Pre-Budget Report Round-up: Opinion – Cheque’s in the post.

The pre-Budget report certainly contained some complex and difficult tax reforms, but in doing so, the chancellor has set the government a serious challenge to explain them to the electorate in time to win a May election.

Gordon Brown has used smoke and mirrors to push the fuel duty protesters on to the hard shoulder. This is a complicated package of rebates and reforms, some of it backdated and some of it not due until next spring.

It isn’t the simple cut that many protest groups wanted. Will they feel cheated? Or will they accept that they’ve got a good compromise?

On pensions he has also played a very clever game. He has linked everything, but the basic state pension to earnings. The trouble is this effectively leaves the state pension to wither on the vine. The generation that brought in the welfare state will be the last to benefit from it. So what is national insurance for now?

There were well-meaning proposals to widen the enterprise management incentive, help regeneration of deprived urban areas, and more generosity to families.

Will they radically change the face of Britain between now and May 3rd or whenever they have the election pencilled in for? The answer is no.

Deferral relief for disposals of substantial shareholdings

The proposal to provide a deferral relief where groups buy and sell qualifying shares is welcome and it is pleasing that this is still proceeding after the initial round of consultation.

Many other countries give a complete exemption for such gains: the government has recognised that the deferral proposal will not altogether eliminate the competitive disadvantage for the UK and is looking again at the option of introducing an exemption.

However, there are some dark hints that such a relief would need to be looked at in the context of a wider consideration of the corporation tax system, so the corporate sector might not like the price for such an exemption.

One of the most challenging outstanding issues is whether gains can be rolled into intra-group share subscriptions. It would create distortions if acquisitions gave the opportunity for deferral but organic growth did not. On the other hand the Revenue has a legitimate interest in preventing groups obtaining rollover against some of the underlying assets and multiple layers of share investments up the group.

It does appear that deferral will be withdrawn if the new trading venture fails commercially, so that the new shares cease to be in a trading company or holding company of a trading group – this adds a tax burden to a commercial problem, which will not be appreciated by those affected.

The commercial effect of the introduction of the new deferral regime could be challenging. The new regime, when taken with the developing proposals on intellectual property, will cause some upheaval in the positions taken by purchasers and vendors in structuring deals, particularly whether to sell assets or shares. It seems probable that rollover opportunities will disappear on goodwill and simultaneously materialise on shares. Corporates may defer deals as next year’s Budget approaches, either with a view to future improvements in their tax treatment or to avoid additional midnight meetings with the lawyers as the whole tax framework changes about them in the final stages.

Double tax relief

The Finance Act 2000 contained significant reforms to the way that double tax relief is to be afforded to UK companies. The provisions were amended many times during the passage of the Finance Bill and, not surprisingly, as a result, retain a number of rough edges. This has been recognised by the Inland Revenue and the following amendments should be put through in the next Finance Bill.

The first improvement is intended to prevent the mischief known as ‘double capping’. The most common situation in which the double cap applies under the current version of the law is where two high-tax subsidiaries are held in a chain.

This will arise where, for example, a group has made a US acquisition, which has existing Canadian subsidiaries – a not uncommon situation. Only a dividend from the immediate subsidiary in the US can create eligible unrelieved foreign tax (EUFT); the excess tax on a dividend paid from Canada to the US is wasted.

The way in which EUFT is calculated will be changed. EUFT, up to 45%, will be calculated taking into account tax above 30% at each level as profits are paid up through a chain of companies as dividends – not just at the highest level where the mixer cap applies. Companies will be able to set this against UK tax payable on dividends of the permitted type in respect of which credit relief is claimed, as provided for in Finance Act 2000.

The maximum amount of underlying tax to be allowed under the ‘mixer cap’ is currently calculated by working from the actual dividend received and grossing up at 30%, the current rate of corporation tax.

EUFT is calculated on the same basis, using a grossing-up rate of 45%.

In certain circumstances these provisions do not give the measure of either Case V income or EUFT that had been expected.

It is proposed instead that the calculation be based on adding together the actual foreign underlying tax paid and the actual dividend received, and taking a straight percentage of this total.

This revised calculation should ensure that the measure of dividend income coming into the UK is broadly on a like-for-like basis with the current regime. It is also intended to make the calculations simpler to understand and administer, reducing compliance costs for UK businesses.

– Stephen Barrett is the national head of corporate tax consulting for Ernst & Young

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