Bill Dodwell’s tax predictions for the Emergency Budget…

• Expect an announcement on increase in CGT;
• Possibility of £1,000 personal allowance increase;
• Announcement of VAT rise in the coming months;
• Corporation tax reforms discussion document will be issued.

Bill Dodwell, head of tax policy at Deloitte, considers what tax measures the Chancellor is expected to focus upon in the Emergency Budget:

Capital Gains tax
Most of the focus has been on the increase in capital gains taxation, with ‘generous exemptions for entrepreneurial activities’. We hope that shares owned by employees and unquoted shares in trading companies will benefit from lower rates. Both make vital contributions to entrepreneurial activities. We also hope to see relief for the effects of inflation – either through indexation (increasing the original base cost to allow for inflation), or through taper relief (reducing the gain, depending on the ownership period). Interestingly, the Office for Budget Responsibility forecasts lower CGT yields than previously calculated by the Treasury, due to lower prices for shares and property. This forecast definitely shows it will be hard to achieve the original hope of an extra £1bn-1.5bn annually from CGT.

Personal Allowances and National Insurance Contributions
The two big give-aways are the increase in personal allowances and the increase in NIC thresholds. Personal allowances are normally increased by the rate of RPI, in September. If we assume that inflation is about 3%, this would suggest an increase of around £200 (worth £40 for a basic rate payer) and it’s no doubt possible that the Chancellor may wish to announce a round £1,000 increase. Normally, increases in personal allowances benefit taxpayers at their marginal rate – so £200 for a basic rate taxpayer and £400 for a higher rate taxpayer. However, there have been signals that the benefit might be the same – £200 – for both higher rate and basic rate taxpayers. This adds to complexity in the tax system – but is cheaper to implement.

It is possible that the Chancellor will announce the married couples’ allowance put forward by the Conservatives. Under the Coalition agreement, the Liberal Democrats have agreed to abstain, rather than vote against the proposal. The allowance is intended to permit a spouse/civil partner with income below the personal allowance to transfer up to £750 of the unused allowance, provided that the recipient is a basic rate taxpayer. Consequently, the maximum benefit will be £150. Increasing the personal allowance will mean more married couples/civil partners will benefit. It’s thought that about one third of married couples will benefit from the allowance.

It’s likely we know what will happen to NIC. The rates for employers, employees and the self-employed will go up by 1% and the thresholds will be increased by £570 over the personal allowance for employees (the Labour Government plan) and £1,092 for employers (the Conservative plan). This should mean that employers would actually see an NIC reduction for employees earning up to £21,000 and employees earning up to £20,000 would benefit as well. Those earning above these thresholds would pay more.

VAT
The fourth major area of focus is VAT. Many expect that further tax increases will be needed. Consequently, it’s thought that there will be an increase in VAT – partly, no doubt, as the previous Government increased income tax and national insurance. Increasing the standard rate of VAT to 20% would cost someone on average earnings about £150pa.

We do not favour widening the VAT base, through adding VAT at 17.5%, in place of zero-rating. The key categories are food (£11bn); new housing (£4bn); public transport (£2.5bn) and water/sewerage (£1.3bn). Additionally, increasing the 5% charge on domestic fuel to 17.5% would raise £3.6bn. The difficulty with imposing VAT on these items is that the burden would fall disproportionately on the least well-off. Although benefits and tax credits could be increased to compensate the average household, the fiasco over the abolition of the 10% income tax band demonstrated that at least 1 million people (mainly those without children) do not receive benefits or credits.

Taking together the effect of a personal allowance increase of £1,000, the NIC changes and a VAT rise to 20%, those on median earnings (about £23,000) or below would be no worse off and those on more modest incomes could be £200pa better off. The top half of the earnings spectrum would see tax rises.

Pensions
The previous Government decided to cap tax relief on pension funding in respect of higher earners (principally those with income over £130,000). Regrettably the method chosen is complex and arbitrary. It has attracted widespread criticism from employers, pension providers and advisers. Most have suggested that a much better approach to reduce the cost of tax relief on pensions would be simply to set a much lower cap on annual pension contributions – say, £50,000. This would be much easier to understand; would not give anyone marginal tax rates of 100% and would not give pension trustees and employers significant implementation costs. We know that the new Government has been asked to reconsider the approach and it is to be hoped that a plan of this sort will be adopted.

Corporation tax reforms
Businesses will be keen to hear more about George Osborne’s five year plan to reform corporation tax. The Chancellor signalled at his recent speech to the CBI that his ambition is for the UK to have the most competitive corporate tax regime in the G20. This will clearly include rate reductions, a lighter CFC regime (the rules which charge UK tax on low-taxed overseas profits of UK groups) and incentives for managing intellectual property (patents, trademarks, brands and other intangible assets)in the UK.

At the same time, the Chancellor may consider implementing the proposals from the Dyson review, which include redirecting R&D tax credits towards Hi-tech companies, small firms and start-ups, as well as supporting manufacturing. Equally, it’s thought that part of the cost of these benefits will be paid through reducing some allowances. It’s clear that the Government will be issuing a discussion document for business to debate.

At the same time, we hope to hear more about the plans for a Patent Box regime (a special tax rate of 10% for royalties from patents) and also how the Government proposes to take forward the current plans to reform CFCs and the taxation of foreign branches. This latter area is critical for the insurance industry, which is facing changes to its capital requirements, in the Solvency II regime. Solvency II is pushing insurers to conduct their business through branches, rather than subsidiaries. Without an exemption for the income from foreign branches, insurers may well move activities to other EU states, which do offer an exemption or low taxation.

The Coalition agreement set out several other areas for consideration, including: anti-avoidance; the taxation of non-domiciled individuals; and the approach to taxing contractors and small business. Whether we see Discussion documents in these areas is doubtful, given the short time that the Treasury has had to consider such a wide range of complicated tax issues.