Pre Budget thoughts

By Andrew Hubbard, Tenon National Tax Policy Director.

Once upon a time – and no, this isn’t the start of a fairy story – Budgets were all about dramatic announcements of changes in the rates of income tax. These days the element of surprise has largely disappeared because rates and allowances are now announced in advance. So we already know that from 6 April there will be a new top rate of income tax of 50% and that personal allowances will be withdrawn on a sliding scale for incomes in excess of £100,000. We also know the level of personal allowances for everybody else and the NIC rates.

So will individual taxpayers even need to bother to listen to the Budget? We are hardly impartial observers on these matters, but even so, it seems to us that the Budget will be important for taxpayers because the Chancellor will use it to set out his longer-term vision for personal taxation should the government be re-elected.

Our sense is that there will no radical change to the basic shape of the tax system. The basic rate will stay at 20p; the higher rate at 40p and the top rate at 50p. What we suspect might happen over time is that reliefs and thresholds may be used to move more people into the higher rates and over time all reliefs will be restricted to basic rate only. We have seen the beginnings of this already with the pension changes for those on incomes in excess of £130K. There have also been discussions about whether it is right to give higher rate relief to individuals who make gift aid contributions. We don’t expect anything immediate on any of this, but buried away in the mind-numbing acres of small print may well be signs of things to come.

Some of this needs to be put into perspective. £3.4 bn per year would be raised by a 1p in the pound increase in the basic rate of income tax, whereas the total annual amount that the government expected to raise from the 50% tax rate was only £2.5bn and expectations have already been dampened down on the amount of this tax which will actually be received. So announcements about income tax rates are as much about political direction as they are about raising money.

What about capital gains tax? It is hard to believe that an 18% rate is sustainable in the long term where income tax rates are as high as 50%, not least because the difference in rates makes avoidance by turning income into capital so attractive. There are various technical reasons, to do with the Finance Bill timetable in an election year, why we think that an immediate hike in CGT rates is unlikely but in our view it is only a matter of time before there will be a complete rethink here. Our prediction would be that we will go back to the principle that capital gains tax is payable at an individuals highest marginal rate of tax, but that reliefs for business disposals will be increased, so that in practice the highest rate of CGT will only be payable on pure investment assets.

One other thing to look out for is any announcements on residence. Your residence status is fundamental to your income tax position – very broadly UK residents pay tax on their worldwide income and non-residents pay tax only on their UK income – so you would think that the rules to determine residence would be clear and unambiguous. In fact the opposite is true. We’ve never had a proper statutory code for working out a person’s residence and have to rely on principles laid down in decisions of the courts made over 100 years ago, in an era where international mobility was very rare.

Recent attempts by tax tribunals to use those principles in today’s global environment have left the whole issue hopelessly confused. We hope that there will be some moves by the Chancellor to tackle this issue properly and establish a set of clear rules which are relevant to modern business life and which give people certainty about their tax position.

Most stories which begin “once upon a time” finish up with “ and they all lived happily ever after”. Somehow we doubt that this will be the underlying message of Budget 2010. There is a lot of fiscal pain to go through yet and Alistair Darling doesn’t have a magic wand or a fairy godmother!