Incentives

Every year at Budget time the government looks not only at the tax rates but also the reliefs given, especially the more costly ones, to judge if they are still worthwhile. The general thrust of policy has been to reduce the value of tax relief in order to fund cuts in the basic rate of tax.

The Budget rumour machine has focussed this year on profit related pay (PRP) – this comes as no surprise as it is such a valuable relief. Since the Conservatives have made the reduction in basic rate tax their priority, the rumours would appear to have some truth. However, in a pre-election period, the Chancellor will always be looking at the winners and losers from his tax proposals. There are approximately 12,000 employers and over three million employees in PRP schemes. A radical curbing of PRP relief could create as many as six million losers when the dependants of those in PRP schemes are included. The reduction in the basic rate of tax would be highly unlikely to compensate those employees for the loss of PRP tax relief.

One possible change to reduce the revenue lost to the Exchequer would be to limit the tax relief to the basic rate or lower as has been done with other allowances. PRP is one of the few reliefs allowable at all rates of tax. There would be a substantial administrative problem in making sure higher rate tax is paid on PRP. Whereas the married couples allowance is for a fixed amount of money or mortgage. Interest relief is given at source, PRP is a variable amount of money dependant upon profits and the relief could not be easily adjusted through a tax code. It would also add to the complications of the tax system which come at a sensitive time with the introduction of self assessment. Finally, the Inland Revenue has just issued new guidance notes on PRP. Would they have done this if it was going to be abolished?

The employees who would suffer proportionately the most if higher rate relief was abolished would be those earning in the region of #30,000 to #35,000. Would the Chancellor wish to alienate them just in advance of a general election? This does not mean that once the election is safely over, any of the three main political parties would not look at the relief again. The Conservatives have naturally defended their 1987 creation consistently in the House of Commons, but the Labour Party and Liberal Democrats have affirmed their general support for PRP, while questioning whether the relief is sufficiently targeted to prevent abuse.

An incoming Labour government may well reduce the benefit of PRP down to the basic rate of tax assuming the technical problems mentioned above can be solved satisfactorily. Alternatively, it could reduce the number of organisations that can take advantage of PRP – a tightening up of the eligibility of organisations to register PRP schemes would reduce the revenue loss. We are already seeing greater vigilance by the Revenue in administering PRP schemes to ensure any abuse is curbed. There may also be further restrictions on the use of service companies to operate PRP schemes.

To paraphrase Mark Twain “rumours of the death of PRP have been much exaggerated”. These rumours circulate each year and companies who may be putting off a decision to implement PRP schemes for fear of what a Labour government might do are simply losing the opportunity to motivate their employees and increase their net pay. Employees who have been in PRP schemes since 1991 will have received tax benefits of up to u8,000.

This sort of benefit cannot be ignored.

On share schemes, Labour has also been generally supportive and over the last 18 months, shadow Treasury spokesmen Alistair Darling and Andrew Smith have put down a set of principles, while in recent months including elements of Tony Blair’s “stakeholder economy”. This, while itself still less than crystal clear, would appear to mean support for employee participation in the companies they work for. Smith has said Labour “will seek to encourage a culture of long-termism and understand the contribution employee share ownership can make. All the more so, when it is a culture of ownership rather than purely temporary shareholding which is fostered.”

Labour’s stated view is that the motivational effect of share ownership works best if spread from the boardroom to the shopfloor. Share schemes, they believe, should encourage and involve some financial commitment on the part of the individual. Linked in with this is the belief that schemes should be performance related, rather than just part of a fixed remuneration package. Lastly, Labour wish to examine schemes that will encourage workers to make long-term savings, particularly to supplement individuals’ pension schemes.

Smith has stated that Labour has little time for schemes or ideas that appear more concerned with avoiding tax than encouraging share ownership, and Darling reiterated recently that “public money should not be given to people who will do something anyway”. So under an incoming Labour government, especially one faced with a huge fiscal deficit, schemes that do not motivate or increase employee participation may be living on borrowed time.

How would these “principles” be implemented? The chances are that additional tax relief would not be an immediate priority for a new Labour government.

It seems unlikely too, that an extension of the tax net on share schemes will be in the election manifesto.

The toughest line from Labour will probably be to pledge no extension of the current tax breaks. Though Darling did not rule out the possibility of “further reviewing the taxation of share schemes where it can be shown clearly that change would serve the public interest”, it can be safely bet that it would need an exceptionally strong case if further tax concessions were to be awarded.

In many ways, following last year’s Greenbury Report and the Asda “Check Out” share options fiasco, the perceived need for action has disappeared.

While the jury is still out on the effectiveness of Greenbury in reducing alleged boardroom excesses, the reduction in income tax relief for approved options represents a major step-change; more so than anything Labour seems likely to bring in if the party’s business prospectus, released in September, is anything to go by. The thrust of Blair’s approach is to win business confidence and it seems companies should be able to go ahead with existing plans without wondering if a change of government will blow their remuneration policies out of the water.

Alan Olivey is a tax partner in Ernst & Young’s Employer and Private Client Services group.