Tech talk

The Budget 2006 - TT15/06

Today, 22 March 2006, Gordon Brown delivered his tenth, and probably his last, Budget speech.

In what the Chancellor described as a "Budget for schools" he announced a number of measures to achieve the Government's long-term goal of building a "strong economy and a fair society where there is opportunity and security for all".

Mr. Brown confirmed that the economy is stable and growing and that the Government is meeting its strict fiscal rules for the public finances.

The Budget includes the following measures to lock in stability and invest in the UK's future:

• a commitment to increase the child element of the Child Tax Credit in line with average earnings
• an additional payment into Child Trust Funds at age 7 amounting to £250 for all children, with an additional £250 for children from lower-income families
• free off-peak national bus travel in England for pensioners and disabled persons
• an additional £585 million over 2006/07 and 2007/08 to provide further support for personalised learning for schools in England
• an increase in the stamp duty land tax threshold to £125,000 to give further help to first-time buyers
• measures to modernise the tax system and to tackle fraud and avoidance

In a boost for British hopes for the London Olympics in 2012 Mr. Brown also announced a funding package of £600 million to provide training and facilities for athletics.

In a move to placate the growing environmental lobby the Budget includes measures to reduce greenhouse gas emissions. In particular drivers of "gas guzzling" cars will see vehicle excise duty rise to £210, up from £175. This is unlikely to satisfy Greenpeace, however, who have been canvassing for a top rate of £1800.

Mr. Brown resisted the temptation to extend VAT to peerages.

Pensions Simplification & Inheritance Tax

Following last year's consultation, the Government has now announced how it will apply the Inheritance Tax (IHT) legislation within the new Pensions Simplification regime. There are two possible sets of provisions, and the age of the scheme member at the date of death determines which one applies:-

Death of scheme member before age 75

The current IHT will rules continue to apply to registered pension schemes. This treatment was first announced by the Inland Revenue in February 1992, and was updated in 1999 following the introduction of income withdrawal.

To summarise, an IHT charge can arise if a member does not exercise their right to take pension benefits. For example IHT could apply if a scheme member did not take their pension when their life expectancy was seriously impaired, and this resulted in enhanced death benefits being paid to their beneficiaries. Currently, by concession, IHT is not charged where the beneficiary is a spouse, civil partner, or person who is financially dependent on the scheme member. Nor is IHT applied where a scheme member chooses not to exercise a right at a time when this choice does not trigger a charge, (e.g. choosing not to take a pension when they are in good health) and does not vary that choice, even when a reduction in their life expectancy would in strictness trigger an IHT charge.

The concessionary treatment will be included in the Finance Bill. In addition payments made to charity will be exempt from IHT.

Death of scheme member on or after age 75

The application of IHT to Alternatively Secured Pension (ASP) will also be included in the Finance Bill. The Government will apply an IHT charge on the fund remaining following the death of a scheme member in ASP. This will apply where the remaining fund

• Is reallocated to other member(s) of the same scheme, or
  
  
• Is returned to the employer, or
  
  
• Is used to provide benefits for a dependent who is not a spouse, civil partner, or person who is financially dependant, or
  
  
• Has been used to provide a pension to the surviving spouse, civil partner or person who is financially dependent and that pension has ceased. It is possible that where the surviving beneficiary is under age 75 at the date of death there will be an IHT charge on any remaining funds as the original scheme member died in ASP.

In all of the above, the IHT liability is calculated by adding the remaining fund to the original scheme member's estate.

IHT will not apply where the remaining fund is paid to a charity, nor when the remaining funds are used to provide pension benefits for the scheme member's spouse, civil partner, or person who was financially dependent on the scheme member.

Death of a scheme member before age 75 and death of a beneficiary on or after age 75

Where a scheme member dies before age 75, and a surviving beneficiary (spouse, civil partner, or person who was financially dependent on the scheme member) dies in receipt of ASP, any IHT charge that applies on the death of that beneficiary will be calculated based on the estate of the deceased beneficiary and not the original scheme member's.

The IHT charge

IHT will be payable by the scheme administrator who will be responsible for accounting for and paying any IHT on the remaining funds within ASP. The tax payable will be calculated on the value of the taxable funds when the charge arises.

The IHT charge will take priority over any other tax charge that may apply to the remaining fund in ASP. For example, the surplus tax payable on refunds to

employers and the pension scheme tax charge (both currently 35%) on lump sum death benefits payable in unsecured income will apply to the net funds after IHT has been deducted.

Other considerations

The legal personal representatives of the estate will be required to provide information in the estate account about ASP. This will include an estimate of the value of the remaining fund at the date of death together with the name and address of the scheme administrator.

Comment

At least we now have certainty, if only for deaths occurring after age 75 in ASP. And that must be welcome, as are the provisions that will require the IHT charge to be paid from the remaining pension funds. However the potential double tax charges mentioned above will be seen by many as draconian, amounting as they do to a total tax charge, on current rates, of 61%. It will be important, from a tax point of view, for dependants to die on or after age 75.

Recycling of Lump Sums

This issue was covered in detail in TechTalk 06/06. The Revenue today issued revised draft legislation for inclusion in the 2006 Finance Bill, together with 30 (yes 30!) pages of explanatory notes, guidance and examples.

The draft legislation contains two amendments to the original draft issued in February

• the legislation will apply where the lump sum taken is more than 1% of the standard lifetime allowance, thus increasing each year in line with increases to the standard lifetime allowance. Previously the limit was simply expressed as £15,000
  
  
• cumulative increased contributions must be more than 30% (previously 20%) of the lump sum taken

The main changes in the guidance notes are as follows

• if tax offices suspect that recycling has taken place they must send a report to APSS in Nottingham before taking matters up with the individual
  
  
• the recycling rule is not intended to catch individuals who simply increase contributions themselves or who have them increased on their behalf e.g. through salary or redundancy sacrifice, as long as no lump sum is used as a means to increase the contributions, either directly or indirectly
  
  
• it is confirmed that the recycling rule will not apply where payment of the increased contributions was not pre-planned
  
  
• using funds other than the lump sum itself to fund the increased contributions does not necessarily mean that the recycling rule will not apply. It will apply where the individual sets out to use the lump sum as a means, directly or indirectly, to pay the increased contributions
  
  
• the recycling rule will not apply where pre-planning did not take place. The onus will not be on the individual to prove that pre-planning did not take place. The Revenue will however be able to take into account any evidence of pre-planning
  
  
• a significant increase will not, of itself, trigger the recycling rule. The increase may be incidental to and not "because of" the lump sum. For example it could result from a salary increase where contributions are based on a percentage of salary, or where contributions to a scheme are increased across the board as a result of, for instance, a funding deficit
  
  
• where the cumulative contribution test is applied, i.e. where contributions increase over a period of time rather than on a one-off basis, the period of time over which they are measured will no longer be open-ended, but will now cover the tax year in which the lump sum is taken, the two immediately preceding tax years and the two immediately following tax years, i.e. a total of a maximum of five tax years
  
  
• scheme administrators will be able to ask to be discharged from their liability to pay a scheme sanction charge provided they have just and reasonable grounds for so doing. An example of such grounds would be where an arm's length member falsely declares that he/she is not going to use a lump sum for recycling purposes and subsequently does indeed use it in this way

Comment

Some of these changes are welcome, particularly the one on the cumulative contributions test. However our earlier comments from our TechTalk still apply. The issue of determining whether or not pre-planning took place will potentially cause endless conflict between taxpayers and the Revenue. And it is simply crazy that 30 pages of explanatory notes and guidance are deemed necessary to explain three-quarters of a page of legislation!

Major Changes to the Inheritance Tax Treatment of Trusts

The Government has announced that subject to certain very limited exceptions, gifts to all trusts including interest in possession and accumulation and maintenance trusts are to be treated as chargeable lifetime transfers. This applies to transfers made on or after 22 March 2006. This means that where the

value of the transfer exceeds the nil rate band, an immediate charge to IHT will arise.

Given the significance of this measure on insurance based IHT schemes we have decided to cover this in detail in a separate TechTalk (ref TT16/06).

Capital Gains Tax

The changes mentioned above regarding the treatment of gifts to trusts have a number of implications from a CGT point of view

• Transfers in and out of trusts which are treated as chargeable lifetime transfers will now qualify for CGT holdover relief
  
  
• Holdover relief may in some cases be restricted where beneficiaries include the settlor's minor children unless certain conditions are met.
  
  
• CGT is wiped out until now on the death of the life tenant of an Interest in Possession trust. In future this will only happen where the IIP trust meets the new IHT rules, e.g. the life tenant is disabled.

Gifts with Reservation

Where an individual is beneficially entitled to an interest in settled property and it continues to be part of their estate for IHT and the interest ends during their lifetime on or after 22 March 2006, the gift will fall within the Gift With Reservation rules. Therefore if they continue to have use of the property, it will remain taxable as part of their estate.

Venture Capital Schemes

Changes have been announced in relation to investments made into Venture Capital Trusts, Enterprise Investment Schemes and Corporate Venturing Schemes (CVS).

Venture Capital Trusts (VCTs)

In the Finance Act 2004, the Government announced that for investments made in VCTs during the 2004/05 and 2005/06 tax years, enhanced income tax relief would be available at 40% on investments up to £200,000. Given that this was

intended to be temporary, it was widely anticipated that the relief available would drop back down to 20% after 5 April 2006.

However, the Government has announced today that the new rate of relief will in fact be 30% for VCT shares issued on or after 6 April 2006.

Currently shares in VCTs must be held for a minimum of three years to avoid income tax relief being clawed back. For shares issued on or after 6 April 2006, there will now be a minimum holding period of five years.

Enterprise Investment Scheme (EIS)

The current limit of £200,000 per tax year for EIS income tax relief will be doubled to £400,000 for shares issued on or after 6 April 2006.

Individuals who invest in eligible shares in the first six months of the tax year are currently able to carry back up to half of the investment, subject to a maximum of £25,000, and claim relief for the previous tax year. This maximum carry back will double to £50,000 with effect from 6 April 2006.

VCTs/EIS and CVS changes

The limits applying to the maximum size of companies able to raise money under these schemes, i.e. the gross assets test, is reduced to £7 million before investment and £8 million afterwards.

Extension of the Disclosure Regime for Tax Avoidance Schemes

The 2004 Finance Act introduced provisions requiring the disclosure to HMRC of certain direct tax schemes where obtaining a tax advantage is one of the main benefits. The responsibility for disclosure rests with promoters of the scheme and in some cases users.

Although Finance Act 2004 applies to all direct taxes, initially only schemes concerning employment arrangements or certain financial products were required to be disclosed. In 2005 Stamp Duty Land Tax Schemes were also included.

The disclosure regime is now being extended with effect from 1 July 2006 to include the whole of income tax, corporation tax and capital gains tax.

Schemes requiring disclosure will be those falling within certain hallmarks derived from the existing "filters" of confidentiality, premium fee and off market terms.

The time limit for notification of in house schemes is being reduced to 30 days. Inheritance tax schemes remain outside the disclosure regime.

Stamp Duty Land Tax

The threshold for Stamp Duty Land Tax on residential property is increased from £120,000 to £125,000 for transactions on or after 23 March 2006.

A number of measures will be included in the Finance Bill 2006 which aim to clarify the SDLT treatment on a number of situations including

• Where property is gifted and the donee or beneficiary agrees or is required to pay CGT or IHT on the gift, no SDLT will apply
  
  
• Transfers of interests in a partnership including land or property will be excluded provided the partnership is carrying on a trade (unless the trade is dealing in or developing land) or profession.
  
  
• The removal of "seeding relief". Seeding relief gives relief from stamp duty when a property is transferred to a newly formed unit trust in return for the issue of units. With effect from 22 March 2006 onwards there will be a stamp duty charge based on the market value of the property transferred.

UK Real Estate Investment Trusts (UK - REITs)

The new regime governing the legal and taxation framework for UK REITs has been announced. Draft legislation has already been published on HMRC's website and has been covered in some detail in our recent TechTalk (ref 12/06).

Anti Avoidance Provisions For Companies

There are a number of anti avoidance measures introduced to prevent companies avoiding tax by entering into certain types of arrangements that involve financial products.

The arrangements have come to the attention of HMRC under the disclosure rules introduced in the Finance Act 2004 and in most cases use intra-group arrangements to avoid tax on income arising to the group, or create a tax loss when there is no economic loss to the group as a whole.

The following avoidance schemes are therefore blocked from today or earlier where detailed

• avoidance of tax on interest on cash using stock lending arrangements on non commercial terms in respect of arrangements entered into on or after 5 December 2005;
  
  
• arrangements involving purchase and sale of rights to distributions on shares used by financial traders to create tax losses where sales of rights to distribution are made on or after 20 January 2006;
  
  
• avoidance of tax through use of instruments which are economically loans but which are claimed not to be loan relationships because they cannot be settled in cash (so called "mandatory convertibles") but by the issue of shares;
  
  
• exploitation of the group continuity rules for loan relationships and derivative contracts to take advantage of different accounting methods used by group companies, or to avoid tax on discount arising on transfers;
  
  
• exploitation of accounting rules which result in profits on loan relationships being de-recognised, and thus falling out of tax;
  
  
• avoidance of tax in respect of loan relationships under arrangements where the investor receives less than a full commercial lending return (which would be taxable), but another connected party receives the value of that return in a non-taxable form; and
  
  
• regulations preventing arrangements to hedge currency exposures resulting in tax relief where there is a loss on the hedge but no tax charge where there is a profit.

The extent to which these and similar schemes are used for tax avoidance will continue to be examined with the aim of identifying a common solution to closing all such arrangements.

Change to Self Assessment Filing Dates

As part of his review of HMRC online services, Lord Carter of Coles has recommended that paper self assessment returns should be filed with the Revenue by 30 September instead of the current practice of 31 January in the following year.

The Government has accepted this recommendation along with allowing an additional two months until the end of November for online applications.

Introduction of the new filing dates is planned for 2008 and will give taxpayers considerably less time to lodge their tax returns.

Modernising the Tax System for Trusts

A series of measures as part of the Government's aim to modernise the tax system for trusts has been announced to take effect from 6 April 2006.

The provisions aim to bring the main trust definitions and tests in relation to income tax and capital gains tax into line with each other. Our recent Tech Talk 13/06 discusses the new regime at length and the announcement today simply confirms that the measures announced previously will take effect from 6 April 2006 rather than the following year as recommended by Chartered Institute of Taxation. The exception to this is the new residency test for trustees which will take effect from 6 April 2007.

There are however some points worth noting separately:

• The standard rate band of £500 is to be increased to £1,000 from 6 April 2006. This applies to accumulation & maintenance and discretionary trusts
  
  
• The income of settlor-interested trusts will be treated as though it had arisen directly to the settlor
  
  
• Payments to beneficiaries of settlor-interested trusts will not be chargeable in their hands
  
  
• Some changes have been made to the provisions of the Taxation of Chargeable Gains Act 1992 which define whether a settlor has retained an interest in the trust so that minor children will be included
  
  
• Income streaming provisions and the changes to the taxation of capital gains arising to estates in administration are not being implemented at this time.

Tax Rates At A Glance

Income Tax

The Chancellor's proposals will result in the following rates and bands for tax year 2006/07 (2005/06 levels shown for comparison)

Rate of Tax (%)	Taxable Income* (£)
	2006/2007	2005/2006
Starting (10)	0 - 2,150	0 - 2,090
Basic (22)	2,151 - 33,300	2,090 - 32,400
Higher (40)	Over 33,300	Over 32,400

Taxable income is defined as gross income for tax purposes, less those allowances and reliefs available at the taxpayer's marginal rate.
Savings income is taxable at 10% for income up to the starting rate band of £2,150 and 20% for income between the starting rate and basic rate band limit of £33,300 and 40% above this, except for dividend income where the rate is 10% for income up to £33,300 and 32.5% above this.

Personal Allowances

The proposed levels of allowances for 2006/07 are as follows (2005/06 levels are shown for comparison):

Allowance	2006/07	2005/06
Personal allowance	5,035	4,895
Personal allowance (age 65-74)	7,280	7,090
Personal allowance (age 75 and over)	7,420	7,220
Married couple's allowance (age 65-74)*	6,065	5,905
Married couple's allowance (age 75 and over)*	6,135	5,975
Blind person's allowance	1,660	1,610
Income limit for age-related allowance	20,100	19,500
Minimum amount of married couple's allowance*	2,350	2,280

* Allowances where relief is restricted to 10%

Inheritance Tax

The nil rate band increases from £275,000 to £285,000 with effect from 6 April 2006. The rate remains at 40%. The thresholds for the following years will be as follows:

	£
2007/08	300,000 (as previously announced)
2008/09	312,000
2009/10	325,000

Capital Gains Tax

The annual exemption increases in line with inflation from £8,500 to £8,800 with effect from 6 April 2006. The annual exemption for trustees is increased to £4,400. The rates of capital gains tax payable by individuals remain unchanged.

Pension Schemes Allowances

For the tax year 2006/07 the annual allowance is £215,000 and the lifetime allowance is £1.5 million.

National Insurance Contribution Rates

Class 1 (weekly earnings)	2006/07 £	2005/06 £
Lower earnings limit (primary)	84	82
Upper earnings limit (primary)	645	630
Primary threshold	97	94
Secondary threshold	97	94
Employees primary class 1 rate between £94.01 and £630 per week	11%	11%
Employees primary class 1 on excess above £630 per week	1%	1%
Employees contracted out rebate	1.6%	1.6%
Employers secondary class 1 rate above £94 per week	12.8%	12.8%
Employers contracted out rebate (salary related schemes)	3.5%	3.5%
Employers contracted out rebate (money purchase schemes) see note below	1%	1%
Class 2	£2.10 per week	£2.10 per week
Class 2 small earnings exception	£4,465 per year	£4,345 per year
Class 3	£7.55 per week	£7.35 per week
Class 4 rate on profits between £5,035 and £33,540 per year	8%	8%
Class 4 rate on profits in excess of £33,540 per year	1%	1%
Class 4 lower profits limit	£5,035	£4,895
Class 4 upper profits limit	£33,540	£32,760

Note:
For Contracted Out Money Purchase Schemes an additional age-related rebate is paid directly to the scheme by the National Insurance Contributions Office.

Corporation Tax

The corporation tax rates for 2006/07

		Profits
Small companies rate	19%	£0 - £300,000
Marginal rate	32.75%	£300,001 - £1,500,000
Main rate	30%	£1,500,001 or more

Simplification of Corporate Tax Rates for Small Companies

In 2002, the Government introduced a zero rate of corporation tax for companies with profits of £10,000 or less. A marginal rate of 23.75% applied to profits between £10,000 and £50,000. However this meant that some small companies were able to pay out dividends that had not suffered corporation tax therefore in a bid to combat this, in 2004 the Government introduced the NCDR of 19%. This meant that any profits used to pay dividends to shareholders would be taxed at a minimum rate of 19% (unless the dividend was paid to another company). The resulting tax calculations were however extremely complex and in an effort to simplify the tax position for small companies, the zero rate and NCDR rate is to be abolished from 1 April 2006. The effect is therefore that small companies with profits from £0 to £300,000 will pay tax at 19%.

Capital Allowances

From 1 April 2006 small businesses (including partnerships and sole traders) will qualify for first year capital allowances of 50% on expenditure on plant and machinery for a period of one year (previously 40%).
The rate of first year allowances for medium sized companies will remain at 40%.

Stamp Taxes

Land & Buildings

Stamp Duty Land Tax on transfers of land and buildings (consideration paid) will be as follows:

Rate	Land in Disadvantaged areas		All other land in UK
	Residential	Non-Residential	Residential	Non-Residential
Zero	£0 - £150,000	All	£0 - £125,000	£0 - £150,000
1%	£150,000 - £250,000		£125,000 - £250,000	£150,000 - £250,000
3%	£250,000 - £500,000		£250,000 - £500,000	£250,000 - £500,000
4%	Over £500,000		Over £500,000	Over £500,000

New Leases

Duty is the same as above except special rules apply for premiums where the rent exceeds £600 annually.

Shares & Securities

Stamp duty/stamp duty reserve tax on transfers of shares and securities is unchanged at 0.5% for 2006/07.