First of two articles on the main tax changes announced before and since the General Election, in which tax rises for nearly everyone are on the agenda

Tax geeks really love election years. The timing of the electoral cycle generally means that the existing Government delivers a Budget, followed by a Finance Act to deliver at least a minimum of necessary annual tax law. And after the election dust has settled, the new Government (even if the same one) generally has to return to the tax fray, if only to pick up what was missed first time round.

This year, we have a completely new Government, in both style and substance, with the need to deliver compromise fiscal policies from more than one party – and a fiscal crisis, so the second Budget attracted an “emergency” label and the need to deliver an increased tax take.

The key word, used more than once in George Osborne’s speech, was “unavoidable”. Anything nasty for taxpayers or benefit claimants was declared to be unavoidable. If the figures (and he produced a lot of those) hold up, the measures announced will go a long way towards eliminating the so-called structural deficit in the nation’s finances.

Of course, it is traditional for a new Government to get as much unpleasant medicine into the patient as early as possible, when an election is at its most distant – but even the most cynical observer would agree that urgent action was probably required. In present circumstances, even more drastic action on taxation might have been anticipated, especially as the Budget contained some significant tax reductions as well as rises.

But there was not enough time to get all the legislation through before the summer recess, so we have the threat or promise of a third Finance Act in the calendar year. This may represent the start of a trend towards more separate technical legislation in the fiscal process.

In recent years, the Pre-Budget Report has contained at least as much intimation of tax changes as it has of spending plans (although the spending review this year may militate against that). The excitement may be too much for me and I will certainly need a lie-down.

Perhaps ironically, political events thus far have meant that the actual quantity of new tax legislation over two Finance Acts is a good deal less than in most recent years, although a third Act may change that. However, significant changes have emerged and are emerging from this fiscal feeding frenzy, and all solicitors need to get a grasp on at least the fundamentals.

Given all that has happened, the pre-election Budget (on 24 March) seems like something from another era. In fact, it simply represents the start of a new continuum of increased tax rates, some reduced allowances, and attempts to gather more revenue from some of the less headline corners of the tax system (though national insurance in particular can no longer be called such).

More arguably, given the tendency of Messrs Brown and Darling to announce fiscal intentions for years in advance, the recent spate of legislation is simply the next stage in a longer process of increased taxes. This does not seem likely in the current climate to be reversed. Even a Conservative Government untrammelled by Liberal coalition partners would need the money, and while there might be tweaks at the edges of some fiscal policies (in particular towards reduced or eliminated taxes for the lowest incomes), it seems certain that the tax contribution to reducing the fiscal deficit will remain of vital importance to whoever may be in power.

Much of the “emergency” Budget speech was devoted to intended reductions in spending, accounting for 77% of the necessary changes in the public finances, leaving 23% to come from tax increases. For the most part, these spending changes, full details of which have not yet emerged, are not dealt with here.

Significant changes were announced to tax credits, housing benefit, disability living allowance and the rate of increase to certain benefits and pensions, both in the public sector and the private sector. (The changes to pensions in particular have already attracted significant attention. Child benefit is to be frozen, and there is to be a two-year freeze on most public sector salaries.)

Overlying all the many technical and substantive changes in the law is the real prospect of significant changes in the tax balance between Westminster and Holyrood. It seems increasingly likely that additional fiscal powers are going to be devolved.

These may include responsibility for collection and the ability to make both substantive and technical changes in a significant amount of tax law. But that is for the future – Westminster has produced quite enough to be going on with in the immediate past.

The basics (and a bit beyond)

Rates and allowances for income tax, capital gains tax, inheritance tax, corporation tax and national insurance are set out in the panels. These are for the most part unchanged for the current (2010-11) tax year as compared to last year, but both years are included as a reminder and to draw attention to the few figures where there have been changes.

Comment on rates and allowances – now and later

(a) Income tax

The fact that there were to be no changes to the main rates and thresholds was announced in the 2009 Pre-Budget Report and confirmed by FA 2010, s 1(3). This was stated to be because inflation has become negative (the usual month for uprating personal allowances is September), but for those lucky enough to have employment income which has risen, this represents a real tax increase. Furthermore, by the time the allowances came into effect on 6 April, inflation was very much in positive territory.

It was no surprise that no alterations were made to these plans in either of the 2010 Budgets – although the new Government proved itself entirely capable of making “in-year” adjustments in other contexts.

Legislation was already in place for the introduction of the new 50% additional rate of tax for the 2010-11 tax year (42.5% for dividends), although it required to be confirmed in FA 2010 (s 1(2)(c)).

Legislation was also in place for the reduction in the basic personal allowance for those with incomes over £100,000 – Income Tax Act 2007, s 35, as amended by FA 2009, s 4. The allowance will be reduced by £1 for every £2 of income above that level. This will be applied until the personal allowance is reduced to zero, which will occur this year at an income level of £112,950. The marginal tax rate for the slice of income just above £100,000 will thus be 60%, a point which may influence planning. It may make pension contributions or gift aid donations particularly attractive, if relief at an effective rate of 60% (slightly more on a net gift aid donation) is available.

Because of this withdrawal of the personal allowance, the marginal rate for any slice of income above £100,000 will be considerably more than 40%, and that will remain the case up the income scale until the 50% rate cuts in at £150,000.

As noted last year, a particularly nasty effect of the increase in the highest rate of tax is that the trust rate and dividend trust rate of tax are now set at the same rates as the highest for individuals – 50% and 42.5%. These rates will apply to all income of appropriate trusts, without any benefit from a personal allowance, a higher rate band of 40% and with only a very modest basic rate band – £1,000 for 2010-11. This may increase the desirability of making distributions, as well as that of making capital rather than income profits.

One of the biggest announcements in the post-election Budget looked to the future of the basic personal allowance. From 2011-12, the allowance for those aged under 65 is to be increased by £1,000, to £7,475. However, this is to be made effectively available only to basic rate taxpayers, by reducing the size of the band at which basic rate is paid. This restriction is to be £2,500, although the exact amount of the basic rate band will not be fixed until the autumn (when the September RPI figure is available).

This increase, expensive in overall terms, is of course the first move towards the Liberal Democrat target for the basic personal allowance of £10,000. This could have significant effects on the basic income tax structure. For example, if the basic rate band is further reduced on further increases in the personal allowance, the result will be a severe squeeze on the basic rate band and a significant increase in the numbers of those who are higher (40%) rate taxpayers. As the personal allowance increases, the very high marginal rates for those with incomes over £100,000 will broaden and increase in importance.

Unless increases are made to outstrip the basic personal allowance, the increased personal allowances for those aged over 65 will become of decreasing importance, and on current figures will disappear entirely if the full £10,000 figure is reached. Whether eliminating this age differential is politically acceptable remains to be seen.

(b) National insurance

The NI increases from 2011-12, which have been announced and argued over for a number of years, will come into effect. Essentially these represent a 1% increase in each of the rates payable by employer, employee and the self-employed. (This is a doubling, from 1% to 2%, in the rate payable for amounts above the upper earnings or profits limit.)

There is to be some offset in the impact of the rise for employers by increasing the secondary rate threshold (the point at which employers start to pay class 1 NICs) by an extra £21 per week above indexation. In line with the reduction of the basic rate band for income tax, there will be a significant reduction in the upper earnings/upper profits limit, which will reduce the amount of earnings at which NICs are payable at the full rates. Exact details will again not be available until after September.

There is to be a targeted scheme to exempt new businesses in certain regions from up to £5,000 of class 1 employer NIC payments, for each of their first 10 employees hired in their first year of business. The scheme is intended to be running by September, but any qualifying new business set up from (emergency) Budget day (22 June) will also benefit.

National insurance continues to grow in importance as a source of taxation for the Government. This process shows no sign of coming to an end and the proportion of individual and national tax represented by NICs can only be expected to rise further. Already, the NICs paid (by employer and employee) in relation to someone on the average national wage will exceed the income tax paid in relation to that income, and this differential seems certain to increase in future.

(c) Corporation tax

One small ray of sunshine in an otherwise gloomy collection of budgetary tax increases was the announcement of a reduction in corporation tax for UK companies. With effect from 1 April 2011, the main rate will be reduced by 1% per annum over four years, falling from 28% to 24% by 2014. The first reduction, to 27% from 1 April 2011, has already been enacted (F(No2)A 2010, s 1), as it needs to be set in advance for companies which pay “in-year” instalments.

The small profits rate, payable by companies with a taxable profit of less than £300,000, will also be reduced from 21% to 20% on 1 April 2011. (This represents a reversal of policy, as until recently this rate was due to increase. Nevertheless, when these changes go through, the difference between the full rate and the small companies rate will be very small and will perhaps form a target if there is a genuine attempt at simplification of the tax system as a whole.)

Although relatively modest, these cuts could go some way towards ameliorating the UK’s reputation as a high tax jurisdiction. Given the shift towards much higher income tax rates, this change in corporation tax rates could have a significant effect in the decisions about the appropriate medium in which to trade, although it must always be remembered that for individual owners, there remains the problem of how to extract the profits arising within a company.

(d) Inheritance tax

Legislation had already been enacted to increase the IHT nil-rate band to £350,000 with effect from 6 April 2010. This was reversed in the 2009 Pre-Budget Report and the first 2010 Budget went further, freezing the nil rate band at £325,000 until at least 2014-15 (FA 2010, s 8). This set the stage for an election contrast between Labour and the Conservatives, whose manifesto included a £1,000,000 nil-rate band.

In the era of coalition politics combined with the need for tax revenues, this Conservative pledge has been sidelined for the moment, leaving a frozen nil rate band which will affect more estates, particularly if asset inflation starts to increase significantly again.

Capital gains tax

CGT was probably the subject of the greatest speculation ahead of the emergency Budget. An increase in rate seemed inevitable, but by how much, and when would it be introduced? Again, the coalition partners differed – the Liberal Democrats apparently favoured taxing capital gains as if they were income, whereas the Conservatives wanted a more modest increase from the previous 18% rate (which of course had not been in force for long).

In the end, the changes were far from the most extreme that had been anticipated, although their timing did cause some surprise, in that they took effect from midnight on 22 June – F(No2)A 2010, s 2 and sched 1. This was the date of the emergency Budget, and there were certainly a number of sales and other transactions rushed through after the Chancellor had sat down. It may be reasonable to speculate that this Government is not finished yet with CGT, as the changes represent quite a modest move towards aligning CGT rates with those for income tax.

(a) Individuals

As expected by most, capital gains are once again aligned with income, but only to some extent. Where gains remain within the basic-rate band, there is no increase in the CGT rate, basic rate taxpayers continuing to pay at 18%. However, the tax rate for gains in excess of that band will be 28%.

Gains arising on or before 22 June 2010 will be subject to the flat rate of 18%, while the taxpayer is permitted to allocate both their CGT annual allowance and any losses arising in the year in the most tax advantageous way. This will usually be to gains realised after 22 June. There are complex amendments made to cover the situation where gains have been deferred from earlier transactions, such as where corporate bonds have been received in exchange for other securities.

(b) Entrepreneurs

The lifetime limit on which entrepreneurs will pay CGT at 10% rises from £2 million, announced in the March 2010 Budget, to £5 million. Gains arising on or prior to 22 June 2010 will only be entitled to utilise the £2 million threshold. This is a very significant increase and may serve to head off much of the criticism which was being directed at tax increases thought to inhibit entrepreneurship.

It will also demand significant attention to planning in certain circumstances to take full advantage of this relief, and that planning may require to be carried out significantly in advance of an intended disposal – for example, where it is desired to take advantage of the £5 million relief available to each of spouses or civil partners.

(c) Trusts & executries

The effective rate of CGT will be 28% on all gains arising within either a trust or an executry. This may give rise to the need for careful planning. For example, in appropriate circumstances, advances could be considered to basic-rate taxpayers in order to utilise both their personal CGT exempt amount and their basic rate band.

(d) Annual exempt amount

Despite much speculation, there is no change to the annual exempt amount, which remains at £10,100 for individuals, with the trustees’ amount adjusted in the usual way (usually to one half of the full amount).

  • Alan R Barr, Brodies LLP/ The University of Edinburgh

For charts and diagrams please refer to magazine or download the PDF

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