Introduction

According to Gordon Brown, “The Government’s economic objective is to build a strong economy and a fair society, where there is opportunity and security for all”.

His Pre-Budget Report contained a surprising number of measures compared with recent years in which this pre-Christmas extravaganza has tended to come a very poor second to Guy Fawkes Night where fireworks are concerned.

One problem that Chancellor Brown faced was the failure of the economy to match the growth predictions that he had made earlier in the year. Economies may have slowed down around the world but Britain’s has only increased at about half of the expected rate.

Income Tax and National Insurance Contribution Rates

It has now become customary for the tax rates and allowances to be announced in the Pre-Budget Report rather than the March Budget. This is a welcome development since it means that people have time to implement the changes in advance of the start of the tax year.

In broad terms, income tax allowances will increase in line with inflation. This means that the personal allowance will increase to £5,035 from next April with age-related personal allowance increasing to £7,280 for people aged 65 –74 and to £7,420 for those aged 75 and over.

The consequence of this is that around half of all pensioners will pay no tax on their income.

Similar increases in the limits for National Insurance contribution will also apply. Income tax rates are not specifically changed at this point but those for National Insurance contributions are set.

These will remain at 2005/06 rates for the ensuing year.

Child and Working Tax Credit Rates

The child element of Child Tax Credits increases in line with average earnings rather than inflation. The disabled child element and severely disabled elements both rise in line with inflation while the family element remains frozen.

The income threshold for CTC only rises to £14,155 per year while the threshold for CTC family element only remains at £50,000.

The major change in this area is the disregard in Tax Credits for increases in income between one tax year and the next. This figure had previously been £2,500 and created great hardship for those who took on new jobs. From April 2006 it will increase to £25,000.

Fuel Duty

There is to be a continuation in the freeze in main Fuel Duty Rates and the Duty Rates for Road Fuel Gases. This is partly a consequence of continued oil market volatility.

Protecting Tax Revenues

It has become increasingly common in recent years to see the Government with the full backing of HM Revenue and Customs identifying and targeting what they call “specific risks to the tax system”. Once again in the 2005 Pre-Budget Report, there are proposals in this area.

Disclosure Regime

To build on the “success” of the disclosure regime introduced in the 2004 Finance Act, there are to be:

• Proposals to improve the effectiveness of filters for direct tax to ensure they reflect recent developments in avoidance behaviour;

• The extension of the regime to cover avoidance risks across all of income tax, corporation tax and capital gains tax. This will allow HMRC to take further targeted action against avoidance while minimising burdens with compliance;

• Businesses will be required to provide information on direct tax schemes and arrangements devised “in-house” within 30 days of implementation, bringing them more into line with the rules for promoters.

These changes will all take place from April 2006 and it is hoped will allow HMRC to continue to respond swiftly and proportionately to tax avoidance.

The main areas covered are the following:

Sale of lessor companies

In the past, groups have benefited from capital allowances in the early years of a lease before selling lessor companies to loss-making groups to avoid paying tax on subsequent profits. With effect from 5 December 2005 a charge will be levied on leasing companies on the day that they are sold. This will recover the tax benefits that have been taken and as a quid pro quo, an equal relief will be granted on the day after the sale.

Corporate capital losses

Once again with effect from 5 December 2005, anti-avoidance rules are introduced which ensure that capital losses can only be created and used as a result of genuine commercial transactions.

Financial avoidance using stock lending arrangements

With effect from 5 December 2005, arrangements whereby companies or individuals could avoid tax on interest using a stock lending arrangement will be blocked. In future, the taxpayer will be treated as receiving interest at a commercial rate on their cash.

Taxation of Corporate Intangible Investments

With effect from 5 December 2005, avoidance schemes involving corporate intangible investments will be blocked. This will just put the legislation back to where it was originally intended to be when it was drafted.

Capital Gains: Policies of Insurance

The tax rules for capital gains are to be changed to clarify a situation whereby capital losses arising on disposals of certain insurance policies, including capital redemption policies cannot be deducted from capital gains in order to reduce or eliminate liability to tax. Once again these are effective from 5 December 2005.

Transfer of Assets Abroad

With effect from 5 December 2005, action is being taken to prevent UK-resident individuals avoiding tax by exploiting offshore companies and trusts. The legislation relating to the transfer of assets abroad will tighten the rules for exemption from liability and close loopholes.

Inheritance Tax Avoidance

With effect from 5 December 2005, measures will counter:

• Avoidance involving second-hand interests in foreign trusts;
  
• The use of artificial trust arrangements to escape both the IHT “gift with reservation” rules and the “pre-owned assets” income tax charge.

Missing Trader Intra-Community VAT Fraud

The Government is taking steps to strengthen its strategy in this area. While it is taking no specific legislative action at this stage, it is threatening to do so if necessary at some point in the future.

Tobacco Smuggling

New initiatives have been announced for tackling tobacco smuggling.

Oils Fraud

Following concerns about oil fraud, the Government is increasing the duty rate for rebated gasoil and thus narrowing the differential with main duty rates so that incentives for fraud are reduced.

Housing Supply

The Government is intent on persuading Britain to build more homes for future generations. To this end, it has put together what it describes as an “ambitious package of measures to reform the planning system and deliver increased investment in infrastructure to support sustainable housing growth”.

This will lead to the creation of UK Real Investment Trust (UK-REITs). The Pre-Budget Report announces the intention to establish UK-REITs and legislation will be drafted and included in the 2005/06 Finance Bill. It is likely that the legislation will include the following key features:

• The regime will be open to companies resident in the UK that are publicly listed on a recognised Stock Exchange

• Companies or groups that meet the UK-REIT eligibility criteria will not pay corporation tax on qualifying property rental income or qualifying chargeable gains.

• A requirement to distribute at least 95% of net taxable profits on rental incomes to investors, who will then pay tax at their marginal rate.

Research and Development Tax Credits

The Chancellor announced his intention to review and improve the current system for research and development tax credits. There is also to be a programme of introduction of Innovation Centres for British design.

Taxation of Small Business

Perhaps as a response to the negative reaction that previous measures on non-corporate distributions received, the Chancellor has come up with a simple solution. He is abolishing the zero percent rate band for small companies, using the excuse that taxpayers have said that they would favour simplification over options which risk introducing additional complexity. There is now to be a single banding for small companies at 19%.

As a sop to small businesses, the first year capital allowances rate is to be extended to 50% in the year from April 2006, although this only offers a cash flow advantage. As a further aid to cash flow for small companies, the Government is doubling the VAT annual accounting scheme turnover threshold to £1,350,000.

Reform of Film Tax Incentives

The Government has always struggled to provide a sensible incentive for the making of British films that would not be abused by the tax-avoidance community.

It is now planning to introduce a new scheme with effect from 1 April 2006. This will allow small budget films to receive an enhanced tax deduction of 100% with a payable cash element of 25%. This amounts to a benefit worth at least 20% of qualifying production costs.

For qualifying co-productions spending at least 40% in the UK, this represents a benefit of at least 10% of total costs.

Large budget films will receive an enhanced deduction of 80% with a payable cash element of 20%. This amounts to a benefit typically worth 16% of qualifying costs.

Gambling Taxation

Following a comprehensive review of gambling taxation announced in Budget 2004, the Government has finally reached its conclusions.

These are that the existing system remains appropriate!

National Sports Foundation

A National Sports Foundation will be established from April 2006. The funding provided by both the Government and the private sector will be invested in three specific programmes.

• Fit for Sport , which should improve both physical and human infrastructure for community clubs.

• 2012 Kids, building on the success of the Olympics, this will introduced projects and encourage children to take up sport, particularly in schools.

• Women into Sport, this is designed to increase female participation in sport.

Protecting the Environment

The Government is to introduce a raft of measures that are designed to protect the environment. These include:

• Support for alternative sources of energy

• Further measures to improve energy efficiency

• Continuation of the freeze in the main fuel duty rates and duty rates for road fuel gases

• A commitment to introduce a renewable transport fuel obligation and enhance capital allowances for the cleanest bio-fuels plants

• Progress on taking forward the Gleneagles plan of action agreed by the G8

• Progress towards the inclusion of the aviation sector within the EU Emissions Trading Scheme.

• Support for climate change and energy efficiency

• Delivering a clean and efficient transport systems

Building a Fairer Society

The Government remains committed to promoting fairness in society. To this end, it is taking a number of steps and these include:

• An extension of winter fuel payments paid at £200 with households with someone aged 60 or over rising to £300 to households with someone aged 80 or over for the rest of this Parliament.

• An additional £300 million over three years to enable pensioners on pension credit to have central heating systems installed free of charge. In addition they will provide a £300 discount on central heating systems for other pensioners who do not already have one in their home.

• Introducing parent support advisors in over 600 primary and secondary schools.

• Introducing a tax credits package to provide more certainty around tax credit awards.

• Establishing an implementation body to take forward the recommendations on youth volunteering.

R & D Tax Credits

The measures that are to be introduced to support R&D Tax Credits are deemed to be vital to the economy. Therefore a network of creativity and innovation centres is to be introduced, one in each region of the United Kingdom offering start-up help to new design talent and supported by an expanded national centre in London to show-case British design. One might observe that this is hardly the kind of increased tax relief that many innovators would have liked. It is only in the area of medical research and development where there are actually to be increased allowances.

Shared Equity in Housing

There is a planned extension to Shared Equity Schemes. This will be a public-private sector project involving banks and building companies with the Government. Its goal is to enable more first-time buyers to afford to buy property.

Pensions ‘A’ Day Loses its Fun Element

Those who have been looking forward to pensions ‘A’ Day, less than 5 months away, will be disappointed to find that the main attraction, the opportunity to invest in those little luxuries of life is to be removed. It is now planned that the Government will remove the tax advantages of investing in residential property and certain other assets such as fine wines, classic cars and art and antiques through registered pension schemes which are self-directed. They say “this is to prevent people benefiting from tax-relief in relation to contributions made into self-directed pension schemes for the purpose of funding purchases of holiday or second homes and other prohibited assets for them or their family’s personal use. This is hardly likely to prove a popular measure.

National Sports Foundation

The Chancellor’s final announcement was the introduction of a National Sports Foundation. This is intended to support Britain in its move towards the 2012 Olympics and also maximise the opportunity that any English bid for the 2018 World Cup might hold. It is a brave Scottish Chancellor who would wish to enhance an English bid to win a World Cup rather than a British one!

If you have any questions arising from the Pre-Budget Report please contact Philip Fisher.