PBR 07: Deloitte says UK's economic position has worsened

In it’s roundup of the PBR, Deloitte said there was evidence that the prime
minister chose not to go to the country on account of the economic and financial
position of the country worsening.

‘It would now only be possible to give some significant pre-election
sweeteners by raising the already high borrowing numbers still more and hence
endangering the government’s reputation for fiscal prudence,’ Deloitte said.

The firm also noted that the PBR reflected a keen political judgment in
partially adopting the Conservatives’ tax proposals while appearing to direct
extra money at the margin into spending on health and education.

Overall, the PBR was pretty much fiscally neutral, giving away small amounts
for the next two years (mainly on inheritance tax measures) and raising it in
the next two (mainly through the end of capital gains tax taper relief and the
reform of non-domicile taxation).

The chancellor’s acknowledgement of the darker economic outlook is marginal.
He reduced the forecast for growth next year to 2% to 2½%. We are forecasting 2%
– but the outturn could easily be much worse than our forecast. Moreover, it is
noteworthy that the official forecast envisages growth rebounding to a higher
level than previously forecast in 2009/10.

It is this which explains how, after raising his borrowing numbers for next
year by £6bn, borrowing is pretty much back to the previous track within three
years.

We suspect that, without significant further tax rises, borrowing will turn
out to be nearly £10bn higher than the official forecast for 2009/10 and by
2011/12 it may still be standing close to £40bn.

Furthermore, this reflects a central forecast, yet economic risks are now
firmly skewed to the downside. Moreover, given this, and the clear chance that
government spending will not slow as much as the Treasury’s plans envisage, the
risks to borrowing are skewed to the upside.

Mr Darling’s first PBR was a workmanlike performance without the bravura of
his predecessor. But economic circumstances are much less favourable for him.
And they may well get less favourable still. As always, Chancellors can only
achieve what the economy allows. We may be entering a new period of hard
problems and hard choices.

Air Duty

Tax partner Tony McClenaghan, welcomed the announcement to replace Air
Passenger Duty with a tax payable per plane rather than per passenger from 1
November 2009.

‘Proposals to replace Air Passenger Duty with a tax based on the level of
carbon emissions per flight would make the relative carbon cost of a flight
easier to understand.

‘In its current form the relatively low ”flat rate” Airline Passenger Duty
is unlikely to lead to wholesale behavioural change amongst passengers and
simply raises additional tax. It also ignores freight and private flights. In
contrast, having a tax based on the carbon cost of a particular journey could
encourage a change in passenger behaviour,’ he said.

‘It will be interesting to see the outcome of the proposed consultation with
industry and stakeholders. There are many practical issues that would need to be
considered before any such a tax could be implemented. For example, how would
the carbon impact of each aircraft type be measured and verified; how would
figures be obtained from overseas airlines; how would passenger load averages be
included (so as to reflect the benefit of flying with a fully-loaded aircraft)
and checked; how would passenger flights and cargo flights be dealt with under
one regime and how often are all these figures updated?

‘Passengers paying the new tax would also want to know how the additional
£520m generated would be spent. Air Passenger Duty is simply part of general
taxation: is the government prepared to dedicate tax revenue to spending in
particular areas?

‘In practice it may also be very hard to set the tax at a level that would
have a genuine impact on the majority of travellers’ flight choices without
making flying prohibitively expensive for the less well off. The weakness with a
tax such as this is that with the tax levied on the airline and not the
individual, it will make it less transparent for individuals to see the impact
of their behaviour,’ said McClenaghan.

Individual Tax

Patricia Mock, private client services director said there were three main
points of interest for individual tax payers.

‘Firstly, Alistair Darling, perhaps spurred into action by the Conservative
announcements last week, has announced relaxations in the use of the nil rate
band for inheritance tax (IHT). Up to now, if a spouse dies there is no IHT
payable if the assets are left to the surviving spouse or civil partner. ‘When
the survivor dies, only one nil rate band is available. Thus the nil rate band
of the first of the couple to die is lost unless the couple have enough assets
to leave some of them to, for example, children, on the first death.

‘The new measure allows for a transferable allowance for married couples and
civil partners. This means that any unused allowance on the first death can be
used on the second. The allowances themselves, according to the 2007 Budget, are
set to rise to £350,000 by 2010/11. For a couple with a combined estate of
£600,000, where all the assets are left to the surviving spouse on the first
death, this would mean a saving of £120,000, based on current rates.

‘This measure will be welcomed by taxpayers whose main asset is the family
home and do not have sufficient assets to make gifts to children on the first
death. The measure will apply to couples where the first death was before
October 2007 and the second death is on or after 9 October. The Treasury
anticipates that this measure will cost £1bn in 2008/09, although it is worth
noting that there has been a certain amount of planning in this area, which will
no longer be needed.

‘Secondly, and a measure which will have mixed effects, a new flat rate of
capital gains tax has been introduced at 18%, to apply from 6 April 2008. This
is coupled with simplification measures around the calculation process, which
has become increasingly complex over the years, and this aspect will be
welcomed, particularly by unrepresented taxpayers.

‘On the change in rates, there will be winners and losers. The flat rate of
18% replaces the gradual reduction of the gain through taper relief. General
investors in shares and those with buy-to-let or second properties, who achieve
a minimum rate of 24% after 10 years ownership will find their position
improved, although accumulated indexation allowance will no longer be available
(which applied to assets owned before 1998). There will be no holding period
required to benefit from this new rate. However, entrepreneurs and taxpayers who
hold shares in their employer will find a 10% rate replaced by one of 18%. The
changes are bound to mean a flurry of sales in the period up to 5 April 2008, as
people make sales to lock into current rates if this is to their advantage.

‘Finally, there are changes in the non domicile regime. Mr Darling has
proposed a flat rate charge for non domiciles of £30,000, which will apply after
they have been UK resident for seven years. In his speech and in calculating the
yield from the measure, the Chancellor suggested that 15,000 taxpayers would
find it beneficial to pay the levy. The new rules will apply from 6 April 2008
onwards, and to people who have already clocked up 7 years of UK residence on
that day. There is a suggestion that higher charges will apply to those who have
been here for more than 10 years.

‘Coupled with the change is a tightening up of loopholes and anomalies, which
have allowed people to manipulate the rules. We will need to wait for the
legislation to assess the precise impact, but it seems that overseas structures
such as trusts and companies will be affected. There will be a consultation
process on the details of the change,’ she said.

CGT

CGT taper relief for individuals and trustees withdrawn with effect from 6
April 2008, replaced with 18% tax rate. Up to April 2008 the effective tax rate
for entrepreneurs is as low as 10%.

Sam Hart, a director in the Entrepreneurial Business team said: ‘To date, the
optimum capital gains tax rate on an exit for an entrepreneur has been 10%.
However, from next April the tax rate rises to a flat rate of 18% and will
become a much more substantial cost. 10% tax was seen by many as an acceptable
cost on an exit, but 18% is significantly higher and may affect the decision
whether or not to sell. An entrepreneur with a business worth £5 million will
now face an additional tax cost of £400,000.

‘There will of course be winners from these CGT simplification measures.
These will include individuals selling assets that would previously have been
subject to tax rate of 24% after 10 year’s ownership. From April 2008, they can
benefit from 18% tax after day one. This will include assets such as buy to let
properties, second homes and other investments, including shares,’ said Hart.