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DID READERS SEE the report which said that 270 people submitted their income tax returns online on Christmas Day last year? While I did not add to this statistic this year — my father always told me 'never put off until tomorrow what you can do next week' — I did take a little time over the holiday to look back over the Pre-Budget Report. Given that some readers are probably having difficulty remembering who gave them that particularly unattractive tie, the chances of remembering the precise contents of the report are pretty remote. I will therefore help ease readers into the new year by reflecting on what the Chancellor said, and what he omitted so say.
Contradictory
As I look back on the Pre-Budget Report I have two, apparently contradictory, impressions. The first is that, for most taxpayers, nothing much will have changed. Almost everybody will have gone to bed on 6 December in exactly the same tax position as they woke up in that morning. Indeed, as far as individuals and smaller business are concerned, the Treasury was certainly sending out signals that there had been a deliberate policy of responding to the profession's repeated pleas to leave things alone. Most people to whom I have spoken have welcomed this: tinkering on the margins for the sake of it has been one of the most regrettable features of this Government's approach to taxation.
At the same time, we are undoubtedly in the middle of a period of profound changes to the UK tax system, and the 2006 Pre-Budget Report forms a significant milestone in that development. The vast pile of printouts which accumulated on my desk on the afternoon of 6 December was evidence of this. There is no correlation between quantity and quality, but my impression is that this was not just a pile of soon-to-be waste paper, but that it contained a great deal which will be of great relevance to the future shape of the tax system.
Burden on business
An area which has been of particular interest to me over the last year or so is the administrative burdens on business. Perhaps as a member of the Administrative Burdens Advisory Board I have a vested interest in saying so, but I do sense that the Government has finally woken up to the fact that it is no longer acceptable to introduce more and more changes to the tax system without considering the impact that administering those changes will have on business.
There was, I think, some real honesty here about the fact that making things simple can never be an end in itself. HMRC collects broadly £400,000 million in tax every year and the UK population is about 60 million. So, in the ultimate simple system everybody in the UK would get a bill of £6,666 each year. This would be simple, but hardly fair or practical. There is always a trade off between simplicity and fairness, and this came through in the comments on the taxation of company cars. The Government could use the capital allowances system to encourage the use of certain environmentally-friendly fuels. However, this would add complexity to the system, because businesses would have to keep separate records about the fuel efficiency of their company car fleet and advisers would have to prepare yet more schedules to the tax computations to ensure that effect was given to these new allowances.
My suspicion is that most businesses would prefer to keep matters as they are, rather than have to deal with yet another category of capital allowances, particularly as we are only dealing with a matter of timing, although it may be that the consensus would actually be in favour of enhanced allowances for a specific category of cars. The point here is that the Government has put the matter up for debate rather than imposed a new policy without thought of the administrative complexities that it would bring. This is progress and, I hope, a sign of things to come.
New TMA regime
Another interesting area is the reform of the Taxes Management Act, a topic regarded by many people as dry and technical. This is a misjudgment because the TMA goes to the heart of how the tax system is experienced by taxpayers on a daily basis. The latest round of proposals concerns penalties, and I recommend that anybody who has not yet read the consultative document should do so as a matter of priority. There seem to be two main thrusts to the new proposals:
- the first is to align penalty provisions across all of the taxes;
- the second is to ensure that penalty provisions are properly proportionate to the behaviours which they are intended to punish.
The second point interests me in particular. I think that reform here is well overdue. My experience in practice is that the current system is not working properly. It is becoming very hard to predict when penalties will and will not be applied, but there is definitely a trend for Inspectors to try and impose penalties for what previously would have been regarded as purely technical adjustments. At the same time, the level of penalties for serious tax offences is often relatively modest. So in practice penalty weightings of between 15% to 35% seem to cover the vast majority of situations. This cannot be right and I support the principle of a much broader range of penalty loadings.
My concern, however, is that this might only work in one direction. Inspectors will be happy to apply higher penalties in serious cases, but will they also be prepared to accept that in cases at the other end of the spectrum, especially in cases of technical disagreement or genuine error, no penalties will be due? I am sure that HMRC's guidance to Inspectors will stress this even-handed approach but relationships between taxpayers and the authorities are a problem, which both sides need to address.
I am pleased that the proposal to have a specific penalty for taking an unreasonable tax position has been dropped. I cannot see how this could have worked, and it would have been a bone of contention which could have taken away much of the positive impact that the penalty reforms could have.
Worst of all worlds
Then there is avoidance. The Government has been retreating from reliance on traditional 'black letter' drafting of anti-avoidance provision towards a more subjective general anti-avoidance principle (see Martin Edhouse's article 'Taken at the flood', Taxation, 7 December 2006, page 231 for a discussion on this subject). We see it this year in the proposals for restricting relief for personal capital losses, just as we saw it last year with the bolting on of anti-avoidance principles into FA 2003, Sch 22. Now this is not the place to debate whether or not it is appropriate to have a series of mini anti-avoidance rules without an overall framework in which they can operate consistently, but it is worth standing back from all of this and wondering just where it leaves us.
We could end up with the worst of all worlds. We have to deal with the horrendously complex technical rules and then have to contemplate the general anti-avoidance rules on top of everything else. Sch 22 consists of pages of very tightly drafted rules designed to prevent employment income being disguised as capital which are very largely irrelevant in real avoidance cases (because of the new anti-avoidance overrides), but which cause endless practical difficulties in genuinely commercial transactions such as management buyouts. If we are to have an anti-avoidance principle, it will be necessary to get rid of vast swathes of specific anti-avoidance legislation: we need one or the other, but not both.
Tax motivation
Finally, the Pre-Budget Report considered managed service companies. The detail on these is covered by Paula Tallon in her article 'MSCs: a new era' later in this issue of Taxation, but I want to link it here to the comment in the Pre-Budget Report that the Treasury is still concerned about 'tax-motivated' incorporations. They are both reflections of what is in essence the same problem: the very different tax and National Insurance treatment of dividends as opposed to remuneration. At some point this very difficult issue is going to have to be tackled because until it is resolved everything else, e.g. TA 1988, s 660A, IR35, managed service companies, anti-incorporation measures, is simply attacking the symptoms rather than the underlying problem. Any solution will of course be far from easy, and there will be winners and losers in any new regime, but until there is a properly thought-out regime for the taxation of small businesses we are going to face ever more disputes about what the appropriate tax base should be. The Treasury has not said much recently about the review of small business taxation. Let us hope that in 2007 we will get some substantive proposals.
There is more to managed service companies than dividends versus remuneration. Certainly some managed service companies have exploited the tax regime to an extent which might be regarded as unacceptable by the Treasury, but there are plenty of managed service companies which are set up for perfectly legitimate reasons, not least because of the reluctance of many major contractors to take on direct labour because of the employment law considerations. Thus reform in this area must be conducted on a fully-rounded basis. If we end up with a series of rules which are only designed to tackle extreme avoidance and which have no relationship to the commercial reality of many managed service companies, it will be another case of a sticking plaster being used to paper over the cracks.
Unhelpful process
Finally with regard to the Pre-Budget Report process itself; I am sure that I was not alone in finding the way that the material was published on the Internet on the day of the Pre-Budget Report extremely unhelpful. The split between Treasury and HMRC press releases is, perhaps, inevitable, but even taking this into account, the material on each site seemed to be distributed in a way calculated to make it is as difficult as possible to find. This was further complicated by extra material being added at various times during the afternoon: I was never quite sure that I had seen everything. Some important material did not seem to merit its own press release, but was buried deep in the Pre-Budget Report document itself. Given the length of this document, it is not acceptable to leave tax professionals to have to navigate it without any assistance, just in case it mentions something of importance which has not been flagged up elsewhere.
So next time, please can we have a more logical process of distributing the material and, at a minimum, the publication of a list of everything which is to be published on the day together with links to the relevant page.
It may be that I am still under the effects of a post-Christmas glow, but I do see this year's Pre-Budget Report as being largely positive. This is because it did not try to do too much but was instead a further building block in the process of re-formulating a modern tax system. A lot of that work is not particularly exciting, but it needs to be done and it is right that proper time is given to getting the fundamentals right. HMRC appears to have heeded the message about consultation. The scars of previous failures to consult will take some time to heal, but if the approach to consultation in this Pre-Budget Report is the model for the future, we may collectively manage to get the tax system into the shape it needs to be.
Andrew Hubbard is a tax director of Tenon, accountants and business advisers.
