Pre-Budget report: Robbing Peter to pay Paul?

Pre-Budget report

FDs face a New Year tax hangover from the pre-Budget report. With the 17.5% VAT rate that was restored on New Year’s day adding further pressure to recession-strained profit margins, there are also a number of other ramifications from last month’s PBR.

It was seen by many in the tax world as unexpectedly restrained, given the mounting national deficit and a lack of ways to tackle it.

There were few headline tax rises or spending cuts announced; some speculated that the “real Budget” has effectively been deferred until after the general election. While on the surface Alistair Darling was keen to emphasise his confidence that growth would return to the UK economy “toward the end of the year” – giving the embattled UK economy less than a month to reverse out of a two-year cul-de-suc – there were further issues lurking within the PBR for FDs to mull over.

It gets personal
In setting out his “tough, but necessary” measures to increase tax, Darling declared “the biggest burden will fall on those with the broadest shoulders” – namely, those with the largest incomes. The 50% income tax rate on earnings above £150,000 will come into force on 6 April. Many FDs fall squarely within that tax bracket: Financial Director’s own 2009 Salary Survey saw the average annual salary of FTSE-100 FDs rise to £493,849 (£975,038 including cash and share bonuses), while FTSE-250 FDs averaged £299,114 (£521,429 with bonuses) and AIM-listed FDs averaged £168,768 (£263,273 with bonuses).

But FDs on more modest incomes cannot expect a reprieve: the tapering away of personal allowances for salaries above £100,000 also comes into force in 2010, while the freezing of said personal allowance at £6,475 – which, as BDO’s senior tax partner Stephen Herring says “is effectively a stealth tax” – will further increase income tax payments.

While other board members turn forlornly to their FDs and advisers for ways to manage the upcoming income tax onslaught, any ideas will need to be considered carefully. Capital Gains Tax (CGT) was a surprise omission from December’s PBR, given the Treasury’s concerns over the revival of income-into-capital schemes to take advantage of the lower CGT rate. However, Dave Hartnett, permanent secretary of tax at HM Revenue & Customs, has publicly vowed to clamp down on these and other “aggressive” tax avoidance measures.

There is also the restriction of higher rate tax relief on pensions from April 2011 to worry about. For those with gross incomes between £150,000 and £180,000 – where “gross income” is annual income plus both personal and employer’s contributions to a registered pension scheme – income tax relief will be tapered from 50% to 20%. Darling promises that “no one with an income below £130,000 will be affected” – but advisers are likely to suggest directors look into alternative reward schemes for higher earners.

In line with the freeze of personal allowances, the Chancellor also froze the inheritance tax threshold for individuals at £325,000 for 2010, rather than increasing it to £350,000 as planned. This, he said, will bring in £450m by 2012-2013.

Bashing the banks
Darling again targeted bankers’ bonuses in what was widely judged as an election-motivated move. The Bank Payroll Tax is, at this stage, a one-off levy of 50% on discretionary bonuses over £25,000 paid to banking employees between 9 December 2009 and 5 April 2010. The institution is liable for Bank Payroll Tax on amounts over £25,000 on top of any employers’ National Insurance (at 12.8%) already paid.

Just a week after the PBR, HM Treasury chief secretary Liam Byrne said the initiative may yet be extended beyond 2010 “if there is any evidence of simply deferring bonuses beyond that date”. Bank Payroll Tax is also not a deductible expense for income tax or corporation tax purposes – a further bid by the Treasury to discourage large bonus payouts – and there are now concerns that it isn’t just banks that will face the tax.

Hedge funds and asset managers are up in arms that the legislation is poorly drafted and was currently too catch-all. Tullett Prebon, the inter-dealer broker, has allegedly offered to help broking staff relocate to its offices outside the UK if they choose to – with certain caveats – in response.

The government has been quick in trying to fend off worried institutions and is looking at potentially redrafting the rules.

“The definition of a ‘bank’ by HMRC for this tax is very broad,” says Leonie Kerswill, tax partner at Pricewaterhouse?Coopers. “It wouldn’t just affect banks and building societies; other financial institutions, such as private hedge funds and asset managers could even be affected.”

No doubt those FDs will need to consider who takes the hit: the company by incurring the extra tax, or the employee by receiving a smaller bonus.

NI contributions rise again
National Insurance (NI) contributions are rising across the board from 6 April. Employees’ NI will increase by half a percent to 11.5% at the basic rate, and 1.5% at the higher rate, while employers’ NI will increase by the same amount to 13.3%. Alistair Darling announced a further 0.5% hike in 2011, taking employees’ NI rates to headline highs of 12% and 2% and the employers’ NI rate to 13.8%.

With recruitment at a low, there are concerns that raising employers’ NI could dash any employment recovery hopes. The “tax on jobs”, as BDO’s Herring describes it, could make businesses more reluctant to employ new people as both new and existing staff become more expensive to the company.

Paying more employers’ NI on an employee’s gross salary is not the only effect of the rate hike. Non-cash benefits for employees such as company cars and fuel reimbursements will be subject to the higher employers’ NI tax rate. Darling briefly commented in his speech about making changes to company car tax and fuel benefit charges, which could further affect the tax paid by a company on these benefits.

However, Darling announced that electric company cars would be exempt from employers’ NI tax levies for five years, with electric vans being exempt from fuel benefit charges, to encourage “green” investment.

Company perspective
There was some cheer for the New Year. The small business rate for corporation tax will remain at 21% in 2010-11, instead of increasing to 22% as initially proposed. This provides some relief for entrepreneurs, small businesses and subsidiaries of larger groups that fall within the small company taxation limit.

The “time to pay” scheme, which allows struggling businesses to apply to HMRC to defer or draw up a revised timetable for tax payment, has also been extended, to the approval of the business community.

From 2013, corporation tax on patent income will be levied at 10% rather than the full rate, in a bid to encourage companies with intellectual property rights to stay in the UK. Paul Smith, head of international tax at Grant Thornton welcomes the move, but notes: “It’s unfortunate it’s not being brought in now; 2013 is a very long time away.”

This was never going to be an easy PBR to deliver given the economic terrain in 2010. But the sentiment echoed by many is that the government should have been more forthcoming.