Return to normality?
First of two articles on this year's Budget and Finance Act, looking at the impact on personal taxation of the deficit reduction strategy
After the excitement of 2010, which included for those even mildly obsessed with taxation an election, a coalition, an emergency Budget and (be still my beating heart) not one, not two, but three Finance Acts, 2011 marks something of a return to normal processes. Thus there was a single Budget, in March (though traditionalists will mourn that it did not coincide with the Cheltenham National Hunt racing festival); and it has been followed by a single Finance Act.
A new Chancellor longs to set out his stall as one of the “greats” with his first proper Budget. Such a Budget is ideally festooned with fundamental reforms, great principles and (if at all possible for a Conservative) political capital through tax cuts. Such a stall is much easier to set out if you have plenty of money and an absolute parliamentary majority. Such advantages were not available to George Osborne, hamstrung by coalition and having a good deal less than no money to give away. And in any event, the plans already announced to cut the budget deficit to levels approaching sustainability severely restricted room for manoeuvre in the medium term.
So perhaps, to borrow a word from the Chancellor’s predecessor but one (which he would hate to do), Mr Osborne was forced into a “prudent” Budget. If there was little here to frighten the horses, there might not be enough to encourage them to run their fastest race. There were some surprises – the doubling of entrepreneur’s relief to £10 million of gains at 10% (itself following recent large increases) was an extremely significant move for those affected. A further reduction in full rate corporation tax was unexpected. The large increase in the personal allowance for income tax, and switching off the fuel duty escalator (at least temporarily) had, before the Budget, moved to the category of “expected”. But the increases in direct taxation on the oil industry were clearly outwith the expectations even of those directly affected.
Much of the material accompanying the Budget confirmed what had already been announced, such as moves against disguised remuneration through trusts, and the doubling of the “super rate” of national insurance contributions from 1% to 2%. Still more looked ahead to what might be to come – such as a complete alignment of income tax and national insurance, and a true bonfire of tax reliefs via the tax simplification project. The 50% tax rate may have a limited shelf life, and some may welcome that a decision on this will be influenced by what it actually raises in taxation overall.
There does seem to have been a genuine move towards early publication of intended changes and consultation on these intentions. Thus, drawn together in a single Budget document (which was difficult to find one’s way round, whether in hard copy or even electronically), were new changes to be included in Finance Act (“FA”) 2011; previously announced changes, together with modifications following consultation, also to be included in that Act; and future tax changes, to be legislated in FA 2012, other bills or secondary legislation. The total quantity of change was as large as ever.
The following sections deal with some of the main tax changes announced or confirmed.
All income tax allowances and rates for 2011-12 had already been announced and are reproduced below (see also FA 2011, ss 2 and 3). The additional rate remains in effect when incomes reach £150,000; and personal allowances are lost gradually as income exceeds £100,000. Future index-based changes in allowances and thresholds will be based on the Consumer Prices Index, rather than the Retail Prices Index.
New announcements were made for 2012-13. The personal allowance will increase to £8,105 as the next stage of the Liberal Democrat pledge to take it towards £10,000. While the benefits of the rise in 2011-12 for 40% taxpayers were removed entirely by the fall in the basic rate band to £35,000, this is not repeated for 2012-13. The basic rate band will fall, but only by the amount of the increase in the personal allowance and thus to £34,370, leaving some benefit from the increase in personal allowance for 40% taxpayers, although of course not for those who lose the allowance entirely when their income exceeds £100,000 by twice the amount of the allowance.
A new online tax calculator is to be introduced, to enable individuals to calculate tax and overall tax rate.
No further increases in national insurance were announced, although the rise in the rate which applies to earned income above the various thresholds from 1% to 2% goes ahead from 6 April 2011, as do the increases in the main rates by 1%. Overall, these represent very significant rises from earned income. Indexation of NI thresholds will be based on the Consumer Prices Index, rather than the Retail Prices Index.
The various rates of national insurance are shown in the tables below and right.
Of much greater potential long-term interest was the announcement of consultation on the integration of income tax and national insurance, which would clearly be a major exercise. It is not a simple process; and the removal of some distortions would clearly cause others. Given that any full integration would involve very significant rises in the rates of income tax, it may not get very far. But in the meantime, the Government has confirmed that it will not extend NICs to individuals above state pension age, or other forms of income such as pensions, savings and dividends.
Capital gains tax
The annual exempt amount is increased from £10,100 to £10,600 for 2011-12, with that for most trusts being half of that amount at £5,300 (FA 2011, s 8).
The lifetime limit for entrepreneur’s relief is increased from £5 million to £10 million for disposals on or after 6 April 2011 (FA 2011, s 9). No other changes to entrepreneur’s relief were proposed, despite calls for the 5% shareholding requirement to be withdrawn, which means that the relief will generally not be available for EMI option holders, who tend to hold much lower percentages of their employing company’s shares.
There are, in addition, changes made to the technical rules on value shifting (FA 2011, s 44 and sched 9); companies leaving capital gains tax groups (s 45 and sched 10); and companies entering a group with existing losses (s 46 and sched 11).
It will be confirmed that rights under EU single payments schemes are assets eligible for roll-over relief from capital gains tax.
The nil rate band remains frozen at £325,000 until 2015-16. As with other allowances, if an indexed rise is then to occur, the Consumer Prices Index will be used as the default indexation basis.
From April 2012, it is proposed that a reduced rate of IHT will apply where more than 10% of a deceased’s net estate is left to charity. This reduced rate will be 36% instead of 40%. Consultation is proceeding on this issue. It may be somewhat more generous than it looks at first sight, because the net estate from which the 10% charitable bequest must come will be calculated after IHT exemptions, reliefs and available nil rate band. Certainly for those with charitable intentions in any event, it may provide a further incentive.
In the other direction, the disclosure regime (for tax avoidance schemes) is to be extended to IHT on transfers into trust.
But in another move in favour of taxpayers (and their beneficiaries), some changes in the IHT treatment of pensions and pension funds more generally may make the use of pension funds more palatable as a means to pass on assets to the next generation (see further below).
Legislation for Junior ISAs (individual savings accounts) will be introduced and the accounts should be available in the autumn of 2011. These are intended to replace child trust funds (and are not available to those with a CTF), but of course without a state contribution. Draft consolidated Individual Savings Account Regulations were published with the Finance Bill (see now FA 2011, s 40), incorporating the changes to be made by the extension of the rules to those aged under 18.
Those aged 16 and 17 will be able to operate their own accounts; otherwise they will be managed by those with parental responsibilities. Withdrawals will not be permitted before the child becomes 18. Accounts may be of the cash or the stocks and shares variety, but subject to an overall total contribution limit which is not fixed yet, but will be far less than the adult ISA allowance. Within this overall limit, there will be complete freedom as to the allocation of the type of investment (i.e. as between cash and shares, but subject to normal ISA restrictions).
The normal ISA allowance is increased to the arithmetically awkward £10,680 for 2011-12, with further increases tied to the Consumer Prices Index.
The last vestiges of tax freedom in National Savings ordinary accounts are to be removed, with the abolition of the exemption for the first £70 of income. At current interest rates this would, of course, have required the investment of a very substantial amount of capital.
Qualifying time deposits will move to having basic rate tax deducted at source for new accounts from April 2012.
Enterprise investment schemes and venture capital trusts
For shares issued on or after 6 April 2011, the rate of income tax relief given under the enterprise investment scheme (EIS) increases from 20% to 30% (see FA 2011, s 42).
Significant further changes (which have a certain familiarity from earlier versions of the rules) from April 2012, subject to state aid approval, will:
- increase the thresholds for the maximum size of qualifying company for both the EIS and the venture capital trust (VCT) schemes to companies with gross assets of no more than £15 million before investment (currently £7m), and the employee limit to no more than 250 (currently no more than 50);
- increase the maximum annual amount which can be invested in an individual company from its current level of £2m to £10m;
- increase the annual amount which an individual can invest from £500,000 to £1m.
The changes here had been announced and discussed, but modifications were announced.
Pension tax relief will remain for all rates of tax, but the annual allowance will be restricted to £50,000 from 2011-12. However, the blow has been softened by the ability to carry forward unused allowances from up to three previous years, effectively utilising the earliest year first. This applies only if the taxpayer was a member of a registered pension scheme in the earlier year in which there are unused allowances, but there is not required to be any contribution actually made (whether by taxpayer or an employer) in that earlier year. And although the reduced annual allowance only takes effect for 2011-12, the ability to carry forward unused allowance applies from years before the current tax year. (See FA 2011, s 66 and sched 17, paras 3-5, amending FA 2004.)
This is a much simpler tax relief system than previously, and especially as compared to the complicated “false transitional” rules for 2009-10 and 2010-11 (false because the regime to which they were a transition will never came into effect). It may also be seen as more generous, other than for those who wish to make very high contributions to very large pension funds.
The lifetime allowance will be restricted to £1.5m (from £1.8m) from 2012-13 (FA 2011, s 67 and sched 18). However, a degree of protection, at the cost of not being able to make further contributions, will be available to those whose pension funds already, or are expected to, exceed £1.5m but are or will be below £1.8m. Full rules on protection have yet to be announced.
Following consultation, if charges to tax arise, these can generally be paid from the pension fund (FA 2011, sched 17, para 15).
The requirement to take an annuity from age 75 has been removed – FA 2011, s 65 and the 109 (!) paragraphs of sched 16.
It should be noted that the inheritance tax treatment of unspent pension funds has also been reformed, and pensions can now again play a significant part in estate planning.
Alan Barr, Brodies LLP and the University of Edinburgh
Part 2 of this article, on business, employment and land taxation, will be published next month
Charities: giving encouraged
Apart from the potential inheritance tax relief mentioned in the main article, there was a very useful (and slightly surprising in its size) measure to encourage charitable giving, which increases from £500 to £2,500 the maximum value of benefits which can be received by individuals and companies as a result of making donations. But the benefit must still remain at a maximum of 5% of the donation. (See FA 2011, s 41.)
From April 2013, rules will be introduced to allow charities to claim a repayment similar to gift aid on small (less than £10) donations without the need to obtain gift aid declarations. This will be restricted by compliance conditions and capped at a total of £5,000 per charity.
Gift aid will also move to online filing, to facilitate repayments to charities.
There was a somewhat throwaway remark about tax reductions for taxpayers who give works of art, or similar objects, to the state. While there are some tax incentives in this area, they usually relate to the art work itself, rather than the donor’s other liabilities.
Perhaps unsurprisingly, there was a low takeup of the facility to direct general tax repayments to charity and this facility is to be withdrawn. So too has the payroll giving 10% supplement.
Major changes were made to the complicated anti-avoidance rules for substantial donors in FA 2011, s 27 and sched 3, inserting a new chapter 8 into part 13 of Income Tax Act 2007. While some have questioned whether the new rules are necessary or likely to be effective (and indeed whether they may strike unexpectedly), it is hoped that this will clarify the complicated former rules and focus on financial advantages to the donor. The idea behind the rules is to prevent tax relief for those who benefit financially from their donations to charity, for example by making a donation which is then used to construct a building employing the donor’s company to do so. It is perhaps of the nature of such anti-avoidance rules that they can catch the innocent as well as the guilty, but care will certainly be required when dealing with large donations by those who have relationships other than that of donor with the subjects of their largesse.
Domicile and residence: major proposals
A major consultation has been launched on the taxation of non-domiciliaries, and this will remain open until 9 September 2011. The proposals include the removal of the current tax charge when non-domiciles remit foreign income or capital gains to the UK for the purpose of commercial investment in UK businesses – which includes the development and letting of commercial property. There are to be some restrictions on residential property and the leasing of moveable property.
However, the £30,000 annual charge to remain in the special remittance basis regime is to be increased to £50,000 for non-domiciliaries who have been resident in the UK for 12 years. There are few other changes proposed to the current regime, although suggestions to simplify the rules would be welcomed.
Another major consultation, with the same last response date, is on the introduction of a statutory test for residence. This would be a fundamental development for the UK tax system, where with few exceptions the rules defining when someone is resident in the UK have developed from case law which is not wholly consistent, and (in particular) from the practice of HMRC and its predecessors over many years.
The proposed statutory residence test, as with the current rules, will, for some purposes, have different rules for “arrivers” and “leavers”. The test will not be wholly based on the amount of time spent in the UK, although that will be relevant. As in recent case law, there will in some circumstances be attention paid to whether connections with the UK have been severed.
As with Gaul and so much else, the residence test is intended to be divided into three parts. Part A contains conclusive non-residence factors that would be sufficient in themselves to make an individual non-resident. Thus non-residents for the previous three years who are present in the UK for fewer than 45 days in the current tax year would not be resident; and those who had been resident in one of the previous three years would not be resident if present in the UK for fewer than 10 days. Leaving to carry out full time work abroad and spending fewer than 90 days in the UK (with only 20 of them working days) would be another instance of conclusive non-residence.
Part B contains conclusive residence factors that would be sufficient to make an individual resident. As is the case under current law, presence for 183 days or more would meet this test, as would possession of only a single home and that home being in the UK (unless excluded from being resident under Part A). Again, there is an extension to cover full-time work in the UK.
Part C would only apply to a person whose residence status was not determined by Part A or B. It will be used for more doubtful cases and the idea is that individuals should compare the number of days spent in the UK with a number of defined connecting factors. It incorporates the principle that residence status should adhere more to those already resident than to those who are not currently resident.
The connecting factors would include the residence of the individual’s close family; the availability of accommodation (which is used during the year), reviving a factor which has more recently been treated as having less importance; work in the UK; time spent in the UK in the previous two tax years; and whether more time was spent in the UK than in any other single country. These factors would then be combined with the number of actual days present in the UK, with a different scale applying for “arrivers” (those not resident in all of the three previous tax years) and “leavers” (those who were resident in one or more of the three previous tax years). The principle would be that the fewer the number of days spent in the UK in the tax year, the more factors in favour of UK residence would have to be present for the individual to be UK resident. Thus an “arriver” who spends between 90 and 119 days in the UK would have to have three or more factors in favour of UK residence before being considered resident; while a “leaver” spending the same time in the UK would remain resident if he had two such factors present.
If enacted, such a test would put on a formal and somewhat clearer footing a question which is dominated by vague and unsatisfactory considerations on which it is almost impossible to give clear advice.