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Tax Rates 2004 / 05
Budget
Summary Introduction
A Chancellor approaching an election does not want to raise taxes or cut
public spending. A year ago, Gordon Brown suggested that he would not
have to do either, because he made predictions of economic growth - which
would keep tax revenues buoyant - which some regarded as over-optimistic.
It was rumoured that Gordon Brown had abandoned Prudence, his constant
companion of earlier Budgets. However, he closed this year's speech by
invoking her again - "Prudence with a Purpose" remains his motto.
Even so, he spent some time making it clear that the borrowing required
by this year's measures was within his "golden rule", and the
books would balance within the economic cycle.
At first sight, there are few major changes that will affect most people
- Mr Brown seems to be tinkering with details, rather than rewriting large
areas of the tax system. We should be thankful for that. Even so, there
were still about 80 press releases issued by the Revenue and Customs giving
details of the tinkering. This booklet summarises the main changes and
outlines their likely effect on the average taxpayer.
Significant points
- Income
tax allowances increased in line with inflation
- New
cap on approved pension schemes to apply from April 2006
- Increases
in tax rates for trusts
- Closure
of tax avoidance schemes for CGT
- New
charge on "pre-owned assets" from April 2005
- New
minimum tax charge for small companies paying dividends
- Inland Revenue and Customs & Excise to merge
Tax rates and allowances (Table A)
Personal allowances and higher rate thresholds were increased in line with inflation. The rates of tax for individuals are unchanged. The benefit is in the region of £220 for a higher-rate taxpayer. This benefit is much smaller for a person on a low income, but is likely to represent a larger share of that person's tax bill.
The overall effect is complicated by the different rates which continue to apply for general income, interest and dividends, and the possibility that a separate claim may be made for tax credits to be repaid by the Revenue. The calculation of the tax position remains as complex as ever.
Income split between husband and wife
Over the last year, the Inland Revenue have been giving publicity to their views on some arrangements which save tax by splitting businesses between husband and wife. The Revenue believe that they often have the right to give the income back to the higher-rate taxpayer who runs the business, cancelling the tax saving. Many tax advisers think that the Revenue usually do not have that right.
The Budget does not contain any new measures about the basic argument, but one method of avoiding it has been closed down: it was possible to split income 50:50 for tax purposes by putting the shares in the joint names of husband and wife, even if the actual split was different. This will no longer apply to income received from a closely-controlled company on or after 6 April 2004: the income will be split between husband and wife according to their actual ownership of the underlying asset.
| Tax Trap |
| Do you jointly own shares in a family company? |
Working Tax Credit (WTC) and Child Tax Credit (CTC) were introduced for the first time in 2003/04. Provisional claims for that year were based on 2001/02 income, and shortly have to be revised to take into account actual 2003/04 income. The rates of WTC and CTC for 2004/05 have been in many cases increased in line with inflation, but some elements have not (e.g. the amount of childcare cost that the Revenue will cover). The full table of rates is too large and complex for this brief summary.
Until now, WTC (like its predecessor Working Families Tax Credit) has usually been paid by employers through the payroll. To reduce burdens on business, the Revenue are consulting on the possibility that WTC will be paid directly to the claimant by the authorities.
Rates and limits (Table D)
The percentage rates of NIC remain unchanged. There are small increases in the thresholds and upper limits, and also in the flat rate weekly payments under Classes 2 and 3.
Company cars and fuel (Table C)
The taxable benefit on most company cars will increase again for 2004/05, because the level of CO2 emissions at which the minimum 15% charge starts to increase drops to 145g/km from 155g/km. This means that the charge for most cars will increase by 2% of the original list price - unless they were already on or near the maximum (35%), or are still below the minimum.
The same increase will apply to the benefit of free fuel for use in a company car, because that is based on the same percentage applied to a fixed figure of £14,400.
It has been confirmed that the base level of emissions will be lowered to 140g/km for 2005/06, and this figure will be held for 2006/07.
Company vans
Last year it was announced that the £500 flat rate taxable benefit on the provision of a company van would be reviewed. From 6 April 2005, there will be no taxable benefit on the provision of a company van where an employee is required to take the van home at night, and any other private use is forbidden. Where private use is allowed, the rate will remain at the current level until 5 April 2007; it will then increase to £3,000, and a new charge of £500 will be introduced to cover the provision of fuel for private use.
Childcare
For some years, the provision of childcare by an employer through a "workplace nursery" has been a tax-exempt benefit in kind. Provision by other means has generally been taxable, although vouchers are free of NIC. From April 2005, a new £50pw exemption will apply to a wider range of "employer-contracted" childcare, and existing "workplace nurseries" will remain exempt.
Although in many cases this is an attractive new exemption, it will not always reduce the tax charge. Some existing exempt nurseries will be subject to the new £50pw limit, which will increase the tax charge; and vouchers of over £50pw will gain from a tax exemption on £50, but lose by NIC being charged on the excess over £50.
| Tax Tip |
| Paying childcare costs could be a tax break next year |
Following protests about the difficulty of meeting above-inflation increases in Council Tax, the Chancellor announced that there will be an addition of £100 to the winter fuel payments for pensioners over the age of 70. The increases in personal age allowances are above the rate of inflation, which should remove some pensioners from the charge to tax.
Pension contributions (Table B)
The "earnings cap" for personal pension contributions and occupational scheme benefits is set at £102,000 for 2004/05 (2003/04: £99,000). The maximum contributions for different ages are set out in the table.
It is confirmed that the rules for tax-approved pension schemes will change radically from 6 April 2006. The new limit will be based on the funds available to buy benefits at the date of retirement, rather than on contributions or on the benefits themselves. The cap is to be set at £1.5m to start with, with set increases up to £1.8m by 2010. Transitional rules will give some protection to those who are over the limit at the outset. Anyone else who cashes in a larger fund after that date will suffer a 55% clawback charge on the excess, which can be taken (after tax) as a lump sum.A smaller clawback applies if the excess is taken as a pension.
Individual Savings Accounts (ISAs)
The maximum amount which can be contributed to a tax-free ISA remains £7,000 for 2004/05. It has been announced that this will fall to £5,000 in 2006/07.
Venture Capital Trusts (VCTs)
From 6 April 2004, it will no longer be possible to defer the tax charge on a capital gain by investing in new VCT shares. There will still be income tax relief on up to £200,000 of new shares (increased from £100,000 before 6.4.04), and the rate is increased to 40% for the two years 2004/05 and 2005/06 to compensate for the loss of CGT deferral. VCT shares remain exempt from tax on gains or income.
| Tax Tip |
| VCTs get better income tax relief, but worse CGT relief |
Enterprise Investment Scheme (EIS)
CGT deferral remains available for investment in new EIS shares. The maximum limit for 20% income tax relief on investment is increased to £200,000 (from £150,000) from 6 April 2004.
Film schemes
For some years, the 100% tax relief for investment in "British films" has led not only to finance for the UK film business but also to a separate tax-avoidance industry. Steps were taken to close this down by restricting the tax relief available to "inactive business partners" from 10 February 2004, and by introducing "exit charges" on those whose tax schemes allowed them to enjoy the 100% relief on costs, but walk away from any later tax on income. This has led to a crisis among those who are actually making British films, but the Government is determined to close down the avoidance schemes. A new credit will instead be given directly to producers of films costing up to £15m.
Tax rates 2004/05
The tax rates for discretionary trusts are increased to 40% on general and interest income (from 34%) and 32.5% on dividends (from 25%). This brings these rates in line with those payable by a higher-rate taxpaying individual, and means that no income tax can be saved by retaining income within such a trust. Distributions of income to beneficiaries will now come with a tax credit representing 40% of the gross income paid out, or 40/60 of the net payment. Trustees will have to be very careful with their calculations following the change of rates, because they are likely to be giving out larger tax credits (at 40%) than the tax they have paid on the income (at 34%). This leads to a liability to pay the difference to the Revenue.
The CGT rate for all trusts increases to 40% (from 34%). As the beneficiaries do not receive any credit for CGT paid by the trust, this is a straightforward tax increase.
Proposals for 2005/06
The Revenue have published a consultative document proposing a number of significant changes to discretionary trusts for 2005/06, and also trusts in which the settlor has retained an interest. Trustees will need to keep themselves informed about the progress of these proposals, because they may lead to planning opportunities and pitfalls around 5 April 2005.
Annual exemption and tax rates
The annual exemption for individuals has been increased to £8,200 for 2004/05 (2003/04: £7,900). Trustees receive half this figure (£4,100 for 2004/05; £3,950 for 2003/04), although this may be shared between trusts which have been set up by the same person.
Anti-avoidance measures
The Chancellor has closed down two tax avoidance schemes which took advantage of reliefs which might be available to a trust, but would not be available to the settlor of the trust. The schemes involved transferring an asset into trust and claiming gifts relief to pass the chargeable gain to the trustees; then selling the asset in the trust with the benefit of the trustees' extra relief, so the gain passed in by the settlor would not be taxable.
From 10 December 2003:
- Where
a settlor could ever benefit from the trust in the future, gifts relief
can no longer be claimed on transferring an asset to the trust, so the
gain up to that point will be charged on the settlor.
- Where
the asset is a house, and the first rule does not apply, the settlor
will have a choice - either gifts relief can defer the charge when the
house is transferred into the trust, or the trustees will be able to
claim the only or main residence exemption for a beneficiary living
in the house, but not both.
Rates
The rates of IHT remain 40% on death and 20% for lifetime chargeable transfers. The nil rate band rises from £255,000 to £263,000 on 6 April 2004.
Pre-owned assets
In December, the Chancellor announced the intention to introduce a measure to close down an IHT loophole. Where someone gives away an asset (e.g. a house) but continues to enjoy it (e.g. by living in it), it is supposed to stay part of their IHT chargeable estate because of a rule called "gifts with reservation of benefit" (GWROB). A number of schemes have been designed to get around the GWROB rule, and the Revenue want to deny the benefit of these schemes.
The proposal was to introduce, from 6 April 2005, an income tax charge on the current use of an asset where that asset was formerly owned by the user. The income tax charge would be similar to the "benefit in kind" that an employee might have on the use of an asset provided by an employer.
This has led to a great deal of controversy and protest, because it will apply to arrangements which were established in the past, when there was no indication that such a tax charge would be introduced. The Revenue have responded that it is not retrospective, in that it is the current use after April 2005 that will be taxed, not the transfer in the past; but many such arrangements cannot now be undone.
The Chancellor has confirmed that this measure will take effect from 6 April 2005, but has introduced a number of exemptions and relieving measures to deal with some of the complaints against it. In particular, where a person has set up a structure which cannot be undone, it will be possible to elect back into the IHT charge in order to avoid the new income tax liability.
| Tax Trap |
| Do you have the use of any assets you used to own? |
SDLT was introduced as a whole new tax last year, and a number of minor changes have been made to tidy up the rules. The most significant new rule is to bring transfers of land interests into and out of partnerships within the scope of SDLT for the first time. They remain within the older Stamp Duty until the change takes effect on Royal Assent to the Finance Act (probably July).
Rates
The rates of Corporation Tax are unchanged for the year commencing 1 April 2004 at 30% for companies with profits over £1.5m, 19% for companies with profits between £50,000 and £300,000, and zero for companies with profits up to £10,000. The same marginal rates as before apply to those with profits between £300,000 and £1.5m, and between £10,000 and £50,000.
Small companies
In December, the Chancellor announced that he would take steps to prevent tax avoidance by the owner-managers of small companies taking profits out of the business by dividend rather than salary. Some thought he might impose NIC on dividends, or reintroduce an Investment Income Surcharge, or tax the owners on the income of the company. In the end, the rule change appears much less drastic, although it is not clear yet exactly how it will operate in practice. Where a company with profits of up to £50,000 pays a dividend on or after 1 April 2004, the company has to pay a minimum of 19% in corporation tax on the profits used to pay that dividend. A company with that level of profits would otherwise have a lower corporation tax rate.
| Tax Tip |
| Does your company pay CT at less than 19%? |
Transfer pricing
In the past, the Revenue could require companies to increase their taxable profits if they had sold cheaply to, or bought dearly from, foreign connected companies. Such transactions, which were not at "arm's length prices", had the effect of artificially shifting profits out of the UK, and the "transfer pricing rules" could shift them back again.
It is now clear that European rules, and some other treaties, do not allow such rules only to apply to "foreign" companies - so they will now apply to UK groups of companies as well. From 1 April 2004, UK groups will have to consider whether they need to make adjustments to reflect "arm's length pricing" on transactions between UK trading companies.
Fortunately, there is an exemption for small groups, and medium-sized groups will not have to self-assess an adjustment (the Revenue will only direct one "in exceptional circumstances"). Also, the Revenue have said that they will only enquire into the matter if there is a reasonable amount of tax at stake - if one company pays tax at a significantly different rate to the other.
Small groups are those with fewer than 50 employees and either turnover or assets of less than €10m (about £7m). Medium-sized groups have fewer than 250 employees and either turnover of less than €50m (about £35m) or assets less than €43m (about £30m).
The separate rules on "thin capitalisation", where a foreign holding company introduces a small amount of share capital and a large amount of debt to finance a UK subsidiary, have been brought within the main transfer pricing rules from 1 April 2004.
Management expenses
Until now, investment companies have relieved their running expenses as "management expenses", but trading companies with an investment business have not been eligible for this relief. Relief will be extended to trading companies from 1 April 2004. On the other hand, the rules will specifically deny a deduction for management expenses which are capital in nature, after the courts recently held that existing rules did not disallow them.
Research and development
The rules on R&D are amended to make enhanced reliefs available to companies for accounting periods ending on or after 1 April 2004 for large companies, and from a later date to be announced for small and medium companies. The definition of qualifying R&D has been simplified, and a wider range of types of expenditure will now qualify, to include software, power, fuel and water used for qualifying R&D.
Community Amateur Sports Clubs (CASCs)
The CASC scheme, introduced in 2002, gives some of the benefits of charitable status to qualifying sports clubs. These are extended from 1 April 2004 to exempt trading income of up to £30,000 and property income of up to £20,000 from corporation tax. An exempt CASC will not have to complete a tax return every year.
Capital Allowances
The 100% first year allowance for small business expenditure on computers has not been extended, so it ends on 31 March 2004. The general rate of FYA is increased for small businesses from 40% to 50% for one year from 1 April 2004 (companies) and 6 April 2004 (others).
Renovation of premises
A new relief will be introduced in 2005 (provided the European Union does not raise objections) to give 100% tax relief for expenditure on renovating business premises in the approximately 2,000 "enterprise areas" which currently qualify for Stamp Duty Land Tax and other reliefs. The capital costs of renovating a property will be treated as allowable expenses, if the property has been vacant for a year when the project begins.
Construction Industry Deduction Scheme (CIDS)
During 2003, the Revenue announced the intention to reform the CIDS (following on from a major revision in 1999). This has been deferred to April 2006, but the new rules will be included in this year's Finance Act. In the meantime, the Revenue "will increase compliance activity" to ensure that traders are following the existing rules.
Lloyd's underwriters
For many years, there have been reliefs for traders who transfer their business to a company - they can preserve the benefit of unrelieved losses against income from the company, and can defer capital gains arising on the transfer of the assets on incorporation. These reliefs are now extended to a Lloyd's underwriter who incorporates on or after 6 April 2004.
Registration thresholds
From 1 April 2004, the level of taxable turnover at which a business is required to register for VAT increases by £2,000 to £58,000. The level of predicted future turnover at which a business can deregister also rises by £2,000 to £56,000.
Flat rate scheme
The flat rate scheme was introduced in 2002 to simplify the affairs of small businesses. It is now available to those with taxable turnover of up to £150,000, and total turnover of up to £187,500. A flat rate trader claims no input tax on expenses (except for fixed assets costing at least £2,000 gross), but accounts for less than the usual 7/47 on receipts from customers - the lower "flat rate" depends on the type of business.
To encourage more businesses to register for this scheme, the flat rates were all reduced from 1 January 2004. This means that a flat rate trader can still receive the same amount from customers, but will pay less of it to Customs. There is a further discount for a trader who is within the first 12 months of VAT registration.
| Tax Tip |
| Have you thought about the flat rate scheme? |
Annual and cash accounting schemes
These two schemes for small companies are extended from 1 April 2004 by increasing the maximum turnover level for entry from £600,000 to £660,000. Traders within the scheme will not have to leave until turnover exceeds £825,000. The effect of leaving cash accounting - having to pay over all the VAT on debtors - will also be deferred for six months, easing cash flow for the business.
Demonstrator vehicles
Car dealers can recover the input tax on the purchase of cars to use as demonstrators. A scale rate will be introduced from a date to be announced after Royal Assent to the Finance Act (probably July 2004) to require output tax of up to £140 a year if the business allows employees to have private use of these demonstrator vehicles.
Groups of companies
Customs have redefined the conditions of eligibility for group registration. This is aimed at artificial structures established by VAT-exempt traders to obtain services without paying VAT on them, but it may also affect some joint ventures which are purely commercial in nature. The new rules only allow group registration where the companies could be consolidated in the same set of group accounts under UK accounting principles.
Gift Aid
You cannot claim income tax relief for a gift to charity if you get something in return - that is not a gift. However, there is an exception for payments which only give the right of entry to premises, where the preservation of those premises is the object of the charity. This was intended to cover annual subscriptions to such bodies as the National Trust, but has been exploited by some other organisations to gain tax relief for "day membership" (i.e. entry fees at the gate). The rules are to be tightened up after consultation with charities.
Merger of Revenue and Customs
The Chancellor announced, as expected, that the two main revenue-raising departments will be merged. Mr Brown hopes for a large amount of saving in public spending from this and other reforms to the public sector, but the effect on taxpayers will be hard to assess in advance. Dealing with a single authority may be useful, but coping with a department which is going through a reorganization may lead to delays and difficulties.
Anti-avoidance measures
The Chancellor declared his determination to reduce the benefit of major tax avoidance schemes, either currently in existence or in the future. There were measures to close specific loopholes on VAT on buildings,financial products and finance leasing, and new requirements for:
- law
and accountancy firms who market avoidance schemes to register such
schemes with the Revenue;
- traders
with over £10m of turnover to make certain declarations to Customs
about the use of VAT-avoidance schemes which will be on a published
register.
The Revenue carried out "pilot tests" of a shorter, simplified tax return last year, and they will extend it this year before rolling it out nationally in 2005. The shorter return will only be available to people with relatively simple tax affairs, and these will be selected from what was on the tax return last year. If you are not selected, you cannot apply to be part of the pilot!
| Table
D Rates and limits for 2004/05 |
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| Employee's Contribution | ||||||||||||||||||||||
| Contracted
in: 11% on earnings between lower and upper limits, 1% above
upper limit. Contracted Out: 9.4% on earnings between lower and upper limits, 1% above upper limit. Earnings over £79 per week qualify for benefit, and must be reported under PAYE, but no NICs are payable until earnings exceed £91 per week. The reduced Class 1 contributions payable by certain married women and widows rises to 4.85% for earnings between £91 and £610 per week, 1% above £610 per week. |
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| Class 2 (Self-employed) | Earnings over £4,215 per year | £2.05 per week | ||||||||||||||||||||
| Class 3 (Voluntary) | No limit applicable | £7.15 per week | ||||||||||||||||||||
| Class 4 (Self-employed) | Profits between £4,745 and £31,720 | 8% | ||||||||||||||||||||
| Profits above £31,720 | 1% | |||||||||||||||||||||