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BDO Stoy Hayward predicts grim fiscal outlook in budget

April 1st, 2009

Chancellor needs to focus on the medium term fiscal deficit

In these unprecedented fiscal times the economy is at the forefront of the entire nation’s collective mind. Everybody is looking to the Government for strategies to help move us out of a recession, but we are all keenly aware that fiscal stimulus comes at a cost to the taxpayers – there is no such thing as a “free lunch”.

Stephen Herring, Senior Tax Partner at BDO Stoy Hayward, said: “The key issue, as recently highlighted by Mervyn King, is whether or not the Chancellor will be able to reconcile the need to increase taxation in the medium term with the shorter term perception that further fiscal stimuli are required?”

It will be of great importance for the Chancellor to indicate how, in the medium term, he intends to reduce the annual budget deficit. At the 2008 PBR, he forecasted this to be £77.6bn, £118bn and £105bn in 2008/09, 2009/10 and 2010/11 respectively, but this will certainly be far higher now due to multiple factors including falling tax revenues, bank bail-outs and rising unemployment.

Here is a full list of predictions for what the Budget may hold for us this year. We have given our predictions a mark out of ten as to their benefit to UK plc.

The Chancellor may respond to Opposition calls for the corporation tax rate to be cut from 28 per cent to 25 per cent (or lower) to restore the UK’s tax competitiveness. This could be achieved without significant cost to the Exchequer if certain other reliefs (eg capital allowances) were reduced. [10/10]

If the Chancellor wished to introduce a further - but temporary - fiscal stimulus to support employment levels, he should consider a short term reduction in the employers rate of National Insurance from 12.8 per cent to, say, 8 per cent until 5th April 2010.

This could cost approximately £20 billion but would boost the profitability of major employers and influence them to reduce redundancies as the recession in the real economy deepens. [7/10]

He should comment upon the future VAT rates and indicate that this tax, which currently collects around £80 billion, could, as a least bad partial solution, be increased beyond the previous 17.5 per cent rate when the temporary reduction to 15 per cent expires on 1st January 2010.

The UK’s 17.5 per cent VAT rate is towards the lower end of major European countries. [8/10]A somewhat similar - but arguably more taxpayer friendly - measure could include targeted reductions of VAT in more challenged sectors.

A very recent example is the proposed French reduction of VAT on restaurant meals from 19.6 per cent to 5.5 per cent. [3/10]The sheer quantum of losses being generated, and carried forward, are likely to shelter taxable profits for some years to come.

For example some of the UK banks may now have sufficient losses to allow them to pay no tax for many years. The Chancellor may therefore be considering the introduction of a limited life for losses which extinguishes the loss after a certain number of years.

This would be similar, for example, to Italy which only allows ordinary trading losses to be carried forward for 5 years. [2/10]

Having announced a new top 45 per cent rate of income tax, to apply to income over £150,000 from 20011/12 onwards, it is inevitable that the Chancellor will come under pressure to extract further amounts from the highest earners, perhaps by creating an additional top rate of 50 per cent or more on incomes over £1m.

It should be noted that the current proposed increase from 40 per cent to 45 per cent is only expected to increase income tax receipts by only £670m. Further increases risk significant harm to the UK’s status as a place to conduct business but would not make a significant contribution towards curbing the budget deficit. [1/10]
Will the Chancellor tamper with the extent to which higher rate income tax relief applies for pension contributions? Currently, income tax relief is available at an individual’s highest income tax for contributions up to £235,000 pa (2008/09).

Substantial pensions are very much in the public eye but it should be emphasised that the maximum tax exempt pension fund permitted under the current HMRC limits would only buy an index linked pension of perhaps £70,000 pa; a small percentage of the high profile arrangements. [3/10]

The Chancellor should clearly explain HMRC’s position regarding UK taxation (particularly of businesses) and the UK’s European Union Treaty obligations (notable the “Freedom of Establishment” and “Freedom of Movement” Articles).

Increasingly, taxpayers are appealing tax cases from the House of Lords to the European Court of Justice claiming that the UK tax legislation is invalidated by European treaty obligations. [9/10]

The Chancellor should respond to the concern of UK resident multinationals about the introduction of restrictions for interest relief (”worldwide debt cap”) combined with the introduction of the participation exemption for dividends received from overseas subsidiaries.

For example, HMRC is likely to be keen to curtail tax deductions for interest on debt to acquire overseas subsidiaries, the dividend stream from which will no longer be subject to corporation tax. [5/10]

Whether he will “de-couple” the maximum rate of Stamp Duty Land Tax on commercial and residential properties which is currently fixed at 4 per cent to “kick-start” the ailing commercial real estate market bearing in mind that a far higher percentage of commercial property sales are taxed at the 4 per cent SDLT rate. [7/10]

On “carried interest” the Chancellor could increase the tax rate by partly replacing the capital gains tax treatment by an income tax treatment.

However, to avoid being perceived as being too negative towards encouraging investment, this might be achieved by limiting the lifetime capital gains from carried interest to £5m. [5/10]

For PFI/PPP in the spirit of boosting privately financed Government projects (in addition to the recently announced boosted level of Government funding) there could be a carve out from the world wide debt cap provisions for PFI/PPP projects that have, say, 10 per cent or greater local authority (or similar “Government” type entity) equity interest. [9/10]

The Chancellor has already announced in the PBR 2008 that he is proposing to remove the benefit of the basic personal allowance for those earning over £140,000 pa and reduce it by half for those between £100,000 pa and £140,000 pa. Will he be tempted to apply this principle to all personal reliefs? [3/10]

Darling may be tempted to introduce additional anti-avoidance legislation following the recent revelations concerning planning in the financial sector taken to reduce personal taxation on “excessive” remuneration/pensions/compensation packages.

Almost inevitably poorly targeted, such measures can easily increase the perception that the UK is becoming an unfavourable location for entrepreneurs and key executives to be located. [1/10]

We expect confirmation that he does not intend to tamper with either inheritance tax or capital gains prior to the General Election following his reforms to permit the transfer/aggregation of IHT reliefs between married couples (and civil partners) and the introduction of the flat 18 per cent rate of CGT.

Despite being very high profile these two taxes collect only £8bn in total even in a good year (which this is not!) out of total tax receipts of £516bn. [8/10]

Stephen Herring, Senior Tax Partner at BDO Stoy Hayward concluded: “There are a number of areas such as VAT, corporation tax and pension relief for higher rate tax payers, where the Chancellor may be driven to implement significant changes.

We do not consider that this will be a budget of long term giveaways or sweeteners despite it being in the run up to an Election. We hope the Government can provide the nation with a vision for its fiscal structure enabling the regeneration of businesses and the sustainability of Government finances.

“Now is the time for the Government to put economic priorities over political expediency. This will need to be a Budget setting out a road map for Government finances of medium term austerity.”

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