Coalition Budget Review

Date: 25 June 2010

Introduction

The Emergency Budget of the coalition government is one of the most important budgets for many years. It has made radical changes to the tax system and significantly cut benefits.

The coalition has also promised to review the taxation of small business, including IR35, and to reform the way tax policy is made. Some of the measures announced as recently as this March have been ditched, while others are on the way out. Spending has been cut back hard, with serious implications for contractors, at least in the short term.

This report provides a summary of the Budget and draws out some conclusions for our clients.

Corporation tax rate

The small business rate of corporation tax will go down by 1% from April next year, from 21% to 20%. This will be a significant benefit to you if you have a limited company and pay yourself a small salary with the balance in dividends.

This is in line with the advice we give to our clients – i.e. to take a minimal salary and pay yourself in dividends.

IR35

IR35 is a significant issue for many contractors. While it remains in effect there is some good news on the horizon, as we reported recently; the coalition has recently stated,

"We will review IR35, as part of a wholesale review of all small business taxation, and seek to replace it with simpler measures that prevent tax avoidance but do not place undue administrative burdens or uncertainty on the self-employed, or restrict labour market flexibility."

So, that’s good news but contractors should still endeavor to treat IR35 with caution while it remains in effect.

Income tax

An increase of £1,000 in the personal allowance will come into force from next year. This sounds good but will make little difference for most clients.

This is because the personal allowance will interact with other parts of the tax system so higher rate taxpayers won’t see a tax reduction despite the increased allowance.

Furthermore, the point at which higher rate tax becomes payable will be frozen for at least some of this parliament. So even if you’re not a higher rate taxpayer now, the failure to take proper account of inflation means you are more likely to become one.

National Insurance Contributions (NICs)

The recent budget has not changes NI contributions, leaving the previous government’s 1% increase in place. Although, there have been some minor adjustments to employer contributions.

Employee contributions will rise by 1%. You will pay 12% on earnings up to the higher rate threshold and 2% on earnings above that.

The level of the higher rate threshold is expected to be set later in the year. For 2010/11, the threshold is £43,875 a year, or £844 a week.

Employer NICs

These will also increase by 1%, to 13.8%. However, there are two new reliefs:

• the threshold at which employer NICs is payable will be increased by £21 a week above indexation; and
• new businesses in areas other than London and SE England will not have to pay the first £5,000 of NICs for each of their first 10 employees. This relief, called ‘Regional Employer NICs Holiday for New Businesses’, is expected to begin in September this year, and continue for three years.

If you run a limited company and pay yourself a salary higher then the personal allowance, you will be affected by the increased NIC costs.

Capital Gains Tax (CGT)

The rate

CGT will be increased to 28% for disposals by higher rate taxpayers which take place on or after 23rd June 2010. This is a 10% increase over the current rate of 18%. Basic rate taxpayers still pay 18%.

Inflation

CGT has been set at a lower rate than income tax:

• for basic rate taxpayers, the income tax rate is 20%, so the CGT rate is 2% less;
• higher rate taxpayers pay either 40% or 50%, so the 28% CGT rate is a considerable reduction.

It’s been claimed that one of the reasons for the lower rate is to provide a rough and ready compensation for inflation. Though this doesn’t distinguish between short and long-term gains.

Entrepreneur’s relief

Currently, a gain of up to £2m on the sale of your business is taxed at only 10%. From 2011 entrepreneur’s relief will be raised to £5m. The increased threshold will benefit freelancers with larger businesses.

The relief is a lifetime limit; it doesn’t apply to each disposal. So if you have already made a gain of £500,000 and received entrepreneur’s relief, your lifetime limit reduces to £4.5m.

You need to be careful with Entrepreneurs Relief. Please talk to us before counting on this as there are hidden dangers (e.g. selling parts of the business).

Other reliefs and allowances

Don’t forget that CGT doesn’t apply at all if your gains are £10,100 or less each year.

VAT

VAT will go up to 20% from 4 January 2011.

How does this affect invoices?

If you invoice after 4 January for services you supplied before the change in rate, you can choose to invoice at 17.5%. If you do, there is no need to tell HMRC.

If the period of your invoice includes the 4th January, you can choose to split it, so that the part before 4 January is at 17.5% and the balance is at 20%

What about the flat rate scheme?

If you use the flat rate scheme, the percentage that applies to you will also change from 4 January 2011. HMRC say that the new figures should give the same outcomes for businesses.

For computer and IT consultancy, the new percentage is 14.5%, up from 13%; the percentages are the same for structural and civil engineers and providers of labour-only building services. Management consultancy is now 14%, previously 12.5%.

Capital allowances

The capital allowances regime has changed frequently and this Budget introduced additional changes. 

For this year and next, assets qualifying for capital allowances (other than cars) can be deducted from profits as long as their total cost is not more than £50,000. In 2012, this will drop to £25,000.

If you are planning major capital investments, please get our advice on the timing of purchases. We’d obviously want to get this right so we can maximise your tax reliefs. For example, it may make sense to spend the money a little earlier, and benefit from the higher allowance.

Pensions

The last government introduced a restriction on tax relief for pensions for individuals with taxable income of £150,000 a year or more. This has proved to be very complicated to implement, as contributions by employers to final salary schemes have to be valued, which is both expensive and difficult.

This government announced that while it ‘will continue with plans it inherited to raise revenues from restricting pensions tax relief’, it plans to change the method. Instead of complex valuations, it is considering introducing a significantly reduced annual allowance.

In the current tax year, you can put the lower of your earnings and £255,000 into your pension, as long as the total pension pot does not exceed the lifetime allowance of £1.8m.

The new proposal is that the maximum annual contribution will shrink back from a maximum of £255,000 per annum to somewhere between £30,000 and £45,000.

If you have your own company, it can make contributions to your pension scheme. These contributions are free of NICs as well as income tax, as long as your total income is below the £150,000 threshold discussed above.

Since the government may reduce these limits in the future this may be a good time to put a lump sum into your pension; that would be the most tax-efficient way of optimizing your pension.

Given the planned reduction in limits, this may be your last chance to put a significant sum of money into your pension.  Please seek expert advice when considering tax and pensions. However, we believe that effective planning can get you significant savings.

Spending cuts

While not strictly part of the budget we do want to make a few comments on spending cuts as they present significant implications for contractors.

The coalitions government has indicated that the deficit will be addressed through spending cuts and increased taxation – in a ratio of 0.75 to 0.25 (former to latter).

The Public Sector is expected to bear the brunt of this and suffer cuts of around £113bn over the life of the parliament.  This obviously presents a danger for contractors working in the Public Sector.

However, contractors should draw some comfort from knowing that in many cases government departments may be more likely to engage interim vs. permanent staff due to pension and employment law provisions.

Furnished holiday lets

Freelancers who have properties let out as holiday homes were hit hard by the last government’s withdrawal of key tax reliefs. The coalition promised to reverse this but this may take some time.

The new legislation, which has not yet been published, will increase the number of days properties have to be available for commercial letting, and the number of days they are actually let. Currently properties qualify for the reliefs if they are available for letting for 140 days and actually let for at least 70.

The good news is that the reliefs now extend to properties in the rest of the European Union, so if you let a holiday home in countries such as France, Spain or Greece, and these meet the qualifying conditions, you should qualify for these generous tax reliefs.

Conclusion

So, we have seen significant developments coming from this recent Emergency Budget. Key developments include:

• Reduction in Corporation Tax from 21% to 20%
• Likely demise of IR35
• 1% increase to Employee & Employer Contributions
• Capital Gains Tax to increase to 28% for disposals by higher rate tax payers
• Entrepreneurs Relief raised to £5million
• VAT to increase to 20%
• The value of assets qualifying for capital allowances to drop from £50,000 to £25,000.
• Proposed reduction in limits for pension contributions to between £30,000 to £45,000.

This Budget highlights the need to do proper tax planning and be proactive in doing so.

At My Accountant Friend we work closely with our clients to ensure they are operating most tax-efficiently and are up-to-date with any and all regulatory and other tax changes.