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Two plus two equals five! That seemed to be the optimistic arithmetic at the time of the Budget earlier this year in which was announced the Government's biggest ever spending programme on public works, to be coupled with the biggest ever programme of benefit hand-outs to the unemployed, the employed on low incomes and on middle incomes, those retired from employment, and with plans to include even those not yet working because they are still infants, and all this coupled with allegedly the lowest tax rates ever. The maths looked to be under strain on any view, and even now, it seems hard to reconcile the increasing burdens which are to be placed on the working population with the spectacular tax breaks being offered to a privileged few through taper relief and the substantial shareholdings exemption, coupled with existing generous reliefs for business and agricultural property.
My entirely uninformed guess is that the era of new tax reliefs and exemptions is now well and truly over. I discount the wild rumours which occasionally circulate of inheritance tax being abolished, or the erstwhile half-hearted suggestion that something might be done in relation to the impact of capital gains tax on portfolio investors.
Instead, the Government has resolved to wring the last penny out of all existing taxes. There is some particularly vicious talk about VAT tax-avoidance schemes, with a warning of the intention to 'increase the number of challenges brought against existing abusive tax-avoidance schemes, and identify and challenge new schemes before they can be widely marketed'. The intention must be to frighten the living daylights out of the tax avoider so that he gives up the whole idea. Unfortunately, whilst this may work for private individuals who have their cars taken and crushed at Dover, the same strategy will not work against the VAT avoidance industry, where the players are major quoted companies. No doubt Customs are pinning great faith on their 'Halifax' argument that transactions entered into solely to avoid VAT liability are neither supplies, nor are they made in the furtherance of an economic activity. It has to be said, that nearly all Budget statements in recent years have included similar tough talk about tax avoidance, and the huge sums which are about to be retrieved by stamping it out, but, sitting where I am, I have not noticed any decline in the avoidance industry.
Before turning to some points which caught my eye out of the Pre-Budget papers, I cannot help observing that the standard of the official material issued plumbs new depths each year. I would rather read a hand-out from a double glazing company. What few press releases one gets are awash with propaganda, rhetoric and extravagant over-statements but short on information and facts. One of them reannounces no less than three times the extension of the VAT flat rate scheme, and yet there is no press release at all on the review of the rules relating to residence and domicile, despite there being some important remarks on this topic at paragraphs 5.81 and 5.82 of the Pre-Budget Report itself, reproduced on this week's Update pages.
VAT amnesty
Hopefully no reader of this magazine has any clients operating above the VAT threshold without being registered, but any such new clients who come forward for advice will need to know that there is to be something akin to an amnesty operated by Customs for a set period of time; the full announcement is as follows:
'[The Government] will launch a high profile scheme under which - for a prescribed time period - unregistered businesses operating above the threshold will be given a one-off opportunity to come forward voluntarily for registration, in return for the mitigation of their penalties.'
At present there is no suggestion that this will operate for direct tax purposes as well; the main thrust of it is in relation to VAT. Whether the mitigation of penalties means no penalty at all or just a reduced penalty is not yet clear. Note also that the proposals are not yet in force and we await a further announcement as to when it is to start. We can only hope that it will be soon, as otherwise advisers who are approached by unregistered businesses in the interim period will be in some difficulty about acting for them.
Employee benefit trusts
Draft legislation has been published to replace the existing rules in sections 43 and 44, Finance Act 1989 which govern the Schedule D deduction for 'potential emoluments'. New rules here have been anticipated for some time to block off the avoidance possibilities with employee benefit trusts, and although the published legislation is stated to be 'draft only', it is nevertheless of immediate effect from 27 November 2002. Initial reactions seem to suggest that this could be the end of the line for this particular avoidance opportunity, widely adopted in the financial sector to avoid Schedule E liabilities on large staff bonuses.
The new rule is broadly that there is to be no deduction to the employer for sums paid for an 'employee benefit contribution' until such time as the money is applied by the making of a payment or transfer of assets giving rise to tax liability under Schedule E. The deduction cannot be greater than the original figure put into the trust. Also, the making of a loan by the trustees will not provide a deduction to the employer, nor will any benefits to a wider class of beneficiaries not within the Schedule E charge.
An obvious question which arises is what happens when the employer is taken over and loses its identity before the benefits are provided, given that these trusts may be long term vehicles.
The other side of this coin is that there is to be a new statutory rule allowing a deduction for the cost of providing shares for employee share schemes. This is to be operative for accounting periods starting on or after 1 January 2003 and this will be a notable departure from the modern principle that tax liability follows the accounts figures. Those operating employee benefit trusts would urgently like to know how this new relief dovetails with the new legislation on potential emoluments, but regrettably no draft legislation for the share relief is yet to hand.
Residence and domicile
The bizarre tale of a possible change in the residence and domicile rules continues with the uncertainties here still very much continuing. To date, there has been no formal consultation, although privately interested parties have been requested to make their submissions. Clearly, the Government has not yet formulated any conclusions, except that it still believes that the current rules cannot be allowed to survive. What we are to get next is a 'background paper to aid discussion', but evidently the whole business is going forward at a leisurely pace and I would not be advising non-domiciliaries to panic ahead of 5 April 2003.
Capital allowances
Another avoidance measure with immediate effect deals with schemes by which assets (other than machinery and plant - so the thrust is towards property) qualifying for capital allowances have had their value artificially depressed prior to a sale, in order to secure increased balancing allowances at the time of sale. The draft legislation states, bold as brass, that it applies where 'as a result of a tax-avoidance scheme' the proceeds of the asset are less than they otherwise would have been. The definition of 'tax-avoidance scheme' is any arrangement the main purpose, or one of the main purposes, of which is the obtaining of a tax advantage, and in turn, there is a definition of tax advantage in section 577(4), Capital Allowances Act 2001 which encompasses the obtaining of 'an allowance or greater allowance'. The new legislation appears harsh as not only is the tax avoider denied the hoped for balancing allowance but also the residue of qualifying expenditure thereafter is nevertheless to be treated as if the balancing allowance had been made! So the hoped for tax advantage is irretrievably lost.
Construction industry scheme
The rules relating to subcontractors in the construction industry which were overhauled as recently as 1999 are to be overhauled yet again. Under the existing rules, subcontractors without a registration card cannot work at all (except as employees), those with registration cards may not be able to work as the tax deduction at source can put them out of business, which leaves only those with exemption certificates in the clear.
What we are to expect under a new régime is the ending of registration cards and gross payment certificates and, in their place, a verification service, coupled with an employment status declaration. We have yet to see the full details of the proposed new régime.
VAT flat rate scheme
Just seven months after the introduction of the VAT flat rate scheme we have an announcement that it is to be extended. This follows current experience with nearly all new tax legislation of a relieving nature, which is that a tentative and very limited régime is first introduced and then progressively tinkered with in succeeding years. From April 2003, businesses with an annual turnover of up to £150,000 will be eligible for the scheme and this will make it of much wider impact. In advance of next April, I would suggest that practitioners should be reviewing their smaller business clients to see if the flat rate scheme might be appropriate for them.
What was missing?
Most of the anti-avoidance provisions announced with the Pre-Budget Report deal with large-scale tax-avoidance opportunities, and we can no doubt expect many other aspects of smaller scale tax planning to feature in next year's Finance Bill. In the meantime, here are one or two current opportunities.
Eversden trusts
A gift in trust for the spouse for a suitable period of time (normally not less than three months is considered advisable) followed either by discretionary trusts or interest in possession trusts for children is not a gift with reservation of benefit for inheritance tax purposes according to the High Court decision in Commissioners of Inland Revenue v Eversden [2002] STC 1109. The decision is under appeal by the Revenue but it is thought that the taxpayer should succeed on the wording of the legislation. If the continuing trusts are for the children, it is often best for the trust asset to be of a non-income producing nature, such as a holiday home used by all the family or a single premium insurance bond. Some advocate putting the main residence into such a trust, but the trustees will then face a stark conflict of interests: the settlor will be expecting to remain in sole occupation whereas the life tenants of the trust will be enjoying nothing with the tacit understanding that they will not complain about this (and of course family relationships can always deteriorate). If the continuing trusts are discretionary, then the value is best limited to the inheritance tax nil rate band to avoid immediate inheritance tax liability, and in these cases the main residence is certainly not suitable in view of the Revenue's Statement of Practice SP 10/79, controversial though it may be.
Drawbacks of the arrangement are that the initial disposal to the trust has normal capital gains tax consequences, and liability will arise on a chargeable gain. In addition, either a potentially exempt transfer or a chargeable transfer arises on the termination of the spouse's life interest, which will go forward on that spouse's inheritance tax clock for seven years.
Otherwise, the trust has little impact for income tax and capital gains tax purposes, since the trust will be designed to be one in which the settlor retains an interest and so income and gains will remain those of the settlor for tax purposes. In view of the inheritance tax associated operations rule, the better view is that the spouse's initial interest should be for a fixed term at the outset; there may then be worries about Ramsay applying but the reply to that is that there is a clear statutory régime on offer to the taxpayer.
Melville
The opportunities for giving away valuable property without incurring either inheritance tax liability or capital gains tax liability continue to be available under new Melville schemes. See the item headed 'Tax-efficient giving' in Taxation, 28 November 2002 at page 213 for more details.
Offshore trusts
There are new flip flop schemes for offshore trustees which have not to date been published. Experienced practitioners in this field will advise in any suitable case.
Secondhand bonds
A single premium life insurance bond is a chargeable asset for capital gains tax purposes where purchased secondhand. It is thought therefore that it is possible to secure a capital gains tax loss by reference to the purchase price if the policy is surrendered. The surrender will give rise to the normal chargeable event liability on any profit over its original premium but that liability should be much less than the capital gains tax saved.
Incorporation
The opportunities for small businesses to save tax by incorporation and payment of profits out by way of dividend have been well documented and discussed in this magazine over the past few months. There has been talk that the IR35 provisions might be extended to deal with this type of planning, or some other type of apportionment provisions introduced to collect full liability on the dividends, but there is nothing in the Pre-Budget Report suggesting that the Government has any concerns here. In fact, I did see one newspaper report suggesting that consideration was being given to offering similar reliefs to the self employed; perhaps this was just wishful thinking!
Strong rhetoric
These are just a few of the many examples of tax planning as we currently know it and despite the strong anti-avoidance theme in the press releases, the Chancellor is a long way from securing 100 per cent of his intended revenue. In reality, the national revenue is much more a case of two plus two equals three and a half, with the leaky pipe letting some out on the way.
