Budget Analysis - Tax experts turn on Clarke

As the dust settled, the deeper implications of the Budget became clear. Chancellor Kenneth Clarke’s central Budget plank was a massive attack on legitimate tax avoidance by ‘ingenious’ accountants. The response from tax experts was swift, with many offering immediate alternatives to the ‘wheezes’ blocked by Clarke.

Anger at the phasing out of tax relief on profit-related pay turned to talk of replacements, in the form of approved profit-sharing schemes, while others talked of campaigning to force Clarke to change his mind as in last year’s plans to levy tax on share options for lower-paid workers.

The Budget was seen by many commentators as ‘dull’, but talk of tax changes provided the profession with a wealth of opportunity to demonstrate its talents.

Major doubt surrounds the Chancellor’s claims for revenue generated by changes to the capital allowance rules, while cuts in income tax could create an increase in Council Tax.

Battle lines will now be drawn over the attack on tax avoidance. Clarke listened to the concerns of the Revenue and Customs, agreeing to redeploy more than 2,000 staff to investigation work. But accountants will fight to protect their profession in the wake of attempts to blur the distinction between tax avoidance and evasion. Opportunities for trouble-making are rife, which all makes for a fascinating run-up to the General Election.

Commentaries by Accountancy Age staff

PRP

Tax experts are encouraging clients to set up successors to profit-related pay in the wake of the Chancellor’s decision to scrap tax relief on the popular scheme.

Son of PRP is likely to take the form of an approved profit-sharing share scheme (APSS). Price Waterhouse is already advising clients to introduce the scheme from next April to smooth the transition from PRP.

Under APSS, which was introduced in 1978, employees ‘sacrifice’ up to u8,000 or 10%, whichever is lower, of their salary which can then be reclaimed in shares at the end of the year. The shares can be cashed in tax free after three years.

PW’s reward consulting practice partner, Paul Wigham, said APSS had been less popular than PRP because of administrative hassles and the risk of fluctuating share prices. ‘A company introducing such a scheme in 1997 will see the first tax-free payment in 2000 when PRP tax-relief is totally phased out,’ he said.

‘But it’s actually the most tax efficient way of remunerating employees in the UK.’

The Chancellor’s plans to phase out PRP relief met inevitable resistance from industry.

John Lewis chairman Stuart Hampson has asked his 36,000 employees to write to their MPs. He said: ‘I am not about to march on the Treasury, but I am thinking about how to register my disappointment and whether the Government can be persuaded to change its mind.’

Chantrey Vellacott’s head of economics, Maurice Fitzpatrick, added: ‘Lobbying will be rather similar to that which followed the proposed abolition of tax-approved share option schemes in July 1995, from which the Government eventually backed down to allow options of up to u30,000 per employee to retain tax-approved status.’

Howard Evans, finance director of chemicals group Courtaulds, said: ‘Some of our operations have PRP schemes and they will have to look at their options. Salary sacrifice schemes will become an increasing trend, but there is plenty of time over the next few months to develop a consensus over the best alternative.’

Coopers & Lybrand’s head of PRP, Ian Nichol, said profit-sharing schemes are a natural successor as the only other tax-favoured method of rewarding people under existing legislation.

He said: ‘But there’s always been talk about the fact that PRP is, in essence, such a good idea that there must be something to take its place.

Something will be introduced over the next couple of years, but it won’t cost the Exchequer as much.’

KPMG tax partner Sarah Kling warned: ‘There are a lot of companies which will not be able to have APSS because of onerous requirements for the shares. There are several ideas going round to maintain the PRP ‘effect’ but the requirements of the legislation mean that superficially clever ideas, for example, involving loans, are unlikely to work.’

Capital allowances

Confusion surrounds the calculations underpinning the change in capital allowances rules announced last week, as tax experts and industry leaders are unable to make the Treasury’s numbers add up.

Analysts at the Inland Revenue and the Office for National Statistics suggest that up to a quarter of all UK plant and machinery investment will be affected by the reduction in writing down allowances from 25% to 6% for assets with useful lives of more than 25 years.

The move is expected to generate #325m in extra revenue 1998-99, and #675m the following year. The figures allow for the present level of ‘tax exhaustion’ and the fact that some capital expenditure is likely to shift from longer-lived assets to shorter-lived, to escape the new tax rule.

Although most commentators and tax experts have called the change a ‘backdoor utilities tax’, the effect on most utilities is not huge. Paul Marsh, deputy group finance director at regional electricity company (REC) Eastern Group, soon to be demerged from Hanson, said the impact at his u2.3bn-turnover company would be u5m-u10m a year. The other RECs would probably pay less, he said, adding: ‘The water companies have surplus ACT, so in cash terms all it means is that they will pay tax sooner rather than later.’

Marsh said of the Treasury’s forecast: ‘It’s hard to see how you can get #675m. You can maybe get halfway.’

British Airways chief financial officer Derek Stevens was unsure whether the measures would hit the world’s favourite airline, which depreciates aircraft over 16 to 20 years. ‘I don’t think it’s fully thought-through by the Government – which is par for the course,’ Stevens said.

Attention has turned to the oil industry, though a spokesman for the UK Offshore Operators Association said it was not yet clear whether or to what extent the tax change would affect its members. If it does, ‘it might be by accident rather than design’, the spokesman said.

But John Cullinane, a tax partner at Arthur Andersen, believes that the move is also designed to stop or prevent cross-border leasing deals. He also points to the recent privatisation of power stations in Victoria, Australia. ‘It’s strongly rumoured that the investment structure has enabled US and/or UK investors to get their capital allowances from the UK and the US,’ Cullinane said.

This would not be likely to raise extra tax, he added. Rather, ‘the Government is warding off a potential loss of revenue through aggressive cross-border tax planning’.

Local authority taxation

Local authorities will be forced to raise a greater proportion of their finances from local taxes over the next two to three years as the Government gets back to local tax levels last achieved by the Poll Tax, warns the Institute of Fiscal Studies.

Cuts in income tax paid to central government, said the IFS, will lead to a drop in the level of revenue grants paid from Treasury coffers from nearly 80% of local spending to 75%.

This will force council finance directors to scratch around for other sources of income. Many can look forward to either hiking council tax payments substantially above inflation until the end of the decade or dramatically cutting spending.

For London boroughs and other metropolitan authorities, any decision to raise council tax rates would meet with stiff resistance. Many already have large backlogs of unpaid tax and a further levy could simply add to the list of debtors.

The Government has proved successful in turning the spotlight on local authority spending. Last year it raised the capping level on London boroughs, but few took the opportunity to raise tax levels and push spending up against their cap.

With this in mind, the Chancellor could be gambling that the 6% and 8% rises in council tax that would be needed to offset central grant cuts will not materialise. Instead councils will be faced with postponing spending decisions and making deep cuts in spending, despite the hardship this will cause.

Public sector expert at the IFS John Hall said the Chancellor had not just looked for a quick fix to cut income tax by 1p when he shifted the tax burden onto local council tax payers in the Budget. He was continuing a trend that would run for several years. ‘The Treasury wants to get back to levels of local tax paid when the Poll Tax was introduced,’ he said.

‘It is still making up for the u140 it chopped off the Poll Tax before the 1992 General Election,’ he said.

CIPFA’s chief economist, Chris Trinder, agreed there was a trend to central Government switching tax raising to local government, but said it was less marked than the switch to expenditure taxes like VAT. He pointed to the Government’s aim to keep inflation below 2% as a bigger blow. ‘Average earnings look like they will grow by 4.5% next year, which means councils will either be forced to cut staff or keep down salary levels. I don’t see how they can keep comparable salaries for even senior staff.’

Hall added that the capping rules would be very tight in 1997/98, particularly for district councils. ‘There is a looser regime for counties, London boroughs and Metropolitan councils, which carry out more politically sensitive work, like education and community care.’

If district councils spend more than 0.5% over the government’s target under the standard spending assessment rules they will be capped, whereas larger authorities will have failed to reach their caps in the last two years. The largest slice of district council budgets is spent on housing, with the knock-on effect of hitting the already beleaguered construction industry again.

Peter Greenwood, chairman of the Association of District Councils, said: ‘The overall settlement is disastrous for local government, with provision for services increasing by less than the rate of inflation, grant support reducing in real terms and more to be raised from council tax payers.

The government claims to have increased provision for education and the police, but this is at the expense of cuts in other local authority programmes.’

Trinder believes public sector finance departments will accelerate the switch to cheap labour after the Budget.

An increase in the use of female accountants and unqualified staff will be used to cut staff costs. ‘About 30,000 finance jobs have been shed in the year up to June 1996 across the UK,’ he said. ‘But it is not just about job losses. Councils have also been bringing in women accountants and unqualifieds because they are cheaper. It is a trend across the board, in all industries, but local government has been particularly zealous.’

Keith Ford, chairman of the health financial management association, said he was pleased with the health service settlement. The commitment to provide #1.6bn extra funds would lead to a rise of u1bn in real terms.

But he pointed out that much of the money would make up for #400m in cuts last year and health trusts were still coping with an underlying deficit of about #200m.

Share bonuses

The Society of Share Scheme Practitioners claims the Chancellor’s move to block initiatives paying annual bonuses in shares, to avoid paying national insurance contributions and PAYE, will have an adverse impact on legitimate long-term remuneration strategies.

Under the new regime, all benefits worth over #30,000 received under non-approved share arrangements – L-tips or unapproved share options – will be subject to PAYE and NIC. Approved schemes remain unaffected.

SSSP president and Arthur Andersen partner Brian Friedman said: ‘Not only will the new regime catch every unapproved share option scheme and L-tip plan in the future, which itself will be a logistical nightmare, but because of a glitch in the regulations, many employees with existing L-tip awards will find themselves with windfall benefits, at the expense of their employers.’

KPMG tax partner David Tuch added: ‘The Chancellor ought to differentiate between the pre-meditated avoidance of NIC on City bonuses and genuine attempts by companies to encourage employees and executives to hold shares in the longer term, in a manner consistent with a stakeholder economy.’

Property tax

The Chancellor’s move to slam the door on a property tax loophole could cause chaos for landlords and lead to a two-tier property market, tax experts warn.

Pannell Kerr Forster’s principal VAT consultant, Tim Buss, said measures to clamp down on lease and lease-back ploys to avoid VAT will create havoc because landlords will lose control over whether they can charge VAT on rent. Charging will depend on the use the tenant makes of the property.

With effect from Budget day, landlords were barred from charging VAT on rent for new leases, unless the property is used at least 80% of the time for taxable business purposes. Previously landlords could elect to charge VAT on rent to tenants.

Deloitte & Touche VAT partner John Kennedy said: ‘Property developers will no longer be able to make the election with confidence knowing that their cost would not include VAT.’ Kennedy feared the measures could fuel a move towards a two-tier market, because landlords’ costs could be higher if they rent to non-business entities such as charities. He added that the lack of transitional rules to phase in the measures could have repercussions on existing leases, particularly where the developer has agreed rent terms but not granted the lease.

Redeployment of Revenue staff

A massive redeployment of Inland Revenue staff from self-assessment to tax investigation will not take place for at least 18 months. Senior officials clarified the department’s position after Chancellor Kenneth Clarke declared in his Budget that 1,000 employees will be relocated to collection and inquiry work once self-assessment is ‘complete’ as part of the ‘Spend to Save’ initiative. The ambitious u800m scheme is designed to uncover savings of #6.7bn.

A further 1,000 staff will be moved to investigations rather than given early retirement as part of Civil Service rationalisation.

Revenue official Tony O’Neill said: ‘We will need at least a year of self-assessment before we can take stock. We need to go through the first year of processing returns before we make a review.

‘We are looking at April 1998 at the earliest.’

But tax experts warned that the Revenue’s redeployment plans were fraught with danger.

KPMG tax investigations director Chris Glasson said: ‘It’s viable, but I don’t agree with their time-scale. Self-assessment is giving them quite a headache, so I imagine they will keep staff rather than redeploying them. They will be pouring people into self-assessment just to keep the show on the road.’

Price Waterhouse’s head of personal tax John Whiting added: ‘The aim of self-assessment is to have loads of people available to redeploy to other areas. But let’s not commit everyone before the system is up and running.

‘Besides, the people who are doing simple clerical and processing jobs at the moment might not be the people to let loose on tax investigations.’