UK: The 2011 Budget

Introduction

George Osborne's second Budget had few shocks, although the reduction in the headline rate of corporation tax seemed to have been a well-kept secret.

The Coalition Government has introduced a new way of setting tax policy. This includes a strict timetable for any changes to be announced in a spring Budget, followed by consultation during the summer, leading to the publication of draft legislation in the autumn. The Finance Act will then be signed off by the end of the calendar year, with new rules applying from the following 6 April.

Many of the Chancellor's Budget announcements will become effective next year or later, and we anticipate a flurry of consultation papers over the coming weeks in line with the new policy structure outlined above. Hopefully the new timetable will help the Government to achieve its objective of creating a more certain and stable tax system.

An essential ingredient in the Government's tax-making policy was the establishment of the Office of Tax Simplification (OTS). The OTS issued two important reports ahead of the Budget, the first reviewing 155 tax reliefs and the second reviewing the taxation of small businesses.

The Chancellor responded to those reports by proposing the removal of some outdated reliefs. He also promised consultation on merging the operation of income tax and national insurance contributions (NIC), which if successful, could simplify the tax system dramatically and substantially reduce the burdens on smaller businesses. The possibility of merging income tax and NIC is clearly a major issue which will take time to resolve. However, in the meantime there is clear scope to modernise the current system for collecting NIC.

The main theme of the Budget was the reform of the nation's economy to encourage growth and jobs. Besides the reforms prompted by the OTS's reports, the Chancellor is anxious that the UK should be a location which appeals to international businesses. However, we wait to see whether the reduction in the headline rate of corporation tax and the other reforms now underway are sufficient to tempt businesses to move here.

Several changes in the income tax and NIC rates for 2011/12 were announced last year which means anyone earning over £42,475 pa will be paying more in income tax and national insurance from 6 April 2011, so they will certainly be feeling the pinch.

The Chancellor has already started taxing higher income taxpayers more heavily in the current tax year. Those on £100,000 pa and upwards have lost the benefits of the personal allowance, while those on taxable incomes over £150,000 pa have also been paying 50% on income above this level. But there are too few top rate taxpayers to fill the Chancellor's coffers, hence the need to widen the net – and share the pain.

1 Personal and trust taxes

1.1 Personal tax and NIC rates and thresholds

Income tax rates and thresholds will remain at their 2010/11 levels in 2011/12, except where noted below. All rates and thresholds are set out in the Appendix.

The main and additional rates of NIC will increase by 1% for 2011/12. The primary threshold will rise from £110 to £139 per week and the secondary threshold will rise from £110 to £136 per week. The upper earnings and profits limits for NIC will be reduced by £1,400 so that they remain aligned to the higher rate threshold.

The personal allowance for under 65s will increase by £1,000 to £7,475 for 2011/12. However, the benefit of this increase will not be passed onto higher rate taxpayers as the upper threshold of the basic rate band will be reduced by £2,400 to £35,000.

For 2012/13, the personal allowance for under 65s will increase by a further £630 to £8,105. The benefit of this increase will be passed on in part to higher rate taxpayers as the upper threshold of the basic rate band will be reduced by £630 only, to £34,370.

From 2012/13 indexed rises to income tax and NIC thresholds (along with other direct taxes and individual savings accounts (ISAs)) will be linked by default to the Consumer Prices Index (CPI) rather than the Retail Prices Index (RPI) unless specified otherwise. However, employer NIC and age-related thresholds will continue to be indexed to RPI for the duration of this Parliament.

1.2 Income tax and NIC reform

Over recent months both the influential Mirrlees Review and the recent report of the OTS into the taxation of small businesses have recommended that the Government should consider the merger of income tax and NIC. In his speech the Chancellor made reference to the fact that income tax and NIC have operated as two fundamentally different systems, resulting in unnecessary costs for employers. He announced that the Government will consult on 'merging the operation of income tax and NIC'. The Budget report recognises that any change will be complex and involve a wide range of policy and implementation issues. It makes it clear that the contributory principle will be maintained and NIC will not be extended to individuals above the state pension age or forms of income other than earnings (for example pensions, savings and dividends).

1.3 Tax simplification

Prior to the Budget, the OTS produced a detailed report looking at 155 out of the 1,042 reliefs which it had originally identified.

The report identified a number of long-term projects which the OTS considered were ripe for detailed review:

• the possible merger of income tax and NIC;
• aligning the treatment of employee benefits, simplifying many minor benefits with a de minimis limit;
• the need for a complete review of inheritance tax (IHT) and the taxation of trusts rather than tinkering with reliefs;
• the need for a review of capital gains tax (CGT) and in particular the growing difference between the regimes for individuals and companies.

The OTS's report listed 2 reliefs which were out of date, 45 reliefs which it considered had no ongoing policy rationale and should be abolished and 17 reliefs which could be simplified.

In the Budget report, the Government signalled its intention to abolish 7 obsolete reliefs this year and then abolish a further 14 next year after a period of consultation. This second list includes luncheon vouchers and the provision of late night taxis; the latter is likely to be controversial. There is then a third list of 22 reliefs which the Government plans to abolish after 2012 after an appropriate period of notice and this list includes flat conversion allowances and land remediation relief.

In his speech the Chancellor said he had decided not to accept the advice of the OTS to abolish community investment tax relief, but instead he would encourage taxpayers to take it up. This relief was described by the OTS as particularly complex and so it will probably need some work to make it more user-friendly.

That leaves one relief unaccounted for and it appears that the OTS's recommendation to abolish the relief for miners' free coal has been omitted from the Budget report, perhaps because it would have been too sensitive an issue.

The Budget report says that the Government is to consider the other areas raised in the report within a wider programme of work for the OTS. It remains to be seen whether the Government agrees that an overhaul of IHT and the taxation of trusts is indeed required.

1.4 IR35

IR35 was announced by the previous Government in Budget 1999 as an anti-avoidance mechanism. Its purpose was to address the avoidance of tax and NICs on what might be employment income through the use of intermediaries, such as personal service companies or partnerships.

The OTS was asked to look at the issue of IR35 in response to the view that IR35 as it stands is not particularly effective, yet is administratively burdensome. The OTS report identified that this was a complex area with no clear consensus on the way forward. It offered three options:

1. suspend IR35, with a view to abolishing the legislation permanently;

2. retain IR35 legislation in its existing form but with explicit commitments from HMRC to make specified changes to the enforcement of the legislation; or

3. consider the introduction of a genuine business test to exempt certain businesses from IR35.

The Government announced in the Budget report that it will retain IR35 because abolition would put substantial revenues at risk. However it has committed to make clear improvements in the way that IR35 is administered. These include setting up a dedicated helpline, producing guidance on cases that HMRC considers are outside the scope of IR35 and restricting reviews to high risk cases.

1.5 Enterprise investment scheme and venture capital trusts

The Government has announced a number of changes to the enterprise investment scheme (EIS) and venture capital trust (VCT) rules.

Legislation will be included in Finance Act 2011 which will increase the rate of EIS income tax relief for an individual from 20% to 30%. This measure will apply (subject to state aid approval) to shares issued on or after 6 April 2011.

A number of other changes announced in the 2009 Pre-Budget Report (PBR) and March 2010 Budget will also apply from this date, being:

• a company must not be 'in difficulty' to qualify for the schemes;
• the requirement that a company must carry on its qualifying trade wholly or mainly in the UK, is to be replaced with a requirement that the company issuing the shares must have a 'permanent establishment' in the UK;
• the requirement for a VCT's shares to be included in the official UK list, is to be replaced with one that its shares must be on an EU regulated market;
• the requirement that a VCT must hold at least 30% of its qualifying holdings by value in qualifying ordinary shares, is to be increased to 70%, and the definition of qualifying ordinary shares will also be changed to allow VCTs to include shares which may carry certain preferential rights to dividends.

The Government has also announced that legislation will be introduced in Finance Act 2012 that will apply (again subject to state aid approval) to shares issued on or after 6 April 2012, which will increase:

• the employee limit to fewer than 250 full-time employees (currently 50 employees);
• the size threshold for the gross assets test to no more than £15m before investment (currently £7m immediately before investment and £8m immediately thereafter);
• the maximum annual amount that can be invested in a company to £10m (currently £2m);
• the annual amount, qualifying for income tax relief, that an individual can invest under the EIS to £1m (currently £500k).

It was also announced that legislation will be introduced to prevent companies whose trade consists wholly or substantially in the receipt of feed-in tariffs (FITs) or similar subsidies from qualifying for EIS or VCT in cases where they do not start generating commercial electricity before 6 April 2012. However, companies who have issued shares prior to 23 March 2011 will not be affected by this change.

1.6 Review of non-domicile taxation

The Government announced in Budget 2010 that it would review the taxation of non-UK domiciled individuals. In this Budget, the following reforms have been proposed:

• increasing the existing remittance basis charge (RBC) from the current £30,000 per year to £50,000 per year for individuals who have been UK resident for 12 or more of the previous 15 years and who are claiming the remittance basis of taxation. The £30,000 RBC will remain for those who have been UK resident for at least 7 of the past 9 years but less than 12;
• removing the charge to tax when non-UK domiciled individuals claiming the remittance basis remit foreign income or capital gains for the purpose of commercial investment in UK businesses; and
• simplifying some aspects of the non-UK domicile rules to remove undue administrative burdens.

The Government will consult on the detail in June with the intention of introducing the changes from April 2012, and has confirmed that there will be no further substantive changes to these rules for the remainder of this Parliament.

Comment: Commentators had speculated ever since the RBC was announced in the 2007 PBR that raising the RBC would be a tempting and popular method of increasing tax revenues. Bankers have been bearing the brunt of populist taxes but this opportunity has proved too tempting to ignore. The increased RBC is to some extent balanced out by the exemption for remittances for the purpose of commercial investment in UK businesses. It will be interesting to see how non-UK domiciled individuals react to these changes and whether this will result in an increased exodus from the UK.

The expression 'for the purpose of commercial investment in UK businesses' will need to be clarified and it is frustrating that further details are not available at this stage. It is likely that anti-avoidance rules will be introduced to prevent any perceived abuse of this measure.

Any simplification of the non-UK domicile rules would be welcome but the extent to which this will actually assist non-UK domiciled individuals is not yet known.

1.7 Statutory residence test

The Government has announced that it will consult in June on the introduction of a statutory residence test to provide greater certainty for taxpayers. It is intended that this will be implemented from April 2012.

1.8 Capital gains tax: Annual exempt amount

From 6 April 2011 the annual exempt amount will increase from £10,100 to £10,600.

From April 2012 the default indexed rise will be by reference to the CPI as opposed to the RPI. The default indexed rise will apply unless overridden by Parliament.

1.9 Capital gains tax: Increase in lifetime limit on entrepreneurs' relief

Entrepreneurs' relief (ER) was introduced in the 2008 Budget at the same time as other major changes to the CGT regime, including the introduction of a flat CGT rate of 18%.

ER gives individuals the ability to make a claim for an effective CGT rate of 10% on certain qualifying disposals of business interests. Each individual had a lifetime limit of £1m of gains that could be covered by ER. That limit was increased to £2m from 6 April 2010 and then to £5m from 23 June 2010.

From 6 April 2011 all qualifying gains up to an increased lifetime limit of £10m will attract the 10% tax rate.

In order to qualify for the relief, the disposal must be of:

• all or part of a trading business carried on by the individual, whether alone or in partnership;
• assets used in the individual's business, whether alone or in partnership;
• shares in the individual's personal trading company; or
• assets owned by the individual and used by his personal trading company.

For the purposes of the relief, a personal trading company is one where the individual was an officer or employee of the company holding at least 5% of the share capital (which must carry at least 5% of the voting rights), with both conditions having been met throughout the 12-month period ending on the date of the disposal. If a trade ceases, the disposal must be made within three years of cessation of the trade. The relief can also be claimed by trustees but only if a beneficiary personally qualifies by satisfying the rules, including the requirement for a minimum 5% personal shareholding.

If the previous lifetime limit has been used, or partly used, at 5 April 2011, additional relief up to the new limit of £10m will still be available, although the increased limit will only be available for further gains realised from 6 April 2011. No other changes are made to the rules for the relief.

1.10 Gift aid benefit limits

Under current legislation, if an individual or company donates more than £10,000 to a charity, the benefit (aside from gift aid tax relief) which they can receive from the charity while still obtaining tax relief on the donation is capped at £500. From 6 April 2011 for individuals, and for accounting periods ending on or after 1 April 2011 for corporate donors, this benefit limit will increase to £2,500.

Also, there will be new guidelines to help clarify what constitutes 'a benefit'.

1.11 Self-assessment donate

Under 'self-assessment donate', taxpayers completing tax returns through the self-assessment system could direct that a tax repayment should be made to a specific charity of their choice. Taxpayers may also apply gift aid to this donation.

This scheme will be removed from the 2011/12 tax return allowing resources to be redirected to the introduction of an online claims system for gift aid.

1.12 Charitable giving

The Government announced various measures to encourage charitable giving including:

• reducing the rate of IHT from 40% to 36% for those estates leaving 10% or more of their wealth to charity (to apply from 6 April 2012);
• consulting on proposals to encourage donation of pre-eminent works of art or historical objects to the nation in return for a tax reduction;
• introducing a new system of online filing to reduce bureaucracy for charities;
• introducing a small donations scheme which will allow charities to claim gift aid on up to £5,000 of small donations per year without the need for a gift aid declaration (to apply from April 2013).

1.13 DOTAS: Inheritance tax

IHT avoidance is being brought within the disclosure of tax avoidance schemes (DOTAS) regime with effect from 6 April 2011. The disclosure regime will apply where:

• property becomes relevant property (defined as per s58(1) IHTA 1984 – settled property in which no qualifying interest in possession subsists other than certain exceptions) as a result of arrangements;
• a main benefit of the arrangement is that an advantage is obtained in relation to a relevant property entry charge (the charge to IHT which arises on a transfer of value made by an individual during that individual's life as a result of which property becomes relevant property).

However, arrangements are excepted from disclosure if they are of the same, or substantially the same, description as arrangements:

• which were first made available for implementation before 6 April 2011; or
• in relation to which the date of any transaction forming part of the arrangements falls before 6 April 2011; or
• in relation to which a promoter first made a firm approach to another person before 6 April 2011.

1.14 Anti-avoidance: Listed tax avoidance schemes

HMRC believes taxpayers are prepared to enter into high risk schemes to exploit a cash flow advantage of retaining tax while continuing to dispute a liability. This advantage results from tax and interest only becoming payable under some tax regimes once HMRC has proven each use of a scheme to fail.

The Government intends to address this behaviour by a minority, by removing the cash flow advantage of using such avoidance schemes. It will bring forward proposals to list specific schemes in regulations, with a range of options to ensure that users of the listed schemes do not benefit from retaining the tax in dispute. Users of schemes will be encouraged to pay the disputed tax earlier than is currently required or will face an additional charge for late payment of the tax when it is found to be due.

The schemes proposed for listing will be subject to Parliamentary scrutiny to ensure schemes are only listed where there is a strong case for doing so, including independent advice to support HMRC's assessment of the strength of its arguments. The proposed additional charge will be expected to remove any cash flow advantages from using the scheme.

A consultation document on these proposals will be published in May 2011 with a view to developing legislation for inclusion in Finance Bill 2012, in accordance with the new approach to tax policy making.

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