UK: The 2011 Budget

Last Updated: 28 March 2011
Article by Smith & Williamson


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The Chancellor responded to those reports by proposing the removal of some outdated reliefs.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.

Comment: The rates and increases for 2011/12 had all been announced in previous Budgets. The Chancellor was at pains to stress that the 1% NIC increase and the 50% income tax rate had both been proposed by the previous administration. He also highlighted that his change to this inherited programme in raising the threshold for NIC softened the impact of the increase; overlooking that the Conservatives' campaign implied an intent to scrap the 1% NIC rate increase altogether.

The wider backdrop was to present the 50% income tax rate as necessary, but temporary.

Linking threshold rises to the, historically, lower CPI is estimated to increase the annual tax take by over £1bn by the end 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).

Comment: It is not clear from what has been said so far whether the Government has in mind a full merger of income tax and NIC, resulting in a single rate of tax on earnings, or whether it is thinking in terms of keeping the two taxes running in parallel but with identical definitions.

While the latter course would improve the position, there is a 'once in a generation' opportunity here for a major simplification of the tax code by means of a full merger of the two taxes, although the resulting increase in the basic rate of income tax would need to be carefully explained to taxpayers.

Nothing was said about employers' NIC. Employers' NIC is a major contributor to the total tax take, producing something in excess of £50bn a year, but it is essentially a payroll tax masquerading under a different name and it is unlikely that it will be scrapped.

The possibility of merging income tax and NIC is clearly a major issue and it is not going to be resolved any time soon, but in the meantime there is clear scope to modernise the current system for collecting NIC.

From 6 April 2011, Class 2 NIC will be collected on 31 July and 31 January (the same dates that income tax is payable), but by an entirely separate payment process. An individual who is both employed and self-employed has the right to defer paying Class 2 and 4 contributions until the precise liability is known after the end of the tax year, but this deferment process is paper based and outside the normal selfassessment system. Bearing in mind that all self-employed individuals are in the selfassessment system the OTS recommended that Class 2 and 4 NICs should also be brought within that system.

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.

Comment: The removal of reliefs which are now past their sell-by date is a welcome move, particularly as it will remove some 100 pages of legislation from the statute book.

However, major pruning of the existing tax code would be necessary to achieve a real simplification of the system. The Chancellor has announced plans to consult on the options for integrating the operation of income tax and NIC and it remains to be seen whether the Chancellor has the appetite to tackle the other long-term projects mentioned above.

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.

Comment: It is disappointing to see that the Government has failed to grasp the IR35 nettle.

IR35 is a symptom of an old-fashioned tax system which does not cope adequately with modern work patterns and which acts as a barrier to the enterprise culture that the Government wishes to encourage.

In short this is an area that needs some joined-up Government thinking, but the prospects for a review in the foreseeable future are now looking slim.

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.

Comment: The increase in the EIS income tax relief to 30%, together with the proposed increase in the annual investment limit for individuals under EIS are positive changes. This should result in individuals being more incentivised to invest in smaller and higher risk companies.

In addition, the proposed increase in the employee limit and gross assets limit should substantially increase the number of companies which can qualify for EIS and VCT investments. Again, this is a very welcome and positive change.

The increase in the maximum amount that can be invested in a company under the schemes in any 12-month period from £2m to £10m is particularly welcome. The £2m limit has historically been very restrictive for qualifying companies raising funds.

The measures should stimulate and boost investment into smaller companies and go towards plugging the so called 'equity gap'. Overall, we expect to see an increase in the popularity of the schemes in the coming years.

In relation to the changes announced for companies receiving FITs, this is not an unexpected development. The Government is not keen to offer tax relief for funding companies that benefit from FITs or similar subsidies.

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.

Comment: Currently residence is a very complex area and taxpayers often have no certainty as to their residence position, especially when trying to make a distinct break from the UK. The introduction of a clear and ideally internationally competitive statutory residence test is long overdue and would be a welcome development.

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.

Comment: The fact that the Chancellor did not refer to any further upward review in the headline rate of CGT is welcome. Combined with his stated intention to reduce the 50% income tax rate when the time is right and his commitment to creating a climate of certainty, this implies stability in the CGT rate. It is also pleasing that there has been no unnecessarily hasty restriction of main residence relief in response to 'flipping' by MPs, although the relief is still under review by the OTS.

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.

Comment: The doubling in the ER lifetime limit to £10m is a welcome increase for entrepreneurs. The Treasury estimates 25,000 to 30,000 people each year are claiming ER. To further encourage business owners, it would have been helpful to relax some of the qualifying rules, particularly the 5% holding requirement.

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'.

Comment: The overwhelming majority of charities and donors will be unaffected by these changes. The current rule that the benefit must not exceed 5% of the gift will remain and so it will only be donors giving over £10,000 to a single charity who could gain an advantage from this change. For example, a £5,000 donor could still only receive a £250 benefit. Also, any benefit provided for large donations of over £50,000 will still be capped. For example, the benefit that could be provided by a charity following a £100,000 donation would be capped at £2,500.

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.

Comment: This was a rarely used method of charitable giving and is likely to have little impact save for a minor simplification to the self-assessment tax return.

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).

Comment: With the recent fall in charitable donations and the expiry in April 2011 of the transitional relief introduced to compensate charities when the basic rate of income tax was reduced from 22% to 20% in 2008, it is no surprise that the Government is keen to introduce further measures to encourage charitable donations. Broadly, the charitable sector has welcomed these reforms although many would like to see the Government go further to fulfill its pledge to boost philanthropy.

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.

Comment: The DOTAS regime has been a useful tool in HMRC's anti-avoidance strategy and it was inevitable that IHT avoidance would be brought within the regime at some stage.

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.

Comment: Although the DOTAS regime brings details of various tax avoidance arrangements to the attention of HMRC at an early stage, there can still be a considerable gap between the tax benefit being claimed (and processed) and the disputed points being investigated and the matter brought to a conclusion. HMRC feels that this may give a benefit of a cash flow advantage even where the arrangement fails so wants a means of removing this benefit in specific cases.

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