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A question of Tax?

A question of Tax?

Sometimes trying to predict what happens in the Budget feels like being a contestant in a gameshow that combines elements of skill with a healthy dose of chance.

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This year it feels particularly difficult; international disrupters indicate one approach but domestic needs and a society tired of austerity indicate another. Will the Chancellor play it safe with a quiet budget thin on rewards? Or, will he make bold gestures with bigger risk but higher returns? 

We both decided to channel our inner Sue Barker and play ‘A Question of Tax’.

The (big) picture round

It goes without saying that the UK is going through a period of unprecedented uncertainty with Brexit and this will dominate the Autumn Budget, overshadowing any economic forecasts but also potentially limiting the chancellor’s scope to do anything radical.  

One of the challenges for the chancellor is to decouple the effects of Brexit uncertainty from more systemic issues within the economy. They will both exist but they may need different responses and one will cloud the other. In one sense, the heightened urgency that now underpins the Brexit negotiations does at least mean we are getting to the point when we may have some clarity – it may not be the clarity we wanted but it will be clarity nonetheless. And with a bit of luck it may mean businesses can stop playing guessing games and get down to proper business planning.

The observation round

Outside of the Brexit bubble, a quick look at recent media headlines will tell you what is bothering individuals and business.

The NHS is under increasing pressure and the government has already made a promise to increase spending on the NHS by 3.4% per year for the next five years – an additional £16 billion in real terms, according to the IFS.  But this will put a strain on the public finances and will need to be funded somehow.

There is also concern over the languishing High Street. The reality is that consumer behaviour is changing and the High Street may be losing its retail allure.  But fingers point to factors that aggravate the situation; business rates increase the tax burden for bricks and mortar businesses whilst on-line competitors (particularly US tech giants) are perceived by some to benefit from a tax perspective.

These are separate but related issues. The issue of on-line retailers is often badged as one of tax avoidance but in fact it is more complex. Increasingly digitalised business models mean that value can be created in locations where a business has little physical presence. Currently no mechanism exists to tax that value. This problem is not UK-specific and there is widespread acknowledgement that governments need to work out how to tax new business operating models as the world moves towards a digital future. In the meantime it is increasingly tempting for jurisdictions to implement a unilateral tax to ensure they get their slice of the cake.  

The UK is no different and, whilst acknowledging the optimum solution lies in international consensus, the Chancellor has been increasingly bullish about being prepared to go it alone on taxing the digital economy.

And then there is housing and the increasing inability for younger generations to get on the property ladder.  There is no silver tax bullet that can solve the housing conundrum but it is a policy lever. One option that has been floated in recent weeks is providing relief from capital gains tax for landlords who sell to long-term tenants (the intention being that the tax saving is shared and not pocketed by one side or the other). All in all, however, it feels like running with the ball rather than shooting for the goal.

Fuel duty may not get adrenalin pumping but it has been frozen for what feels like the umpteenth time. Whilst this is good news for those at the pump it does have a large impact on the public finances. Fuel duties raise 4% of tax revenues and the stated policy is that they should increase in line with inflation each year. Instead they have been stuck at 2011 levels leading to an increasing funding gap. 

The captain’s challenge

There is a clear tension between the Prime Ministers promise of an end to austerity and the growing pressure on public spending. In addition, there is an increased threat of political challenge with many media outlets reporting that some members will vote down the budget in a political show of strength. It is, of course, all linked to Brexit (what isn’t at the moment?) but nonetheless it leaves the Chancellor with a difficult path to navigate on the 29th.

What happens next?

It seems difficult to imagine that we will get through the Autumn Budget without some tax rises, not least to fund the increased NHS spending. But how will the Chancellor pluck this particular goose whilst minimising the hissing?

One option is to row back on existing tax cut pledges on the basis that people will not miss what they never had. The most likely targets in that scenario would be the planned increases in the personal income tax allowance to £12,500 and the increase in the higher rate threshold to £50,000.

A second option is to further limit pensions tax relief which the Chancellor recently described as ‘eye-watering’ and primarily benefits higher rate taxpayers. Nobody is expecting fundamental reform of the pensions regime (although many experts believe this is needed) and so any change is more likely to be focussed around limiting the annual allowance of what can be paid into a pension pot with tax relief (currently at £40,000 but reducing for those that earn over £150,000) and the overall lifetime savings limit (currently just over £1m). This is a difficult balance though. With an increasingly aging population and longer life expectancy the government needs to encourage people to save for retirement in order to limit the burden on the State.  But human nature is such that most people do not think ahead and a reduction in pension tax relief will inevitably reduce pension saving.  Any haircuts to the relief may increase the Exchequer’s bank balance in the short term but longer term could prove to be a damaging own goal.

The issue of how work is taxed in light of new ways of working continues to feel like an area the Government has not yet gripped. Tax experts agree that disparity of tax treatment between the employed and the self-employed is unsustainable and drives behaviour that distorts the market. But until this is addressed in a strategic and holistic way, particularly with an eye to the issues raised by increasing automation and the gig economy, short term measures are likely to continue in an attempt to plug the gaps.  

In the immediate future the focus is on those that provide their labour through Personal Service Companies (PSCs). The issue of individuals who supply services through such companies has been around for many years.  It is key because the tax take from receipt of income by a PSC is very different from that where someone is taken on as an employee, the main distortion being employer’s national insurance.

IR 35 was introduced to help solve this issue back in 2000 by requiring those that provide their work through PSCs (or other intermediaries) to assess whether – but for the presence of that intermediary – they would be an employee, and pay additional taxes and NIC where necessary.  

HMRC are concerned that compliance with IR35 has been patchy and so last year the government reformed the operation of IR35 in the public sector by shifting the responsibility for compliance to the public body that engages the contractor. In essence, if a working arrangement would, absent the PSC, give rise to an employment relationship the body paying the fees had to treat it as such, operating PAYE and, critically, paying employer’s national insurance on the amounts paid to the contractor.   

The government has trailed its intention to extend this IR35 reform to the private sector and the timing of the change is expected to be announced at the Budget. It may be as early as April 2019 although affected businesses are concerned that it will be a far from easy transition. But bearing in mind any reform is estimated to raise approximately £1.2bn in tax and NI by 2022/23 the Chancellor may be keen to fire the starting gun.  

Home or away?

In the midst of Brexit uncertainty there will be pressure on the Chancellor to maintain the UK’s competitiveness on the international landscape. This makes raising taxes in a purely domestic way a much safer bet than risking raising taxes using measures that will impact on international businesses, even though this could be a lucrative source of revenue in the short-term.

The general consensus seems to be that he would be well-advised to keep his powder dry until the terms under which we leave the EU are clearer. Any deal that is ultimately struck is likely to involve close adherence to the EU’s rule book, limiting Hammond’s flexibility on tax. A ‘no-deal’ scenario would give him the freedom to pursue a more independent agenda which could provide an antidote to the disruption many expect a no-deal to produce. A wait and see approach would also give breathing space to a business community that dislikes disruption and craves certainty and stability.  

The fly in the ointment to this low key approach is the tax issues posed by digital business. The EU have proposed an interim Digital Services Tax which would impose a tax on revenues from certain digital services provided in the EU for larger businesses. Views are split on whether an interim tax, particularly one which targets revenues, is the correct answer. A tax on revenues moves away from traditional methods of levying tax based on profits. Its impact will be felt more keenly by businesses with inherently lower margins and, with no clear way of such a revenue tax being creditable within the current international taxing models, there is a very real risk of double taxation. But these downsides have to be weighed against the increasing risk of unilateral action which could result in an impossibly chaotic international approach to taxing digital models.  

Any tax on digital sales will be well-received by the public but they need to be careful what they wish for. There is a genuine concern that a tax so closely linked to revenue will be passed on to the consumer.

If the Chancellor were to impose some kind of digital tax the timing would be a little strange. The EU seems to be making progress with an expectation of agreement by the end of the year (although this may be overly optimistic).  Having said that a consensus approach is the ideal solution, it would be strange for Hammond to impose a unilateral tax now especially with the EU claiming imminent success. But the Chancellor made strong comments about ‘time running out’ at the Conservative Party Conference meaning that this cannot be completely discounted even though we think it is unlikely.

It should also not be forgotten that currently the Government are still committed to reducing the headline corporation tax rate to 17%. Recently the Prime Minister again flagged her commitment for the UK to have the lowest tax rate in the G20 but this could fall by the wayside. In reality a drop from 19% to 17% is unlikely in isolation to affect investment decisions. The attractiveness of a jurisdiction from a tax perspective is not purely a rate question. The tax base, the complexity of the tax code and the administration also play into the equation. And ultimately investment decisions are rarely made purely for tax reasons. It is a factor for sure, but broader economic, political and regulatory stability play a larger part. 

The mystery guest

We should take a moment to think about the balls that may come out of left field on the day. It wouldn’t be the first time there is a surprise on Budget day. If that is to happen, business will be hoping that it will be a measure that gives UK competitiveness and productivity a boost. 

Investment has been slowing and this may be down to Brexit nerves, but there will be pressure on the Chancellor to keep the UK competitive and attractive to foreign investment whatever the Brexit outcome.

Increased incentives for R&D and innovation would be well-received and are generally considered to deliver positive value for money in terms of government spending. A measure such as this would also dovetail nicely with the Government’s ongoing strategy to make the UK a knowledge economy.  

He could also reward infrastructure with a free kick. This sector has been hit hard with measures like the restriction on interest deductions and reduced tax allowances.

Sprint finish

In many ways this will be an unusual budget; it is in October and it is on a Monday.  With a late speech anticipated (the current rumours are that the chancellor may not start until 3.30pm) and publication of the red book not expected till even later, Budget commentators will be wondering when they can issue their statements. If there are unexpected measures then our team are expecting a sprint finish to get insights issued before the final whistle.

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