Briefing Note. Pre-Budget Report 2009

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Pierce Lawrence
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1 Briefing Note Pre-Budget Report December

2 Contents Introduction 3 Personal Tax 4 Incentives. 6 Businesses & Corporation Tax. 7 The calm before the storm.. 8 Summary 11 Contact us. 12 2

3 Introduction Comment The Government faced a mighty challenge in preparing for this year's pre-budget report (PBR). Do they support the UK's economy in one of its deepest recessions since the Second World War or do they concentrate on slashing the enormous debt the country now owes? It seems that Alistair Darling has chosen not to deal with either issue significantly in this rather uneventful PBR. Opting instead to shy away from any controversial further tax hikes and leaving any nasty surprises for after the general election. However, the Chancellor has made three important announcements in this PBR: employers, employees and self-employed national insurance contributions will increase from April 2011 by 0.5% in addition to the 0.5% increase announced in Budget 2009 for those earning over 20,000 a year; bankers discretionary bonuses of 25,000 or more will be subject to a bankers payroll tax at 50%, effective for payments made on or after 9 December 2009; and a new patent box regime will be introduced to attract intellectual property (IP) rich companies to the UK. In this Briefing Note we look at the most significant tax measures announced in this year's PBR and consider their impact on our clients. 3

4 1 Personal Tax 1.1 Personal tax rates Income Tax The Chancellor had already announced in the 2009 Budget increases to tax rates for taxpayers with income over 150,000 per year. He has confirmed these changes will take effect from 6 April Tax year 2010/11 The basic rate of income tax will remain at 20% and the higher rate at 40%, with an additional 50% tax rate for those with income of 150,000 or more from 6 April The basic personal allowance has been frozen at 6,475 for the 2010/11 tax year. There will also be three rates of tax for dividends, the basic and higher rates of 10% and 32.5% will remain but for those dividends falling within the new upper band of 50%, such dividends will be taxable at the new rate of 42.5%. Tax year 2011/12 The PBR has announced that in addition to the 0.5% increase to employers, employees and selfemployed national insurance contributions (NIC) that was announced in Budget 2009, a further 0.5% increase will apply from April 2011 for those earning over 20,000 a year. Therefore a 1% increase on NIC will be effective from this date. This will increase employee NICs to 12%, self-employed NICs to 9% and employer NICs to 13.8%. NICs are the second biggest revenue generator for the Government. This increase will hit the majority of the working population in the UK and will be an unwelcome development for many. Capital gains tax After much speculation, the rate of capital gains tax (CGT) remains at 18% - for the time being. We discuss what changes may be made to CGT in future years. 1.2 Pension schemes Higher rate pension tax relief In the 2009 Budget the Chancellor announced changes to higher rate tax relief for taxpayers with income of 150,000 or more per year. The important thing to remember here is that 'income' includes all income received by an individual, not just their employment earnings. In the Budget 2009 the Chancellor announced that for those high earners, the pension tax relief will be tapered down to 20% from April 2011, i.e. equivalent to the current basic rate pension tax relief. Anti-forestalling legislation was introduced to prevent taxpayers from taking advantage of the period until the change is effective by increasing their pension contributions prior to April In the PBR the Chancellor has made further changes to the anti-forestalling rules so that in essence from 9 December 2009, these rules will now apply to those with income of 130,000 or more, for the current tax year or either of the two preceding tax years. Whilst this is a technical change to some very complicated and technical rules, it is likely to be an unwelcome one for both employers and employees as those affected by these rules potentially widens and employers try to determine who is affected by these changes. 1.3 Offshore evasion There has been much in the press of late detailing the Government's current campaign to tackle offshore tax evasion, the latest initiative being the 'New Disclosure Opportunity' (NDO) with which HMRC has given taxpayers the opportunity to disclose any undeclared offshore assets and pay any tax, interest and a reduced penalty. This opportunity closes on 4 January If taxpayers do not come forward under the NDO they can expect to face a much tougher penalty regime. The PBR has announced that legislation to tackle offshore evasion will be brought forward to catch those that have failed to declare their interests, they will be exposed to the full reach of the law for tax evasion. 4

5 1 Personal Tax The Chancellor also announced a new requirement to notify HMRC when opening offshore bank accounts in certain jurisdictions, which will be supported by a separate penalty regime. The Government warn therefore, that evading tax offshore could result in penalties of up to 200% of the unpaid tax, much higher than any other penalties currently enforced. 5

6 2 Incentives 2.1 Bank payroll tax A temporary new bank payroll tax has been introduced which will apply primarily to banks and building societies who pay bonuses over 25,000 to employees in the period 9 December 2009 to 5 April This forms part of the Government's general strategy to encourage change in the remuneration practices in the banking industry - to curb excessive rewards and discourage risk taking. In particular, the Government hopes that the tax will encourage banks to build up their capital bases rather than paying out significant amounts as bonuses. The tax will apply whenever a company in the financial services sector awards a bonus greater than 25,000 in value, whether it is paid in the form of cash, or shares and where loan arrangements are used. The tax will apply whether the bonus is discretionary or contractual. There is an exception for contractual bonus entitlements where the employer has no discretion as to the amount of bonus because of a contractual obligation preexisting at the time of the Chancerllor's announcement. The company will be required to pay the special tax at a rate of 50% on any bonus amount exceeding 25,000. The tax must be paid by 31 August 2010 and will not be eligible for a deduction for the purposes of corporation tax. The bank payroll tax does not affect the liability to tax of employees who will continue to be subject to tax on their bonus payments in the usual way. Similarly, NICs will be payable in the usual way on such bonus payments. There are anti-avoidance provisions targeted at arrangements through which a bank might seek to avoid payroll tax, for example by the use of loans or payments made through certain types of employee benefit trusts. However, there is evidence that a number of banks have already put in place arrangements to minimise the effect of the new tax, for example, by increasing base salary which is not subject to the new bank payroll tax or deferring bonuses. 2.2 EMI qualifying conditions A relaxation to one of the qualifying tests for HMRC approved Enterprise Management Incentives (EMI) options was previously announced in August 2009 and has been confirmed to come into effect from 6 April From that date it will be open to a company that has a permanent establishment in the UK to grant EMI options (subject to satisfying the other qualifying conditions). Previously, a company had to carry on substantially the whole of its trade in the UK so this relaxation should make it easier for overseas companies to grant qualifying EMI options to UK employees. 2.3 General There are no other major changes to the way in which HMRC approved share schemes or other forms of general share incentives are taxed. However, the new top rate of tax of 50% will apply from 6 April 2010 to those with income above 150,000 and the increase in Class 1 NIC rates from 6 April 2011 will encourage interest in employee share plans that deliver capital gains rather than income to employees. Where share incentives are taxed as income, companies can make use of the ability to transfer to employees the liability for employers' NICs, which are currently charged at 12.8%. In these circumstances, the effective tax rate for higher rate taxpayers under the present rules is 48.68%. From April 2010, when the 50% highest rate of tax applies, the transfer of employers' NICs will result in an effective highest tax rate of 57.4%. From April 2011, when increased NICs rates also apply, this highest effective tax rate will jump to an eye watering 58.9%. Companies will continue to try to use HMRC approved share plans wherever possible in order to take advantage of the CGT rate which remains at 18%. However, the individual limits under these plans will not provide sufficient benefits to senior employees and not all companies qualify for HMRC approved plans. More complex arrangements may be required to 6

7 2 Incentives deliver capital growth, although these carry other risks and may not be appropriate in all cases. HMRC has announced a consultation on new draft legislation to extend the current regime for disclosure of tax avoidance schemes. The draft legislation requires disclosure of arrangements which may result in a tax advantage by reason of employment and also focuses on "income to capital" schemes. HMRC recently stated that it will act to close down any schemes which convert income to capital in order to avoid the 50% income tax rate, so the outcome of the consultation will be important when considering future share scheme design. Interest is also likely to be maintained in salary sacrifice arrangements which deliver NIC savings for employees and employers alike. 7

8 3 Businesses & Corporation Tax 3.1 Corporation tax rates Small Companies It has been confirmed that, with the object of supporting small and medium sized companies through this difficult economic time, the increase in the small companies' rate of corporation tax from 21% to 22% will be postponed for a further year until April The small companies' corporation tax rate applies to those companies with chargeable profits of less than 300,000. The full rate of 28% for companies with a taxable profit of 1,500,000 will remain from 1 April New patent box exemption The Chancellor is proposing to introduce a reduced rate of corporation tax of 10% on income deemed from patents commonly known as a 'Patent Box'. 'Patent Box' regimes have recently been introduced in the Netherlands and Belgium and are seen as a way of attracting technology and high value research and development (R&D) jobs to the jurisdiction. Whilst this is obviously a very positive move, and shows the Government is trying to ensure that the UK remains an attractive place for businesses to carry on R&D activities internationally, it is disappointing that the reduced tax rate will not come into force until after April 2013 and will only apply to 'new' patents i.e. patents granted after the legislation is passed. It also remains to be seen whether this measure will stop the exodus of 'IP rich' companies from the UK, which is as much in response to the uncertainties of the UK's CFC rules as the benefits of tax regimes overseas. 3.2 VAT It has been confirmed that the VAT rate will return to 17.5% from 1 January 2010, after a temporary reduction to 15%. 3.3 Taxation of foreign profits The 2008 Pre-Budget Report announced a package of reforms, some of which were introduced in the Finance Act 2009, to the taxation of foreign profits. These reforms included a foreign dividend exemption for large and medium-sized companies, a worldwide debt cap and a review of the controlled foreign company rules. "Debt-cap" These rules put a cap on the finance expense payable by UK members of a group of companies that is allowable for corporation tax purposes. The cap is determined by reference to the consolidated (i.e. external) gross finance expense of the worldwide group. These rules apply for finance expenses payable in accounting periods beginning on 1 January Since the enactment of the legislation in the Finance Act 2009 the Government has continued its consultation with businesses and a number of areas where practical difficulties will arise have been highlighted. HMRC is preparing to amend the rules so measures to avoid tax mismatches that may occur as a result of companies in a group using different accounting treatments and improving on certain definitions to ensure that the correct and intended result is achieved. These amendments will be generally welcomed by those having to apply these very complicated rules in practice. Controlled Foreign Company Reform (CFC) There was no further detail on the proposed reform on the CFC rules in today's PBR. Detailed proposals are now expected in the New Year, rather than before Christmas as originally intended. 3.4 Research and Development The Government has made a change to the R&D tax relief provisions for small and medium sized enterprises (SMEs) with immediate effect to abolish

9 3 Businesses & Corporation Tax the condition that requires any intellectual property developed as a result of a company's R&D expenditure, to be owned by the company making the R&D tax relief claim. This measure will benefit SMEs which can currently claim R&D tax relief at the rate of 175% of qualifying expenditure. There was disappointment, however, that the Government did not take the opportunity to extend the generous R&D tax relief provisions to the UK games industry. The UK games industry has called for the introduction of a Games Tax Relief for some time and, despite the fact it is larger than the UK film industry, (which has benefited from recent tax reliefs), it has not received any Government help. In comparison its overseas competitors, notably in Canada and France, have received generous tax reliefs. The fear is that this may lead to development studios outsourcing work overseas or relocating outside the UK, which could detrimentally affect the UK interactive entertainment industry's position as one of the world's leading video games industries. including the number of staff, annual turnover and balance sheet totals. In terms of the figures of staff and turnover these are very similar to our current definition, the difference is in relation to a new focus on the economic activity being carried out by an EIS company and the requirement that the company engaged in the economic activity is a 'small enterprise'. 3.5 Changes to venture capital schemes Following the Budget 2009 HM Treasury and the European Commission confirmed that state aid approval has been granted in respect of the Enterprise Investment Scheme (EIS) and Venture Capital Trust (VCT). The approval was however, conditional on certain amendments being made to the rules governing the EIS and VCT schemes. Please see our Hot Topic EC grants, EIS, CVS and VCT schemes state aid approval' Following the PBR, HMRC have published draft legislation intended to implement these amendments. In addition to the conditions required by the EC, the draft legislation also includes a new EIS and VCT qualifying condition which will replace the current gross assets and number of employees requirement. This new qualifying condition is called the "small enterprise" requirement and is defined by reference to an EC recommendation that sets out what a small enterprise is for these purposes, 9

10 4 The calm before the storm 4.1 Is more change afoot? The PBR was not as aggressive as was expected in terms of raising taxes to pay off the country's ever increasing debt. As a result, it may be unwise to assume that these changes are the only ones we should expect in the short term, with controversial tax changes being reserved for after the general election. 4.2 Possible changes? The following changes are open to the Government to raise further revenue and we think it is worth considering these when looking at personal and corporate tax planning in the pre-election period. Increase the VAT rate. EU law permits a top rate of VAT of up to 25%. In comparison with the rest of the EU our current rate of 17.5% is one of the lowest VAT rates in the EU. This does allow the Government some room to increase the VAT rate without making the UK uncompetitive. Increase the CGT rate. With such a wide gap now between the flat rate of CGT at 18% and the top rates of income tax at 40% and 50% for individuals, it is arguably only a matter of time before the Government harmonises rates. There are several ways they could tackle this differential, such as simply increasing the 18% rate or introducing a higher rate of CGT for those assets held for a year or less.

11 Summary As expected the PBR was a bit of a damp squib, failing to deliver any answers to the main areas of taxpayer concern. For companies it offered nothing in terms of progressing the debate on the CFC regime and increasing employers NIC costs. The one shining light was the introduction of the new 'patent box' regime, however this is not due to come into effect until 2013 which may be too little too late for some companies. For individuals there was little to smile about, save that news was not worse. The PBR was as predicted a political one but most commentators agree more tax increases will follow after the election. 11

Contact Us Philip Moss Tax Consultant Erika Jupe Tax Partner

com t 0117 917 4312 f 0117 917 4313 michael.bell@osborneclarke.

Brown Tax Partner t 0117 917 3628 f 0117 917 3629 karen.

com These materials are provided for general purposes only.

12 Contact Us Philip Moss Tax Consultant Erika Jupe Tax Partner Michael Bell Tax Partner t f philip.moss@osborneclarke.com t f erika.jupe@osborneclarke.com t f michael.bell@osborneclarke.com Karen Cooper Tax Partner Mark Woodward Tax Partner Sandra Brown Tax Partner t f karen.cooper@osborneclarke.com t f mark.woodward@osborneclarke.com t f sandra.brown@osborneclarke.com These materials are provided for general purposes only. Osborne Clarke does not accept liability for the contents of these materials and legal advice should be taken in respect of a particular matter. Osborne Clarke 12

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