2005 Pre-Budget Report Summary

Chancellor Gordon Brown presented his Pre-Budget Report on Monday 5 December 2005.

PERSONAL TAX

Rates

The income tax rates and bands for 2006/07 were not announced in the Pre-Budget Report. Details of these are normally made available in the main spring Budget.

Allowances

The Chancellor confirmed the level of income tax allowances for 2006/07. The allowances will be increased in line with inflation and are summarised below together with the other proposed allowances announced in the Pre-Budget Report.

	2006/07	2005/06
	£	£
Personal allowance
-under 65	5,035	4,895
- 65 – 74**	7,280	7,090
- 75 and over**	7,420	7,220

Married couple’s allowance*
- aged less than 75 and born before 6.4.35**	6,065	5,905
- 75 and over**	6,135	5,975
- minimum amount	2,350	2,280
Age allowance income limit**	20,100	19,500
Blind person’s allowance	1,660	1,610

Notes

* Qualifies for relief at 10%

** Reduce age allowance by £1 for every £2 of excess income over the income limit

Child Tax Credit

The Child Tax Credit, which is means tested, is potentially available to families who have responsibility for one or more children. The credit is paid direct to the main carer. There are several elements to the credit but broadly the maximum is an annual amount for 2006/07 of £1,765 per child together with a family element (one per family) of £545 per annum. The amount per child has been increased but the family element has been frozen since the introduction of the credit.

Some credit is likely to be payable for 2006/07 if a family’s income is less than £58,175 a year, or £66,350 if there is a child under one year old.

Working Tax Credit

The Working Tax Credit (WTC) was introduced to reward the work of people on a low income. It also provides working families with assistance to meet the costs of childcare. The annual income threshold for 2006/07 is £5,220 (the same as 2005/06) with a reduction of 37p for every extra £1 of income. The basic maximum benefit is increased for 2006/07 to £1,665.

Childcare costs continue to form part of the WTC calculation at an increased rate of 80% of eligible costs up to a maximum of £175 per week (£300 if two or more children). The rate was previously 70%. This element is paid with Child Tax Credit.

Increases in income within a set limit, between one tax year and the next, do not reduce a previous entitlement to tax credits. The limit for this rises from £2,500 to £25,000 from April 2006. This should ensure that almost all families with increasing incomes will not have their tax credit entitlement reduced in the first year of the increase.

To provide greater certainty for claimants, from November 2006 the Revenue will apply automatic limits on recovery of excess amounts paid where awards are adjusted in the year following a reported change.

From April 2007, the time allowed to report a change that reduces tax credit entitlement will be decreased from three months to one month, shortening the time when people are potentially being paid too much.

From November 2006 it will be mandatory to report more changes in circumstances than at present.

From 2006 the deadline for the return of end-of-year information will be brought forward from the end of September to the end of August.

To improve compliance in the operation of tax credits, the Revenue will more than double the number of prepayment checks carried out on new claims and introduce new training and procedures so that staff can recognise potential fraud.

Child Trust Fund

The Child Trust Fund (CTF) became operational in April 2005 for all children born from September 2002. The government provides an initial award of £250 (£500 for children from low-income families who also qualify for full Child Tax Credit). A child is eligible for a CTF account if Child Benefit has been awarded for them and they are living in the UK. If these conditions are met the award is made automatically with no need to make a separate application.

Vouchers are sent to the Child Benefit claimant and should then be used to open a CTF account.

A further payment will be made to every child for its seventh birthday, again with a higher payment to children from families on lower incomes. The government is consulting on the eligibility and timing of the further payment and is proposing it should also be set at £250 with children from low-income families receiving £500.

Family and friends of the child can make additional contributions of up to £1,200 a year between them.

The income and gains in the CTF will be tax-free and may be accessed by the child at age 18.

Pensioners

The Chancellor has announced various increases in respect of benefits for pensioners:

the basic state pension will rise to £84.25 for single pensioners and £134.75 for couples from April 2006
the guarantee element of Pension Credit will increase to £114.05 for single pensioners and £174.05 for couples from April 2006
the government will extend winter fuel payments at the level of £200 for households with someone aged 60 or over, rising to £300 for households with someone aged 80 or over, for the duration of this parliament.

ISAs

When ISAs were introduced in 1999 they were guaranteed to run for ten years to 2009. Currently the overall annual investment limit is £7,000 with a maximum of £3,000 in cash and this was guaranteed to run until the end of 2005/06. As previously announced, the government will extend the existing limits until at least April 2010.

Residence and domicile

The government is continuing to review the residence and domicile rules as they affect the taxation of individuals and is considering various aspects of this issue.

Shari’a compliant financial products

The government introduced tax legislation in 2005 for individuals and businesses wishing to have access to financial products that comply with Shari’a Law. The government is consulting on how to encourage further innovation and ensure that tax does not create an impediment to the development of new products in this area.

Unclaimed assets

The government proposes that unclaimed assets in the banking system should be reinvested in society while they remain unclaimed. Where the owners can be traced they can be reunited with their assets.

The government has agreed that any unclaimed assets should include accounts where there has been no customer activity for a period of 15 years. The money will be reinvested in the community, particularly in deprived communities, with a focus on youth services and financial education.

Venture Capital Trusts

In 2004 the government announced a temporary doubling of the rate of income tax relief for investments in Venture Capital Trusts (VCTs) to 40%. The future level of this relief will be announced in Budget 2006.

EMPLOYMENT ISSUES

National Insurance Contributions (NICs)

The detailed NIC rates, earnings limits and thresholds proposed for 2006/07 are set out below. The thresholds have been increased but the rates of Class 1 and 4 contributions have been held at their existing levels.

National Insurance rates
	2006/07	2005/06
Employees’ threshold	£97 pw	£94 pw
Employers’ threshold	£97 pw	£94 pw
Upper earnings limit – employees only	£645 pw	£630 pw
Employees’ Class 1 rate on earnings between threshold and upper earnings limit	11%	11%
Employees’ Class 1 rate on earnings above upper earnings limit	1%	1%
Employers’ Class 1 rate on earnings above threshold	12.8%	12.8%
Class 2 – self-employed flat rate	£2.10 pw	£2.10 pw
Class 2 – small earnings exception	£4,465 pa	£4,345 pa
Lower profits limit (for self-employed Class 4 contribution)	£5,035	£4,895
Upper profits limit	£33,540	£32,760
Class 4 rate on profits between lower and upper profits limit	8%	8%
Class 4 rate on profits above upper profits limit	1%	1%
Class 3 – voluntary	£7.55 pw	£7.35 pw

Note

Although employees’ NICs only become payable once earnings exceed £97 per week, any earnings between £84 and £97 per week in 2006/07 will protect an entitlement to basic state retirement benefits without incurring a liability to NIC.

National Employer Training Programme

The National Employer Training Programme will build on the Employer Training Pilots. It is designed to give employers the opportunity to access free and flexibly delivered training for their low-skilled employees. The national programme Train to Gain will be rolled out from 2006/07.

To help businesses with fewer than 50 employees, wages compensation paid to employers, for the time low-skilled employees take off to train, will continue to be made available in 2006/07 and 2007/08.

CORPORATE AND BUSINESS TAX

Better working with business

In the 2005 Budget, the Revenue announced a consultation with small and medium-sized businesses (SMEs) ‘Working Towards a New Relationship’. The newly integrated HM Revenue and Customs (HMRC) published its report on the consultation at the end of November and has announced:

a consultation on companies providing information only once to HMRC and Companies House including consideration of the alignment of filing dates for accounts and returns
improvements to the Employer’s CD-Rom including further calculators for statutory payments and an interactive P11
a reduction in the reporting requirements for Form 42 (the form on which employers report their transactions in employment-related securities, mainly shares and share options) by no longer requiring a form for the first issue of shares in the majority of cases.

HMRC continues to work on:

the ‘Whole Customer View’, in particular developing a single point of contact for business with HMRC and
reducing compliance costs for business.

HMRC will set a target for reducing administrative burdens in the tax system in Budget 2006 and, as a first step towards this target, plans have been announced for £300 million savings for business through reforms to tax administration.

Income recognition and accounting standards

UITF 40 ‘Revenue recognition and service contracts’ was issued in March 2005 to give guidance on income recognition for contracts for services such as those rendered by accountants and solicitors. In brief, it requires income to be recognised as a contract for services progresses.

This will mean that many businesses will be recognising income before an invoice has been issued to a customer and therefore before payment has been received.

The government will legislate in Finance Bill 2006 to enable most businesses affected by the March 2005 changes in the income recognition rules to spread any extra tax charge over three years. Those businesses most severely affected will be able to spread the charge over six years.

Taxation of small companies

A starting rate of corporation tax of 0% was introduced in 2002 and applies to companies with taxable profits of £10,000 or less. Companies with profits between £10,000 and £50,000 enjoy a marginal relief from the small companies’ rate of 19%. The zero rate was introduced to encourage the creation of small businesses and to allow them to grow.

In 2004, the government thought the system was being ‘abused’ and introduced a ‘non-corporate distribution rate’ of 19% on companies to the extent that profits were distributed.

The result has been a complex system and the government has concluded that many self-employed and employed people are still being advised to incorporate simply to reduce their tax and national insurance liabilities.

The government has therefore decided to replace the non-corporate distribution and zero rates with a new single banding set at the current small companies' rate of 19%.

Capital allowances

To ensure that small businesses are provided with incentives to invest for growth, the government will extend the first-year capital allowances to 50% in the year from April 2006.

Research and development (R&D) credits

In 2000, an R&D tax credit was introduced for small and medium-sized companies (SMEs). This enables SMEs to claim tax relief on 150% of qualifying R&D costs. Companies not in profit can take the relief up front as a payable R&D tax credit. They can surrender the loss attributable to the R&D and receive a cash payment of £24 for every £100 spent on qualifying R&D. The scheme was extended to large companies in 2002 enabling them to claim tax relief on 125% of qualifying R&D costs although the cash repayment option is not available to them.

Earlier this year, the Revenue published a discussion document and commissioned market research to determine whether the credits were working and to seek views on changes that could be made.

To date the R&D tax credit regime has suffered from a lack of expertise within the Revenue to determine whether activities qualify. To help deal with this the Revenue will create dedicated teams to deal with claims.

Other proposed improvements include:

a statement of practice to explain how claims from small companies will be dealt with; in particular ensuring that claims for repayments are dealt with promptly and consistently
an expansion of qualifying costs to include payments to clinical trial volunteers and allowing some small company projects classified as capital expenditure for tax purposes to qualify for relief
a harmonisation of time limits and claims procedures across both the payable tax credit and enhanced relief.

Film Tax Relief

In Budget 2005 the Chancellor announced an extension to the current tax reliefs for low budget films until 31 March 2006. The current reliefs were originally due to expire in July 2005. The extension is due, at least in part, to the concerns expressed by the film industry about the proposed replacement relief.

Following a period of consultation, the government has now given details of the proposed new tax incentives for British films. The legislation will be published in Finance Bill 2006. The key features of the proposals are:

the regime will apply to ‘film production companies’. These are companies which have an active involvement in the process of film making
partnerships can no longer become involved in film production to shelter their members’ income from tax
small budget films (films costing £20 million or less) will receive an enhanced tax deduction of 100% with a payable cash element of 25%, amounting to a benefit worth at least 20% of qualifying production costs
large budget films will receive an enhanced deduction of 80% with a payable cash element of 20%, amounting to a benefit typically worth 16% of qualifying costs
the new relief will apply to films beginning principal photography on or after 1 April 2006 with some transitional provisions for other cases.

Details of a new cultural test for British films have been released by the Department of Culture, Media and Sport.

UK Real Estate Investment Trusts (UK-REITs)

UK-REITs have been considered as a means to improve the efficiency of both the commercial and residential property investment markets by providing liquid and publicly available investment vehicles.

The government will bring forward draft legislation to establish UK-REITs for inclusion in the 2006 Finance Bill. Details of the tax proposals will be published by the Revenue before the end of 2005 and 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 as set out in legislation 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 income to investors, who will then pay tax at their marginal rate.

There will also be an announcement in Budget 2006 of final details of the conversion charge applying to existing companies wanting to join the regime.

The intention is to ensure no overall loss of revenue from the introduction of UK-REIT legislation.

Corporation tax reform

A Technical Note published last December gave details of further legislative proposals on the reform of corporation tax. The Note covered topics addressed in previous consultation documents:

the partial reform of the schedular system for companies
the tax treatment of capital assets
the taxation of leasing transactions
tax differences between trading and investment companies.

Following discussions with business, the government has no current plans to take forward proposals on partial schedular reform or the taxation of capital assets.

Leasing transactions are now the subject of draft legislation (see below) which will be included in Finance Bill 2006.

A new item in the Technical Note considered modernising the capital allowance regime for business cars. The government is giving further consideration to this by suggesting a new car pool with a range of first year allowances depending on CO₂emissions.

Leased plant and machinery

Currently a lease of plant and machinery is treated as the hire of an asset:

the lessor brings in the full rentals arising under the lease as income and is entitled to claim capital allowances in respect of its expenditure on the asset and
the lessee deducts the full amount of the rentals payable over the life of the lease.

Provisions are being introduced, effective from 1 April 2006, to align the tax treatment of leased plant and machinery with that of other forms of finance. Where leases function essentially as financing transactions the new regime will:

for the lessor bring in only the finance element of the rentals as income
for the lessee allow a deduction only for the finance element of the rentals
for the lessee provide entitlement to capital allowances.

The new rules will not apply to certain shorter leases (including all those where the term does not exceed five years) so that the great majority of leases will be unaffected by the changes.

Operating and Financial Review (OFR)

Measures to reduce costs on business by removing unnecessary regulatory burdens include the abolition of OFRs for quoted companies. Instead, quoted companies will be required to produce a Business Review. This will maintain the key reporting requirements and performance indicators necessary for shareholders to monitor business performance.

CAPITAL TAXES

Planning gain supplement

The government has issued a consultation paper on the introduction of a planning gain supplement (PGS). Legislation would be introduced to extract some of the windfall gain accruing to landowners from the sale of their land for residential development.

The following are some of the principles that may be considered:

a system for gathering information as to the value of land proposed for development
the government would then set a tax rate on these values
the granting of residential planning permission would be contingent on the payment of the PGS
there may be a lower rate for development on brownfield sites
consideration may be given to allowing developers to pay their contributions in instalments over a period of time.

The government recognises that the introduction of a PGS would need to be accompanied by transitional measures. These would help developers already engaged in land sales contracts that were drawn up before this charge was introduced or those who hold large amounts of land where planning permission has yet to be secured.

ENVIRONMENTAL MEASURES

Protecting the environment

The Pre-Budget Report includes a number of measures to help protect the environment. These include:

a continued freeze in main fuel duty rates and the duty rates for road fuel gases in response to the continued volatility in oil prices
support for alternative sources of energy including further consultation on carbon capture and storage and the announcement of collaboration with Norway in this area
measures to improve energy efficiency including funds for the Carbon Trusts to provide interest-free loans for the introduction of energy-saving measures in the business sector
the introduction of enhanced capital allowances for the cleanest biofuel plants
progress on taking forward the Gleneagles Plan of Action agreed by the G8 in tackling the challenge of climate change.

VAT, EXCISE AND OTHER DUTIES

Annual accounting scheme

The annual taxable turnover limit for joining the scheme is to increase from £660,000 to £1,350,000 with effect from April 2006.

Cash accounting scheme

The government has written to the European Commission with a view to increasing the turnover limit for joining the cash accounting scheme from £660,000 to £1,350,000 with effect from April 2006. This is an increase of more than 100% and may benefit up to one million small businesses.

Car fuel scale charges

The Chancellor announced in Budget 2005 the government’s intention to align the VAT car fuel scale charges with the income tax benefit in kind provisions. This new system is to come into force on 1 May 2007.

VAT and property

The government is introducing a package of measures to modernise, simplify and provide greater certainty for businesses dealing with some VAT and land and property matters. These will include:

a new consultation on supplies where the legal and beneficial ownership in land has been separated
guidance on the revocation of the option to tax after 20 years.

Other VAT measures

The government will be assessing options for providing more help in respect of bad debt relief. The outcome is to be reported in Budget 2006.

The 5% reduced rate is to be extended to the installation of wood-fuelled boilers in qualifying buildings with effect from 1 January 2006.

Alcohol industry

Customs has signalled an intention to repeal or simplify around 30 regulations that affect businesses in the alcoholic drinks industry.

Gambling

Following a review of gambling taxation the government has decided to maintain the current regimes but has made some small modifications to align the tax regime with the Gambling Act.

ANTI-AVOIDANCE MEASURES

Pensions

April 2006 (‘A’ day) will see the introduction of the long awaited new taxation regime for pensions. The government is concerned about potential abuse of the new regime and the Pre-Budget Report contained details of two new measures.

From ‘A’ day the government will remove the tax advantages for investing in residential property or certain other assets such as fine wines, classic cars and art and antiques from pension schemes which are ‘self-directed’. This will include Self Invested Personal Pension Schemes (SIPPS) and Small Self Administered Schemes (SSAS). The effect will be to remove all tax advantages from holding prohibited assets directly or indirectly in such schemes and will broadly mean that it is at least no more advantageous to hold such assets in a pension scheme than it is to hold them personally.

The government is also introducing an anti-avoidance provision to prevent a device known as ‘recycling’. The device works by taking a tax-free lump sum from a scheme which is reinvested back into another scheme giving further tax relief on the amount invested. This in turn allows a further tax-free lump sum to be paid out. The new rules will remove tax advantages in relation to lump sums which are artificially recycled in this way.

Tax schemes

In 2004 new disclosure rules were introduced in relation to certain tax schemes. Broadly the rules require ‘promoters’ to provide details of their schemes to the Revenue shortly after the scheme is sold. The government now intends to:

improve the effectiveness of the ‘filters’ for direct tax to ensure they reflect recent developments in avoidance behaviour
extend the regime to all of income tax, capital gains tax and corporation tax
require businesses to provide information on direct tax schemes and arrangements devised ‘in-house’ within 30 days, bringing them more in line with the rules for scheme promoters.

The changes will be effective from April 2006.

Sale of lessor companies

Groups of companies have benefited from capital allowances in the early years of a lease, before selling lessor companies to loss-making groups, thereby avoiding paying tax on the subsequent profits.

A measure is introduced effective from 5 December 2005 which imposes a charge on the lessor company to recover the tax benefits that have been taken but grants an equal relief on the day after the sale.

Other measures

A number of further measures, effective from 5 December 2005 were also announced in the Pre-Budget Report as follows:

rules will be introduced to ensure that corporate capital losses can only be created and used as a result of genuine commercial transactions rather than to gain a tax advantage
an avoidance scheme that involves stock lending whereby taxable income is converted into a non-taxable receipt is blocked
avoidance that seeks to generate unintended relief for corporate intangible assets is stopped
rules are introduced to counter schemes designed to generate capital losses on disposals of rights conferred by certain insurance policies
action is being taken to stop UK-resident individuals avoiding tax by transferring assets abroad and exploiting offshore companies and trusts
rules are being introduced to stop inheritance tax avoidance that uses second-hand interests in foreign trusts and to close a loophole which allows individuals to avoid paying either inheritance tax or the income tax charge on pre-owned assets
the government is stepping up its activities in an attempt to tackle Missing Trader Intra-Community VAT fraud
further measures were announced in relation to tobacco smuggling, spirits fraud and oils fraud.

Disclaimer – for information of users

This summary is published for the information of clients. It provides only an overview of the Pre-Budget Report, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this summary can be accepted by the authors or the firm.