government was always going to allow a year for unscrambling existing arrangements. This has been confirmed, but it has also been recognised that it may be impossible in some circumstances. Thus there is a rather strange option available to taxpayers, allowing them in effect to opt in to inheritance tax charges, as if there were an accepted gift with reservation. This will eliminate the income tax charge.
It must be remembered that in these days of self-assessment, the onus is on the taxpayer to tell the Revenue about the charge. There will be traps here and the situation will require to be watched for taxpayers who benefit at all from assets given away.
But that has always been the case. The restoration of the spouse relief means that it will again be possible in most cases to utilise a double nil-rate band, which is what most IHT planning should be aiming at.
Alan R Barr, University of Edinburgh