JOURNAL 32

THE PRE-BUDGET REPORT

Gordon Brown did not say much about tax in his tenth (and probably last) pre-budget report; an anti-avoidance provision for managed service companies, a temporary SDLT exemption for new “zero-carbon” homes (he actually called it stamp duty, but he has introduced so many new taxes that he obviously can’t be expected to remember them all), a doubling of air passenger duty, an extension of the bio-diesel fuel duty relief, an extra 1.25p a litre on petrol and a promise of early rulings on business tax (although he may have got that one partly wrong too as it is a recommendation of the Varney review which applied only to large businesses).

HMRC and the Treasury have however made up for Gordon’s apparent disinterest in tax. HMRC have issued 64 pages of press releases and the Treasury a further 33 (plus a large number of targeted regional press releases). There are then a further 20 Treasury reports, consultation papers and other documents plus 16 more from HMRC and 10 sets of draft legislation (with three more promised).

So here are the real tax changes.

1. The government is taking action to tackle Managed Service Company (also known as Composite Companies) schemes, which are used to avoid paying employed levels of tax and NIC’s. From 1 April 2007 these will be taken out of the IR 35 legislation and PAYE and NIC will have to be applied to the income generated by each worker. Actually the consultation document suggests that what is being tackled is evasion, rather than avoidance, but what’s in a word. There is no suggestion that those who have ignored the IR 35 rules and thus defrauded the country should be prosecuted. Indeed it’s carry on defrauding for another four months for them. Of course it could be that the consultation document is wrong and that such companies actually fall outside the current IR 35 rules, contrary to what the document says. But surely no one who hopes to become Prime Minister would deliberately lie in a consultation paper, so that can’t be the case.

2. The CFC rules will be amended to conform with EU law following the ECJ decision in Cadbury Schweppes. But the change will merely allow a company to apply to HMRC to disregard their CFC profit that “arise from genuine economic activity in business establishments in other EU countries. Presumably they will then need to convince HMRC of their genuineness. A “highly artificial avoidance scheme” will also be countered by repealing the public quotation exemption, so forcing a lot more companies to cope with the CFC legislation.

3. There will be yet more changes to the rules on financial instruments. Apparently when HMRC got round to finalising the regulations last month they discovered that the primary legislation is not wide enough to allow them to do what they want to do.

4. There will be more changes to the REIT rules too. In typical Gordon Brown fashion these were bulldozed through parliament in the last budget in the face of much industry criticism. He has now decided to listen to many of the arguments that he so peremptorily rejected last April.

5. There are a number of threatened changes for insurance companies. As Blackstone Franks do not act for any, I have not bothered to look at these.

6. There are a number of corporation tax anti-avoidance rules (applying from 6 December 2006 – it is only fraudsters who are allowed four months grace to continue defrauding), dealing with schemes that involve:

(a) the creation of artificial losses by claiming exemption from tax on annual payments by individuals but claiming a deduction for the cost of acquiring the right to such payments;

(b) using authorised investment funds to avoid DTR restrictions;

(c) the avoiding of the manufactured payment unallowable purpose rule by paying a fee instead of a manufactured payment (or as HMRC put it “by characterising such a payment as a fee”);

(d) using guarantees and thinly capitalised companies to hedge currency exposure in such a way as to generate deductible losses but tax free gains;

(e) using lease and leaseback arrangements that result in claiming a deduction for rent for what is in substance a loan; and

(f) shifting profits offshore and returning them to the UK without incurring a tax charge.

The swathe of anti-avoidance legislation is of course a tribute to the effectiveness of the tax avoidance scheme disclosure rules.

7 The landlord’s energy saving allowance will be extended to include the installation of floor insulation from 6 April 2007. As the allowance is capped at £1,500 this is not an earth-shattering change. The relief allows the cost of energy saving work, which is improvements and thus capital, to be deducted when the expenditure is incurred. The allowances will now continue until 2015 (they were due to expire in 2009) and will be extended to corporate landlords who let residential property. From 6 April 2007 the £1,500 cap will become per building instead of per landlord.

8. The rules on alternatively secured pensions, which were amended last year, are to be further amended so that the beneficiary will be forced to take a minimum pension at aged 75 of 65% of the amount of a comparable annuity. There will also be a bar on using a member’s transfer lump sum death benefit to enhance the pension of another member (such as a relative).

9. There will also be a range of “technical components” to the pension legislation. As this came into effect only on 6 April this year there has been little time for practical problems to surface, so this is probably the first batch of technical improvements, with more likely next year.

10. An investment regulated pension scheme that (with its associates) owns more than 10% in a REIT that invests in residential property will be treated as having an indirect holding in its share of the underlying property. This apparently amends the law to conform with the regulations that the Treasury has issued! This is a novel approach. Normally regulations conform with the law, but as in this case the law only takes effect from 1 February 2007 both should be in effect (assuming the Finance Bill is enacted) by the time the REIT regime begins.

11. There are two SDLT anti-avoidance measures from today.

(a) There will be a notional land transaction where a person acquires an interest in land by a series of transactions (this blocks a number of schemes).

(b) The rules on partnership transfers are to be tidied up to close a possible loophole.

12. A targeted anti-avoidance rule is to be introduced to counter schemes that create artificial capital losses for individuals and trusts; loss relief will be restricted to those arising from genuine commercial transactions.

13. If you invest in microgeneration technology to generate power for your personal use and are able to sell surplus power to an energy company the sale proceeds will be (and apparently currently are) tax free.

14. From 1 February 2007 air passenger duty will be doubled to £10 for flights within the EU (and certain other countries) and £40 elsewhere for the lowest class of travel. Those that can afford Club or First Class will instead pay £20 and £80.

15. The already threatened changes to the VAT partial exemption rules, which have been strongly criticised, are to be introduced in any case. A business will be required to declare that its proposed special method is fair and reasonable. If it later transpires that it is not (on the basis of the information that was available at the time), the special method will be withdrawn retrospectively.

16. The VAT TOGC rules are to be amended to allow the vendor to retain his business records rather than having to beg HMRC to let him do so. This change, which accords with commercial reality, is to be applauded, albeit that it has taken over 30 years for it to happen.

17. As previously announced that standard rate of landfill tax increases from 1 April 2007 by £3 to £24 per tonne.

18. From today SDRT will no longer be payable on Exchange Traded Funds.

19. Personal tax allowances for 2007/08 increase in line with inflation – an extra £190 on the basic personal allowance, bringing it to £5,225. Nothing has been said about the tax rate band thresholds.

20. The self employed Class 2 NIC contributions will increase from next April by 10p to £2.20 per week. The Class 3 voluntary contribution will increase by 25p per week to £7.80. The NIC thresholds all increase in line with inflation.

Robert W Maas

06.12.06