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Chancellor took one of only two chances to be radical

SINCE THE ANNOUNCEMENT of the July Budget Day, I have always thought that the chancellor has two – but only two – opportunities to introduce bold tax reforms and simplification which could be enacted and deliver positive outcomes before the next general election, presumably in May 2020.

His March 2016 Budget always felt the better bet for bold reforms as there has been less than nine weeks since the General Election and boldness generally requires careful planning if it is not to be foolhardy.

The June 2015 Budget includes some interesting reforms and, unfortunately, some measures where the chancellor can be criticised for having made tax more complex and less incentivising. I have selected some announcements, considering them from three different perspectives i.e. incentives, reforms and simplification.

Few predicted an immediate announcement that the rate of corporation tax would be reduced to 19% in 2017 and 18% in 2020 – although I would not be surprised if the 18% targeted rate was accelerated if the fiscal position permits – and I have always been convinced that the ‘headline rate’ matters significantly in decisions about where to locate foreign direct investment activity. The chancellor is wise to ensure that the UK, in an increasingly competitive world, is second-to-none on this parameter.

AIA not A-OK

However, I am disappointed that the chancellor has cut the Annual Investment Allowance from £500,000 to £200,000 from 2016 (surely no one thought it would actually fall to £25,000). This is the principal tax relief focussed upon medium sized businesses; a sector where the UK’s economy underperforms in comparison to the US and, especially, Germany.

The chancellor (and many business commentators) often refers to the imperative to improve the UK’s productivity in comparison to our European and global competitors and one way to improve productivity is to ensure that plant and machinery is renewed and updated on a regular basis. Whilst the tax treatment should never be the ‘tail that wags the dog’ on business investment decisions, a tax nudge favouring investment is a sensible tax incentive.

I was pleased to see that the Chancellor has substantially increased the rent-a-room relief to £7,500 per annum. This measure will only cost the Exchequer £50m for the five years to 2020/21; a very small cost for a measure which may well make a useful contribution to alleviating the shortage of residential accommodation in some cities, towns and rural areas. The Institute of Directors called for this relief to be increased but that it should also be available for other assets which could become part of a ‘sharing economy’.

The limitation in the relief for let residential property to the basic rate of income tax from 2017/18 may well, of course, lead, at the margin, to a reduction in the construction or improvement of rental accommodation as commercial property investment is unaffected. This measure appears to be more of a response to a noisy lobby in the media rather than being based upon an economic analysis of its positive and negative impacts.

I think it is difficult to argue that the July Budget will secure a reputation for the chancellor as a bold tax reformer on a similar basis to previous chancellors such as Callaghan, Howe and Lawson. No significant taxes have been abolished, introduced or had their rates dramatically reduced.

Turning now to measures which will certainly simplify tax reporting and compliance, the abolition of the dividend tax credit and the parallel introduction of a £5,000 annual allowance against dividend income should be highlighted.

This measure very much reminds me of Gordon Brown’s abolition of advance corporation tax which was widely welcomed on the day but the substantial negative impact upon pension funds (which were no longer able to recover the tax credit) took many months to evaluate. There is no doubt that the £5,000 annual exemption will simplify tax compliance for many thousands of taxpayers who own, say, share portfolios of less than £150,000 which will, typically, generate an annual dividend return less than £5,000.

Paying dividends?

It might emerge, however, that it will favour debt finance of SMEs by their shareholders rather than equity finance because the combined effect the deductibility of interest against taxable profits for corporation tax purposes and the reduction in the difference between the effective tax rates borne by the recipient tilts the financing decision towards debt finance.

While this is likely to be more relevant for SMEs, the same tax technical argument could be applied to listed companies which have predominately UK resident shareholders. Many argue that debt finance is already too high and that policies ought to favour more equity finance.

Many commentators have already expressed surprise that inheritance tax is to be made more complicated by implementing the manifesto commitment to introduce a £175,000 relief for an individual’s main residence, my only comment is that (if inheritance must be kept), the chancellor should have abolished the relief for an unused spouse’s nil rate band, not introduced any relief for main residences and merely increased the nil rate band to £1m.

Many countries (including Australia, Canada, New Zealand and Sweden) no longer have an inheritance tax or estate duty and other have substantially higher exemptions (for example the USA exemption is over $5m).

This leads directly to my conclusion that I trust the chancellor will focus over the summer on how to reform, simplify and reduce taxation in his March 2016 Budget. He must know that it makes sense.

Stephen Herring is head of taxation at the Institute of Directors

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