Archives for posts with tag: Gordon Brown

Budget 2012

George Osborne’s budget is the first under the budgetary process in full.  This involves an announcement made in budget 1 (in this case the 2011 budget on 23 March) being subject to consultation over the summer, then the draft finance bill measures are published in December for consideration.  If adopted they are included in the budget statement No 2, this year on 21st March and then published as part of the actual finance bill, this year expected on 29 March.  The measures are considered by parliament and the final amended version emerges in the middle of July.

Meanwhile advance announcements in this budget in 2012 will be consulted on this summer, included in a draft bill next December, and then adopted in the Finance Act 2013 after next year’s budget.

One measure which was going to included in this year’s finance bill was the new statutory residence test we discussed in October last year.  This is to be postponed and will now be brought forward for inclusion in next year’s finance bill, the rules becoming operational from 6 April 2013.  We also learn that the concept of ordinary residence is to be largely abolished and it’s effect preserved in connection with certain overseas duties.

A number of measures in this year’s budget have started with consideration by the Office of Tax Simplification – and one of these seems to have backfired on the government. You’re probably aware that the office started off looking at IR35 and redundant tax reliefs.  It then went on to consider small businesses and some it’s recommendations are adopted here including allowing businesses with a turnover below the VAT registration threshold, called ‘Nano’ businesses, to use the cash basis rather than the full GAAP which, in strictness, they should be using.  OTS think that 65% of the smallest businesses, many not using accountancy services, are using this method anyway!

The OTS went on to look at two further areas, issuing initial reports but not final recommendations; one of these concerned employee shares schemes, the other taxation of the elderly. They identified the problem that the tax affairs of elderly people are quite complex, they often have several sources of pensions and income, often dealt with by different districts and, if the taxpayer’s income is below £29,000, they have been entitled to a higher tax allowance when reaching 65 and a higher allowance still on reaching 75, although if their income is just below £29,000 the higher allowance is subject to clawback.

In the meantime the coalition have been pursuing the idea of substantially increasing the normal personal allowance to take increasing numbers of people outside of the scope of IT.  From April 2012, as was announced in 2011, the personal allowance goes up by £630 to £8,105 and to balance this the higher rate threshold is reduced by £630 from £35,000 to £34,370.  This budget provided that next year, from April 2013, the allowance would increase by £1,100 to £9,205, although the higher rate band threshold would reduce by rather more, £2,125, to limit the benefit of the allowance increase to higher rate taxpayers to 25% of what a basic rate taxpayer benefits by.

Now we know that the Lib Dems want to increase the allowance to at least £10,000 and if this allowance eventually exceeded the higher amounts of the age allowance, and of course you can’t have an allowance which is lower that the personal allowance so the age allowance can be done away with then the complexity of the age allowance and the clawback of the additional relief which gives affected taxpayers a marginal rate in excess of 20% could be done away with.

But George has jumped the gun.  Before the OTS makes its final recommendations and before the ordinary personal allowance has caught up with the age allowance George has decided to accelerate its withdrawal – this is the so-called “Granny Tax”.

The age allowance will be restricted now to those who reached the age of 65 before 6 April 1948 and the higher level of the allowance will only be available to those born before 6 April 1938.  It is also going to be frozen, which is the main complaint of the grannies, that in inflation adjusted terms they will be worse off. Although the pension may well be increased next year to compensate those persons who are affected by this ‘granny tax’, the increase in liability of those whose allowance is frozen has been seized upon by the press.  It reminds me of Gordon Brown’s ill-fated attempt to ‘simplify’ the tax system when he controversially eliminated the 10% starting rate for all income other than savings income.

It is made all the worse because George also decided to reduce the 50% rate to 45% on the grounds that the higher rate was counterproductive, it may well be that it is, HMRC figures seem to suggest it, but of course it makes it look as though he is taking from pensioners to transfer to the very wealthy.

In an historical sense this budget will be seen as the one where the government and the revenue finally accepted the need for a General Anti-Avoidance Rule or GAAR; given the number of targeted rules (TAAR) implemented since 2006 when the first one was introduced (concerning capital losses for CT purposes, and was so successful that it was extended a year later to individuals and trusts for CGT purposes) this should enable a significant reduction in the length of taxation legislation and may allow abolition of individual TAARs which now litter the legislation and account for much of the length of recent Finance Acts.

In the past HMRC have been reluctant to introduce this sort of measure, even though it is a potent one in the war against avoidance, because of the need to have a parallel clearance mechanism so that business can achieve certainty before entering into transactions.  It is claimed that Canada – who introduced a GAAR without a clearance mechanism – have suffered as a result.

Graham Aaronson QC, who suggested the GAAR in a report commissioned in last year’s budget, believes that it is possible to have such a rule as a limited GAAR, Sounds like a contradiction in terms which would allow ‘reasonable tax planning’ and so would not require new clearance mechanisms.  It remains to be seen whether it could be effective, as the arbiters of reasonability in the first instance would be – the revenue, although the final decision would be up to the Tribunals and the Courts.

Investors may have a quite unique opportunity in 2012/13 to secure 78% tax relief – it works like this…

Genuine small start-up businesses can use a scheme to raise capital called the Seed Enterprise Investment Scheme or SEIS – this offers investors a tax reducer relief of 50% which they can set against this year or last year’s liability regardless of the rate of tax they actually pay.  But they can do better than this – if they also make gains during the year 2012/13, and they would be advised to do so if they can, these can be matched against the investment into the SEIS and will be exempt from CGT.  Now the ordinary EIS offers 30% relief and deferral of gains, but this is a genuine exemption worth a further 28%.

Middlemen have already started to try to attract investors and match them with suitable small businesses.  It is obviously very high risk but the relief available may make it worthwhile.

Company cars are subject to good news and bad news – lets look at the… good news first.  From April 2013 the current scheme which gives a business 100% relief on the cost of a car which emits less than 100 g/km of CO2 was to come to an end.  It will now be extended to 2015 but at a slightly lower emission limit of 95g/km.

You can still get an Alfa Romeo Mito 1.3 diesel and claim a 100% FYA after April 2013 but if you want an Audi A1 Sportback you’ll need to be quick as it will cease to qualify after April 2013, its emission value is 99g/km – unless the manufacturer improves efficiency even further.

The Bad news? – well there’s rather a lot of it… cars which emit more than 130 g/km but less than 160 g/km will qualify for an 18% WDA until April 2013, but from that time onwards purchasing such a car will give you a writing down allowance of 8% pa only which at the moment only applies to cars with an emission figure in excess of 160 g/km.

In addition between April 2014 and April 2016 several changes are to be made to the company car benefit in kind scheme which will see the benefit in kind, in other words the tax liability, on some vehicles increasing by 25% over this short period, or indeed even more!  If you have a zero emission vehicle, which at the moment has a zero benefit in kind, from April 2015 onwards you will have a 13% benefit and in the following year this will be increased by a further 2% to 15%.  The maximum percentage for company cars is going to go up as well, it is at the moment 35% but will increase to 37%.  From April 2016 onwards you will no longer need to add the extra 3% for a diesel vehicle.

The announced reduction in the rate of corporation tax from 26% down to 24%, where last year we were told that the rate would go down to 25%, was a welcome reduction for larger companies with profits in excess of £300,000, and next year and the year after the rate will go down to 23% and 22% respectively.  But what of the lower 20% rate that applies to profits up to £300,000?  Would that be reduced as well?

The problem is that if this rate is reduced a 40% taxpayer taking a dividend from a company would be liable to a combination of corporation tax and income tax on the dividend which would be less than 40%. This was the mistake made some years ago by Gordon Brown, in reducing the rate to 19%, which he compounded by increasing national insurance so that a self-employed taxpayer was liable at 41% but dividend extraction from a small company attracted a liability of only 39.25%.

In a throwaway comment George indicated that he intended the main rate to fall even further to 20% in the future when there would then be one rate of tax applying to all companies regardless of size and the marginal relief calculation, necessary for profits between £300,000 and £1,500,000 to avoid a large jump in liability would no longer be needed and the complicated Associated Company rules, which were only reformed in last year’s Finance Act would also not be necessary.

In addition to increasing R&D relief further for small and medium sized businesses, a welcome change, he also confirmed the introduction of the idea of a “patent box”.  Originally dreamed up by his predecessor, Alistair Darling, this would mean that profits derived directly or indirectly from the exploitation of patent rights would be charged at an effective rate of 10% from April 2013 onwards and it worth noting here that this is not confined to patent royalties but also the trading profits that manufacturers derive.  As a response to this and the general reduction in CT liabilities Glaxo SmithKline have already announced a half a billion pound investment in UK manufacturing.

The CFC, Controlled Foreign Company, regime is extensively overhauled as announced last year to prevent it falling foul of EU discrimination laws and will only apply where profits are artificially diverted away from the UK by larger companies, rather than applying by default at the moment unless you benefit from an exemption.

A number of VAT anomalies have been removed from 1 October 2012 so that enjoying a hot chicken from your supermarket, drinking sport nutrition drinks, using self-storage facilities, even going to the hairdresser now that self employed stylists will not be able to rent chairs in a salon on an exempt basis could all become more expensive.

When the last government implemented SDLT, Stamp Duty Land Tax, in 2003 a number of bodies suggested they were too hasty in doing so and since then every year has seen further attempts to limit tax losses caused, at least in part, from the revenue’s Stamps Office seemingly not understanding real world property transactions. Of course, before SDLT came in, they were experienced in valuing legal documents but were not required to be aware of other transactions.

Residential properties costing more than £2,000,000 will now be subject to a 7% rate of SDLT and where companies have been used to acquire this sort of residential property there will be a 15% liability on the transfer into the company, because subsequently the shares can be transferred at a much lower Stamp Duty liability of 0.5% or outside the UK with no liability at all – other measures will include charging gains on the sale of property within these offshore companies to CGT and even a version of Vince Cable’s vaunted mansion tax where a company is used as an envelope to avoid liability.

This podcast can only skim the surface of the budget provisions and further information can be obtained from the revenue and treasury websites. There is a 206 page document “Overview of Tax Legislation and Rates” containing details of all of the budgetary changes which can be downloaded from http://www.hmrc.gov.uk/budget2012/ootlar.htm and The Chancellors full budget report, the ‘Red Book’ as it is called is available from http://www.hm-treasury.gov.uk/budget2012_documents.htm

Bonuses or Dividends?

A not uncommon strategy for small companies is to take a small salary, sometimes one so small that neither tax nor national insurance will be payable and then to distribute the remaining profit as a dividend.  Because the dividend carries a tax credit a basic rate taxpayer will have no liability at all.  Before the late 1990’s there was a link between this tax credit and the corporation tax that the company paid through the medium of ACT, Advance Corporation Tax.  At that time if a company paid a dividend it had to pay this ACT over to the revenue even if it was a loss making company.

 Gordon Brown believed that there was too much abuse by companies and pension funds claiming repayment of the ACT and under some schemes it was artificially inflated. He ended the obligation on the company to pay ACT and substituted, for larger companies, an obligation to pay their CT by instalments.  Tax credits were also no longer to be repayable, for either companies, or pension funds, or even individuals.  This was the source of the allegation that Gordon ‘raided’ the pension funds, he was acting to prevent an abuse, such as that uncovered in the case of the Universities Superannuation Scheme, but pension funds that were not fiddling their tax credit repayments lost out heavily.

However the tax credit survived and is worked out as being 10/90ths of the net dividend paid, equivalent to the basic rate of tax which applies to dividends which is also 10%.

A taxpayer chargeable at 40% will find that the dividend is charged at the lower rate of 32.5% and after deduction of the dividend tax credit is effectively chargeable at 25% of the net dividend received by them.  A taxpayer liable at 50% is charged to tax on their dividends at 42.5% and after the tax credit is deducted is liable to effective tax of 36.1% of the dividend received.

The profits used to pay the dividends are of course taxable in the company’s hands and if it is a small company currently liable at 20% the effective rate for a 40% taxpayer is then 40% of those profits.  For a 50% taxpayer the liability is, of course higher, and the combination of corporation tax at 20% and excess liability at 36.1% is a grand total of 48.88%.

Woe betide a Chancellor like Gordon Brown who lowers the corporation tax rate below 20% because it creates an immediate advantage to dividend payments but…

 Dividends are not chargeable to National Insurance, but salaries and directors’ fees and bonuses can be, which is why this low salary, high dividend strategy is so popular.

Could this all change in the future?  I think the answer is certainly yes, and recent scandals involving government civil servants paying themselves through personal service companies whilst seemingly being immune from the IR35 rules that can deem a person who would have been an employee if the company were not used have not helped.

The simplest weapon would be to take a suggestion that was contained in John Smith’s shadow budget in 1992 – subject close company dividends to National Insurance!  That would put the cat amongst the pigeons and make no mistake and also, of course, it would enable IR35 to be abolished as it would no longer be needed!

This podcast is going to look at a recent case which some commentators have suggested could also be brought to bear against this sort of abuse, the PA Holdings case.  Now PA Holdings is not a low salary, high dividend case, it is a case concerning a National Insurance avoidance scheme marketed by accountants Ernst & Young who employed, at that time, a chap called Jim Yuill who was an acknowledged NIC expert, in fact probably the only one!  The secret behind the scheme which made it feasible was the abolition of ACT.  Companies who wanted to pay dividends before then were obliged to pay ACT, remember, even if they had no profits, but now they didn’t need to!  Jim’s scheme was intended to take a magic wand and wave it over a bonus, turning it into a dividend and hence minimising the income tax liability because of the tax credit and avoiding NIC to boot!

PA Holdings was also a slightly unusual company, a firm of management consultants owned by the employees, today it would be called an example of a ‘John Lewis’ company.  Every employee owned shares and received an average salary for the position that they held.  This policy almost guaranteed a profit at the end of the year which was distributed to all staff by awarding points for the efforts that they put in and distributing the bonus according to the points awarded.  80% of the employees decided to join the new scheme, the remaining 20% opted to continue to receive bonuses directly.

A company was set up in the Channel Islands and the money representing the bonus was used by PA Holdings to purchase shares in this company.  The shares were then awarded to each employee according to the points accrued and then a dividend was paid of the whole of the company’s funds – this would be illegal for a UK company but it was permitted under Channel Island’s laws.  However the Channel Islands company was also for tax purposes controlled and so resident in the United Kingdom so that a tax credit attached to the dividends received.  Then in the following year a new company was established and the process repeated, all over again.

So the employees who joined the scheme received a dividend, and if they were only liable at the basic rate this was effectively tax free, if higher rate taxpayers they had a liability of 25% rather than 40%, then claimed that as a distribution, a dividend, what they received was not liable to NIC either.  Why was this so significant, was it just the abolition of ACT?  No – it was that combined with the decision to lift the upper limit from employer’s NIC – to create what was, in effect, a payroll tax.  Create a tax and somebody will look to see if it can be sidestepped.

The revenue felt that this avoidance of both income tax, because after the tax credit the liability on a dividend was significantly less than the liability on a bonus, and national insurance was unacceptable and so ruled against the workings of the scheme, raising assessments on PA Holdings to recover the tax and national insurance which they thought should have been paid.  PA Holdings appealed and it is believed that there are many other companies who used this scheme or variants of it.

When the case when to the First Tier Tax Tribunal the judge indicated that, in his opinion, there were four questions that needed to be asked:-

 First – was the amount received an emolument, did it represent reward for the work carried out by the recipient?  Earnings within Schedule E as the description of that source was then called from an income tax point of view would be taxable and also be earnings from an NIC perspective.

 Second – was it a distribution, a dividend paid by a company to which the special taxation rules then found in Schedule F, carrying a tax credit to offset against the income tax liability and not chargeable to NIC?

 Thirdly – could it be both?  If so what were the taxation and NIC rules that then applied?

Fourthly, if it was neither, what was it and how should it be taxed, if at all?

The answers to these questions did not require sophisticated analysis or application of anti-avoidance rules such as that evolved in the wake of the Ramsay decision.

Was it remuneration, a reward for work performed?  The answer was clearly yes, and a consequence of that was that the fourth question did not need to be answered.

Was it a dividend, a distribution, and the answer was again yes?  It had been paid in the form of a dividend by the channel islands’ company and to the extent that the distribution exceeded the original capital contributed it was clearly a dividend.

So that brought into play question 3 – how should it be taxed?  It was observed that there was a statutory rule which seemed to govern this situation.  Section 20(2) of the Income and Corporation Tax Act 1988 said ” No distribution which is chargeable under Schedule F shall be chargeable under any other provision of the Income Tax Acts.”  Well that seemed pretty final, from an income tax point of view, as it was a dividend it could only be taxed as a dividend under Schedule F.  However the tribunal pointed out that there was no equivalent rule from an NIC point of view and so NIC was payable.

 It may seem odd that a rule deliberately taxes this income as a dividend and so gives rise to a lower liability but you have to remember that before 1984 there was a tax called investment income surcharge and at that time dividends were taxed more heavily than earned income.  When the surcharge was abolished the legislators seemed to forget to change this rule!

If the decision of the tribunal was allowed to stand PA Holdings would have had an obligation to account for NIC and because of the way it was charged most employees receiving a bonus would already be above the upper limit for NIC contributions or if below it the bonus would take them above their upper limit so that relatively little employees NIC would be payable but, as there was no upper limit for an employer the whole sum would be chargeable to employer’s NIC.  Not surprisingly PA Holdings appealed against this ruling.

From an income tax perspective, however, it meant that employees liable at the basic rate would have no liability on the dividend at all, whereas basic rate tax would have been payable on the bonus, and 40% taxpayers would have a liability of 25% of the bonus received as a dividend rather than a full 40% liability on the bonus.  Not surprising the revenue appealed against this ruling.

The appeal was taken, in the first instance, to the Upper Tier Tax Tribunal who broadly confirmed the decision of the First Tier Tribunal and again both parties appealed to the Court of Appeal who have recently handed down their verdict.  Of the three judges in the Court of Appeal the decision was framed by Lord Justice Moses and the other two judges merely indicated that they agreed with his decision.

Moses has taken a very old-fashioned approach to the problem having stressed that the decision of the first tier determined that in fact this sum represents remuneration.  In his opinion the old case of Salisbury House Estates v Fry in 1930 stresses that the schedules of taxation are mutually exclusive and so if the sum is assessable under Schedule E as remuneration then it cannot be a distribution within Schedule F which was only created in 1965 when corporation tax was created.  He feels that the rule in s20(2) is designed to resolve the situation where a sum which is a distribution is also capable of being taxed in another way as trade profits of a share dealer.

A great result for the revenue but a worrying decision for PA Holdings, but is it also worrying for other taxpayers as well?  I feel it is quite likely that this case will go to the Supreme Court finally and Moses’ decision could well be overturned.  Consider this though, what about the small company where a low salary is taken and the profits which could have been taken as remuneration are taken in the form of a dividend.  Could the arguments in this case apply to create either an NIC liability or possibly both?

From an NIC perspective it is difficult to apply the decision to the situation where a shareholder/director exercises a choice to withdraw profit in dividend form rather than as remuneration and arguably if there could be abuse the IR35 rules limit the scope to avoid liability anyway.

However where a shareholding structure has been designed which gives a shareholding interest to employees which is designed to enable them to take dividends instead of a bonus – sometimes called ‘alphabet’ companies because each employee could hold a different class of shares, and so receive a different bonus there would seem to be a real danger that this would enable the revenue to pursue liability in older cases.

From an income tax point of view it may be much more difficult because of the way in which the law has changed in recent years.  The old-fashioned approach of identifying mutually self-exclusive schedules came to an end in 2005.  The old Schedule E was actually abolished by the Income Tax Earnings and Pension Act of 2003 but initially the old s20(2) survived.  Then in 2005 the Income Tax Trading and Other Income Act completed the process started by the tax law simplification committee of abolishing the remaining old schedules and cases in favour of an approach where the legislation simply describes each type of income.

This 2005 Act inserted a new provision into the 2003 Income Tax Earnings and Pensions Act, section 716A, described in the heading as a ‘Priority Rule for dividends etc of UK companies etc’ says that ‘any income, so far as if falls within Part 2… of this Act and Chapter 3 of Part 4 of the Income Tax Trading and Other Income Act (dividends) is dealt with under Chapter 3 as a dividend.  This seems to suggest two things, the first is that sums are no longer capable of being excluded from charge because they are also potentially taxable in another way, and secondly that the dividend treatment takes priority.   Some commentators have suggested that as dividends fall within Part 7 of the act rather than part 2 a charge could occur but a closer examination of the legislation shows that a sum which is deemed to be income by Part 7 is brought into charge under Part 2 – the dividend would still take priority.

However in 2005 legislation was passed which was designed to attack the alphabet companies referred to above and this provides that a charge can arise in connection with employment related securities where they are issued in connection with tax avoidance.  This suggests that there could be a double liability.  However Dawn Primarolo, then the Paymaster General, made it clear to parliament that this measure was designed to target only “complex, contrived avoidance arrangements that are used, mainly, to disguise cash bonuses“.

For the moment, at least, the dividend extraction strategy of the small company would seem to be unaffected, although the NIC position may still need to be watched carefully.  Attempts to use other methods to disguise bonuses as dividends would seem to effectively counteracted.

But how much longer can or indeed should small companies be permitted by the government to use this strategy of limiting the liability to income tax and avoiding NIC – often totally?