Traps for clients and advisers

Alan Barr wades through another impenetrable Budget to guide you through the basics and beyond.

Gordon Brown just can’t let things lie. It seems that he is almost pathologically incapable of letting well alone; and each Budget and resultant Finance Bill must slaughter a forest of trees (and, these days, bytes). At least this time he has more of an excuse - he needs the money. We all know why. But raising a huge quantity of money can be done with a surprising economy of words - indeed, this aspect has been achieved this year (or, mostly, next year). However, there is still the apparent need for a doorstop of a Bill, in two volumes and mostly dealing with technical changes. (One volume had mistakes in the numbering of Schedules and had to be reprinted. Presumably that kind of thing is covered from the contingency fund.)

Hundreds of pages, thousands of words, tens of Schedules - it is manna from heaven for the tax lawyer (I am sure you can imagine me capering and gambolling with delight, thrilled at the new things to know about - or not). Much of it is impenetrable. It will be pushed through Parliament with the minimum of scrutiny. While it will provide opportunities for those advising, it will provide traps for their clients - and for many advisers as well. The system really is creaking at the seams.

After the moaning (now almost as ritualistic as the Budget itself), what did we get?  This Budget was unusual in some ways; and commonplace in others.

It was late  - the first time in recent years that it has been after the commencement of the tax year. This will add to administrative costs. Its aim was to raise money through taxes - an imposition which has generally been unnecessary in recent years. It probably marked a turning point in this Government’s economic attitude - although in fact the tax burden has already risen considerably since 1997, but generally by less forthright and apparent measures.

And among the commonplace features? It contained as many half-truths  and worse as are the norm these days (for the avoidance of doubt, as some lawyers say,  that is quite a lot of half-truths and worse). The devil is and will be in the detail - and there is a lot of detail.

This Budget, as have all of those by Gordon Brown, also looks forward with quite definite plans for future tax years - sometimes quite a long way into the future. Thus some figures are given at least for 2003-04, but other plans stretch beyond such trivialities as the next election. This in particular allows perceived Good Things to be announced more than once (I calculate that the cuts in capital gains tax have now  been announced approximately 3,892 times, for instance. For the avoidance of doubt, the figure is a joke). It will be interesting to see if the same applies to what might be seen as Bad Things - will the rises in National Insurance be trumpeted quite as many times, even if they do not come into effect until next year?

As in recent past years, much of the Budget speech and surrounding documentation was concerned with spending. The November statement, which used to be concerned only with spending, will no doubt look more like a Budget again. The tinkering will go on.

Notes

Income tax rates and allowances

1. The rate of tax applicable to savings income in section 1A, ICTA 1988, other than dividends, is 20 per cent for income falling between the starting rate and basic rate limits. The rates of tax applicable to dividends are 10 per cent for income below the basic rate limit and 32.5 per cent above it.

2. The rate of relief for the continuing married couple’s allowance and maintenance relief for people born before 6 April 1935, and for the children’s tax credit, is 10 per cent.

3. As announced in Budget 2001, a baby rate of children’s tax credit has been introduced from April 2002. This will mean that for these families CTC will be worth up to £1,049 in the tax year of the child’s birth.

4. For 2003-04, the income tax personal allowance for those aged under 65 will be frozen. The personal allowance for those aged 65 - 74 will be increased to £6,610, and for those aged 75 or over it will be increased to £240 above statutory indexation.

Capital Gains Tax (CGT)

5. The annual exempt amount is increased to £7,700 for individuals, trustees of settlements for the disabled, and personal representatives of the estate of a deceased person, and £3,850 for other trustees. For individuals, the amount chargeable to CGT is added to the income liable to income tax and is treated as the top part of that total. CGT is charged at the following rates: below the starting rate limit at 10 per cent, between the starting rate limit and basic rate limit at 20 per cent, and above the basic rate limit at 40 per cent.

Rates for trusts

6. The rate applicable to trusts remains unchanged at 34 per cent for 2002-03 and the Schedule F trust rate remains unchanged at 25 per cent.

Inheritance tax

7. The value of estates above the threshold is taxed at 40 per cent. The threshold is being increased by £3000 more than statutory indexation. The estimated number of taxpaying estates in 2002-03 will be about 24,000. This is around 4 in 100 deaths.

Pensions schemes earnings cap

8. The main effect of the cap is to set a ceiling on the contributions that can be paid to, and the benefits that can be paid by, tax approved pension schemes. It generally applies to people who contribute to a personal pension scheme, joined o n occupational scheme set up since 14 March 1989, or joined any occupational scheme from 1 June 1989 that was set up before 14 March 1989. From 6 April 2001 the cap will apply to people who contribute to stakeholder pension schemes.

Corporation tax

9. The corporation tax starting rate is reduced from 10 per cent to zero for companies with taxable profits below £10,000. The small companies’ rate is reduced from 20 to 19 per cent for companies with taxable profits between £50,000 and £300,000.

10. Marginal relief eases the transition from the starting rate to the small companies’ rate for companies with profits between £10,000 and £50,000. The fraction used in the calculation of this marginal relief will be 19/400. Marginal relief also applies to companies with profits between £300,000 and £1,500,000. The fraction used in the calculation of this marginal relief will be 11/400.

11. The profits limits may be reduced for a company which is part of a group or has associated companies. The lower rates and marginal reliefs do not apply to close investment holding companies.

But in one of the Budget predictions which proved correct, It is necessary to add the impact of National Insurance to these basic figures before assessing the effects of the Budget changes. The 2001-02 primary threshold (below which contributions are not payable) is £87 per week, or £4,535 per year - the same as the personal allowance for income tax. The upper earnings limit, above which limit earnings are not liable to contributions, is £29,900

Following the changes made in the Budget, rates and thresholds are set out in the table above.

There are some gaps in this table. The primary threshold has a yearly equivalent of £4615 - again the same as what will be the frozen income tax allowance. The upper earnings limit has been fixed, with what some saw as a surprisingly modest  rise, at £30,420. The contrast with the higher rate threshold for income tax (which, including the personal allowance, amounts now to £34,515) will be noted - and this may narrow further in future.

We have not been told what will happen to the higher rate threshold for income tax, nor with the upper earnings limit for National Insurance in 2003-04 - but equally we have not been told that they will be frozen. If the  UEL were to rise with inflation it would go up to £30,920.

It can be readily seen that it is National Insurance which is the area to watch. The introduction of an unlimited band of payment at 1% looks like a wedge which could yield more generous returns in future years.

National Insurance will make the difference in most tax bills not only when comparing year to year - but most especially when comparing the employed with (a) the self-employed; (b) those who operate through companies; and (c) most ironically of all - those who live off investment income. Indeed, when the even lower rates in capital gains tax for business assets is brought into the equation, it can be seen that the very lowest rates of tax can be enjoyed by those who live off unearned income and who can realise substantial amounts of capital. (For older readers, I would remind them that this is a Labour government. This was not formerly the way of Labour governments.)

The child tax credit, and its little sibling the baby tax credit, will only exist in this form for one year. These are quite valuable and should be claimed if available. Their structure means that the credit is available to the higher earner of a couple, who need not be married in order to be a couple for these purposes. The amount on which tax credit is given is reduced by £2 for every £3 by which the income of the higher earner exceeds the higher rate threshold. This means that the baby tax credit would finally disappear at an income of approximately £50,250. The income of couples is looked at individually, not jointly.

From 2003-04, it is all change again, with the children’s tax credit and various child related items in various social security benefits (including the Working Families Tax Credit) being subsumed into what will be called the Child Tax Credit. Despite its name, this is more akin to a social security benefit and may be paid outwith the PAYE system, directly to the main carer. Its rate depends on the joint income of a couple - and it seems that it will not disappear entirely until that joint income is somewhere in excess of £60,000. Thus there be claims to be made on behalf of people who would not usually consider themselves to be eligible for social security benefits! (This is a huge subject in its own right, which frankly requires some serious consideration before attempting to advise on it.)

It should be noted that the new credits and the fact that they apply so far up the income scale will mean very high marginal rates of tax for some taxpayers, when the effects of actual tax, NI and the withdrawal of credits are all taken into account. The marginal rate of tax/credit withdrawal can rise to 60% on certain slices of income. This will complicate “pure” tax planning even for the moderately wealthy.

There is also to be Working Tax Credit, available in effect to give a minimum income guarantee even to the working child-free. This may be of  particular interest to employers with  low-wage, part-time workers

Age-related allowances will continue to rise at least with inflation (and this will be wage inflation, not price inflation), even though the personal allowance is to be frozen. (That freezing is in itself a significant Revenue  raiser for the Government.) The income limit for age allowance has risen already, to £17,900 - which means that additional allowances continue to be available for elderly couples with quite substantial incomes.  It should also be remembered that for married couples one of whom was born before 6 April 1935, there continues to be a married couple’s allowance. This is truly an example of a dying tax allowance, as its recipients gradually succumb. One wonders whether the allowance will disappear before all of its recipients, as the wonders of medical science outstrip the economic expectations of the Treasury.