Wednesday 22 March 2006 marks Gordon Brown’s 10th Budget as Chancellor of the Exchequer.

The economic background to the Budget took a turn for the better in January when the Government received record tax receipts.  Before the January figures were released many commentators speculated that the Government would need to increase taxes to match its spending plans.  Now it is quite possible that further tax rises may not be needed.  UK business has been concerned at the pace of recent tax rises and the complexity resulting from the introduction of many new tax measures. The CBI and others have called for a freeze on new tax measures and asked the Government to consider the impact on UK competitiveness of the anti-avoidance drive.   

Bill Dodwell, tax partner at Deloitte, comments:
“The Chancellor announced several law changes in his 2005 Pre-Budget Report, and a number of consultations have reached their final stages, so we have a reasonably good idea of what will be announced.  Perhaps as a result of so many projects already having been announced, few hints have been given by Government, or HM Revenue & Customs, about potential new measures. 

“Some of the proposed changes are positive – particularly the introduction of REITs, the special tax exempt property investment vehicle.  We hope that the Chancellor will not announce further changes in respect of international matters for companies, following the very substantial changes in 2004 and 2005.  These raised tax through tightening the controlled foreign company and double tax relief rules, as well as introducing disallowance of interest expense in certain multinational investment structures.”

What then can we expect on 22 March?

Business measures
Property companies and investors are looking forward to the launch of the new REIT (Real Estate Investment Trust) regime. The initial rules were announced last December. Listed companies that meet the eligibility criteria will not pay tax on qualifying profits – income and capital gains from property letting. The initial rules required that there were no 10% or greater shareholders and also that a REIT had a relatively low gearing level.  A REIT is required to distribute 95% of its net income to shareholders subject to deducting basic rate tax (22%).  There are also complex rules on dealing with groups, and with non-qualifying activities, such as property development.  Many property groups have asked for these restrictions to be reduced or removed to make conversion to a REIT viable.

The Chancellor will announce in the Budget the level of the conversion tax charge on entry to the REIT regime.  It is also to be hoped that he will address the concerns raised by the property industry, so that the REIT regime may be launched successfully from 1 January 2007. 

The final update to the new Leasing regime – which applies from 1 April 2006 (with transitional rules from July 2005) – may also be announced in the Budget.  Many details of the new rules are already known.  The rules will reverse the current tax treatment of assets leased for more than 5 years, by giving the capital allowances (tax deductions for the asset cost) to the user, instead of to the finance company.  This is likely to increase finance costs for sectors that use long life assets such as airplanes and power stations.

Following the Marks & Spencer loss relief case before the European Court of Justice, the Government will announce how UK rules will be relaxed in accordance with the ECJ judgement.  It is expected that the rules will only allow UK relief for overseas losses where the overseas company has ceased business and so has no other possibility of using the losses.  Previous changes to UK law following ECJ judgments have applied on a worldwide basis; it is quite likely that in this case relief will be restricted to EU losses so as to minimise cost.

During January and February, HMRC consulted informally on proposals which would significantly affect aspects of the tax regime applicable to general insurance companies (including captive insurance companies).  Given the speedy consultation to fit into the timetable for the Finance Bill 2006, changes can be expected in this area, raising tax.

The review of Links with Medium-sized Businesses was announced in the 2004 Pre-Budget Report with the aim of reducing the administrative burden the tax system places on medium-sized business.  The review found that the issues facing medium business are different from those of large or small business, both generally and in terms of tax.  In addressing the issues raised by the review, benefits should be delivered to medium business, other business and HMRC. HMRC will report back on progress on the key items at Budget 2006.

The Olympics, Sports clubs and Community activities
The London Olympic bid included the promise of tax exemptions for the International Olympic Committee, the Olympic organising company and for non-resident athletes (who would otherwise be charged UK tax on their Olympic earnings).  It is hoped that draft legislation covering this will be published.  It is also hoped that the Government will offer similar exemptions to UK sports bodies.  Such an exemption would have little, if any, cost but would save administration for sporting bodies.

Following the withdrawal of the zero corporation tax band from April 2006 for profits up to £10,000, many sports clubs and other community activities will suddenly become liable for small amounts of tax, typically on interest income. It is hoped that the Government will provide a continued exemption from tax for these minor activities, saving administration.

Other areas for an update include:

• Trust taxation reform - draft legislation, together with a summary of earlier consultation, was released by HMRC in January.  The legislation seeks to modernise and simplify the taxation of trusts.  We expect that the draft law will be enacted broadly in its current form because of the proximity of the Budget.
• Inheritance tax on pensions – following the introduction of the new Alternatively Secured Pension, there is the possibility that some pensioners will have surplus funds to be left to their heirs.  The Paymaster General announced a consultation on when inheritance tax should be charged – and it is likely that the Government’s proposals will be announced in the Budget.
• Capital allowances incentives – detailed guidance is expected on the proposed scheme for Business Premises Renovation Allowance (BPRA).  BPRA would give businesses tax breaks for renovating certain brown field sites. 
  
  As part of its policy of promotion of the wider use of renewable road fuels, the Government has announced a new scheme of enhanced capital allowances on expenditure on biofuel plant.  The scheme will be effective from 2007, but is still subject to state aid approval.
  
  Finally, first year capital allowances available to small businesses will be increased from the current level of 40% to 50% for investment in plant and machinery made in the year from April 2006. 
• Tax Disclosure - the Chancellor announced proposals in the Pre-Budget Report to extend the scope of the Tax disclosure regime, introduced in Finance Act 2004, with effect from April 2006.  The focus of the changes will be to extend the regime to cover avoidance risks across all of income tax, corporation tax and capital gains tax (the current regime covers tax advantages arising from the use of a financial product or employment product) and to add to the ‘hallmarks’ for direct tax disclosure. The Treasury Select Committee, in January, urged full consultation to ensure that the right balance is struck between protecting tax revenue and ensuring that the disclosure regime does not place an unreasonable administrative burden on businesses.  It is expected that the Chancellor will announce the new rules in the Budget.
• Gaming Taxes - The Pre Budget Report confirmed the Treasury's view that the broad structure of gaming taxation in the UK has worked well and that they are not envisaging significant change in the transitional period during which the Gambling Act 2005 provisions are implemented. We have been warned to expect changes in Amusement Machine Licence Duty to align this with the Gambling Act, following the equivalent changes in the VAT definitions of Gaming Machines.
  
  It is expected that the rate of taxation for remote gaming will be announced in the Budget. There has been speculation that a low rate of 3-5% will be set; but even this will cause an outcry from the land based operators (who are paying gaming duty rates of 2.5-40%) and is unlikely to be low enough to encourage any of the remote gambling operators to relocate to the UK (most are based in low/nil tax regulatory jurisdictions at present).

Ends

Notes to editors

For immediate comment on the day of the report please call our Budget press hotline: 020 7007 3333

The target set for the central government current tax receipts for the fiscal year 2005-06 was £487 billion with corporation tax receipts at £43.7 billion; at the PBR on 5 December 2005 the forecast had fallen to £458 billion with VAT and corporation tax receipts in the first six months of the year well below target.  The revised corporation tax forecast is £41 billion, with the 2006-07 forecast being £51 billion.

However, current tax receipts in January 2006 were 14.4% higher than receipts in January 2005 (significantly in excess of the Chancellor’s target of 7%), and corporation tax receipts were more than 50% higher.  The increase can be partly attributed to strong profitability in the North Sea oil and financial services sectors, and partly due to the changes in the timing of tax collections from North Sea companies announced in the 2005 Budget.  Although central government spending is also slightly higher than target, the Chancellor looks much more likely to meet his revised PBR forecast.

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