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Budget 2006 - What's changed


Vehicle Excise Duty (VED)

The Government's policy on environmental issues has meant a radical change in taxes relating to vehicles, including a new Vehicle Excise Duty (VED) rate of £210 for new "most polluting" vehicles with high levels of car emissions.

Vehicle Excise Duty was revised in 2001 and is now categorised on a graduated carbon emission bands system. Vehicle efficiency labels were also introduced into car showrooms, with those labelled A to F echoing the VED structure.

The graduated VED for vehicles registered after March 2001is held unchanged for vehicles in bands D and E at £125 and £150 respectively. Vehicles with low emissions in band A will pay no VED (a cut of £65) while vehicles in band B and band C also benefit from cuts in VED of £35 and £5 respectively. Vehicles with high emissions in band F will pay £25 a year more.

A new higher emission band G (for vehicles registered after 23 March 2006) has VED set at £210 a year for petrol driven motors and £215 a year for diesel cars.

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Champagne and Whisky no sins

The so-called 'sin taxes' went up - with notable exceptions. For the fourth year running the Scottish Chancellor froze the duties on whisky and other spirits. In the confident hope of a decent run in the World Cup, or has he put "in anticipation of World Cup success this summer", the Chancellor also froze the duty on champagne, domestic sparkling wine and cider.

However, there was the customary penny on a pint of beer and 4p on a bottle of wine. The inflation-based increase on tobacco puts 9p on a packet of cigarettes and 3p on a pack of five cigars.

Fuel duty increases have been deferred for the second year running to 1 September.

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Child Trust Funds

The Chancellor confirmed there will be further payments into Child Trust Fund accounts at age seven of £250 for all children, with children from lower-income families receiving £500. These payments match the initial payments made to all children born after 1 September 2002. The first of these further payments will be made, therefore, in 2009.

The Government continues to consult on whether further payments should be made into Child Trust Fund accounts at secondary school age. Daniel Godfrey, Director General of the AITC commented, "The Chancellor has gone a long way for the poorest children today, who with this additional top up will now have £1000 invested on their behalf. We would encourage the Government to make a third payment at age 11 and to step up the education programme for parents and children which would help boost financial awareness as well as financial returns."

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Stamp Duty Land Tax

The threshold at which stamp duty becomes payable on most private property rose by £5,000 to £125,000. The Council of Mortgage Lenders noted that, although around 29,000 households would have escaped stamp duty last year if the starting threshold had been the new figure of £125,000 instead of £120,000, a total of around 56,000 households became liable for stamp duty last year purely as a result of house price rises bringing their properties into the starting band. If the starting threshold had been uprated in line with house price inflation since Labour came into power in 1997, the CML believes it would now be over £145,000.

In fact even the government's own numbers, the latest data from the ODPM shows that the average price of properties bought by first time buyers was £135,742.

The Association of Chartered Certified Accountants (ACCA) says that the Chancellor's modest increase in the stamp duty threshold does nothing to change the fundamentally illogical system whereby a £249,000 house purchase deal is subject to 1% tax, while a £250,000 purchase incurs a 3% charge on the whole price. As with Income Tax, ACCA believes the higher rate should only apply on the percentage of the purchase price above the threshold.

Chas Roy-Chowdhury, ACCA's Head of Tax, said, "The vast majority of home buyers find stamp duty an added financial burden when they're purchasing a property. It adds another level of stress onto the often complex buying process. And with rising property prices, more people than ever are paying stamp duty with recent research from the Halifax revealing the average London stamp duty sum is around £7,000."

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Inheritance Tax

Legislation in the 2006 Finance Bill will confirm that Alternative Secured Pensions will be subject to Inheritance Tax where people are deemed to have used the contracts to pass on tax privileged funds rather than draw pension benefits.

The Chancellor decided not to impose any Inheritance Tax (IHT) liability where someone in income drawdown dies before age 75. However, he has introduced a new 40% tax charge where someone in income drawdown dies after age 75. The proposed procedure is extremely complicated - so much for so-called pension simplification.

The government's justification for this harsh treatment stems from their grudging agreement to remove the requirement to buy an annuity at age 75, which was 'specifically designed for those who have a principled religious objection to annuitisation'.

The Treasury and HM Revenue & Customs clearly still have a problem with the fact that many people have non-religious grounds for not buying an annuity. The Chancellor has come up with an unnecessarily complicated mechanism for penalising the dependants of anyone in drawdown who is fortunate enough to survive beyond their 75th birthday. This leaves a bitter taste, particularly since the straightforward solution would be to treat those who are older than 75 in exactly the same way as those less than 75, i.e. to allow the balance of the fund to be paid out less a 35% tax charge.

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Real Estate Investment Trusts (REITs)

The Budget addressed several of the financial sector's concerns about the proposed REITs regime. The immediate result, as the city digested the news, was to see the shares of a number of companies in the property sector move higher in knee-jerk reaction to the prospect of significant investment demand for the new vehicles.

The key changes, buried in the stack of Press Notices accompanying the Budget were:

  • the required distribution rate of net profits to investors will now be lower at 90% (from 95%);
  • the interest cover test will be 1.25x on a pre-capital allowances basis (from 2.5x, and lower than the expected 2.0x);
  • the conversion charge (fee payable by the company to become a REIT) will be 2% of the gross market value of investment properties.

Launches will be possible from 1 January 2007. No comment was made in the press notice on the exclusion of companies with significant shareholders (more than 10%) as being REIT-able. Also, no comment was made on the treatment of foreign properties. Hammerson and Slough Estates have a large foreign exposure but may be able to convert their overseas property holdings into separate REIT-like vehicles in the US and Europe, according to local tax regulations.

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Venture Capital Trusts

After two record years for investment in Venture Capital Trusts (as a result of the doubling in 2004 of the tax relief on offer), the VCT party may now be over. The rate of income tax relief on investments in Venture Capital Trusts is cut back to 30% after two years at 40%. This is still above the original 20% rate. The new rate of income tax relief is introduced as part of a package of changes to VCTs, the Enterprise Investment Scheme (EIS) and the Corporate Venturing Scheme. These changes will, so the Treasury claims, renew the schemes' focus on providing incentives for long-term investments in small companies facing the most severe barriers to accessing equity finance.

Further changes include a refocusing of the 'gross assets test' to £7 million immediately before investment and £8 million afterwards, to focus on the companies most in need of improved access to finance. This effectively cuts the size of companies that VCTs may invest in by half. The existing rule is that VCTs can only invest in companies with gross assets of no more than £15 million at the point of investment and £16 million thereafter. The change will push investment to the smaller end of the scale.

The minimum holding period for new shares in VCTs is extended from three to five years to incentivise more stable, longer term investments.

The new VCT regime comes into force on 6 April 2006. There is likely to be a last-minute rush to take advantage of the tax breaks at 40% as the 2005/06 tax year comes to an end.

The annual Enterprise Investment Scheme investment limit eligible for income tax relief is doubled to £400,000 although the level of tax relief remains at 20%. Investors in EIS' may also treat an additional £50,000 of shares as if they had been issued in the previous year and claim relief accordingly.

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What the Chancellor didn't say

It was a speech full of the usual Brown hallmarks. The Chancellor is a man who does not so much deliver a speech as attack it. But there were certain things he didn't say, which perhaps he should have. Gordon Brown confirmed that the personal allowances to be invested in an ISA will remain at £7,000 for a maxi-ISA and £3,000 for a mini-ISA until April 2010. However, freezing these limits until 2010 is a disincentive. Any Chancellor serious about encouraging saving really ought to be giving people more scope to save.

The small increase in inheritance tax for this year and already set out for the next four years will actually pull thousands more people into paying inheritance tax, since house price inflation is running at a much higher level than the overall inflation rate. The IHT allowance simply is not keeping pace. Inheritance Tax remains the one tax that the Chancellor has not tinkered with in his decade of running the economic ship of state.

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Gilts issuance - why the long face?

On the face of it, the Chancellor's statement that up to two-thirds of nominal and index-linked gilts will be issued at long maturities is good news for pension funds and those looking to purchase annuities.

The proportion of the fixed gilt market represented by long-dated gilts (i.e. over 15 year) will actually shrink over 2006. The £17bn 2021 gilt will fall out of the 'Over 15 year index' - the main gilt benchmark used by the majority of pension funds - in June 2006. As a result, the pre-allocated issuance of £17bn long-dated gilts over 2006 will simply serve as a replacement, not increase the amount of long-dated gilts in issuance.

Gordon Brown claimed that increasing the proportion of long-dated gilts would help meet UK pension fund demand and would improve the current pricing situation affecting gilt markets. However, the detailed budget statement provides little certainty of any real progress to improve the position for UK pension funds. In fact, the total level of gilt sales was a little bit lower than the market had expected.

Nevertheless, pension funds are not forced to buy long bonds, but choose to do so to reduce accounting risk. The possibility that long yields may fall sharply pushing liabilities higher could cause an element of panic demand, encouraging schemes to buy long gilts at any price to mitigate this risk. This appears to have been one factor in the collapse in gilt yields early in 2006.

However the fact that there are now going to be two long maturity fixed coupon auctions and one long maturity index linked auction every three months mean that it is unlikely that we will see a repeat of gilt yields squeezed downwards in the way they were in January 2006. In plain English, there's a reasonable chance that currently miserable annuity rates may recover slightly.

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Trusts get the tax treatment

New created, (or additions to existing trusts) on or after 22 March 2006 will no longer be treated as potentially exempt transfers for inheritance tax purposes unless they are set up for a disabled person.

Proposals in the Budget mean that gifts into most trusts created on or after 22 March 2006 will now be treated as chargeable transfers. This means that a lifetime charge at 20% may arise if the donor's cumulative total of chargeable transfers in the last 7 years is greater than the nil rate band - currently £275,000 rising to £285,000 on April 6 2006. In addition, a periodic 6% charge may also occur every 10 years as well as a charge if assets are paid out of the trust.

In other words, most trusts will now be treated as though they are fully discretionary trusts. Existing trusts may also be affected by these new proposals in certain circumstances. The main trust related definitions and tests for tax on income and chargeable gains are to be brought into line with each other.

Stephen Herring, Tax Partner, BDO Stoy Hayward, commented, "These changes may have a more profound impact on the use of trusts in succession planning. Surprisingly they have been introduced without any consultation with professional advisers as to their effects. For example, lifetime gifts (in excess of the donor's nil rate band) into accumulation and maintenance trusts ("A&M") for children will suffer an immediate 20% IHT charge on the value of the gift."

Anne Young, Senior Technical Manager of Scottish Widows, said, "We are disappointed that the Chancellor proposes to introduce legislation which makes it more difficult and complex for people to mitigate their IHT liability. While many people may not be affected by these proposals it does make the use of trusts in general more difficult. It is even more important than ever to take professional advice before taking any action."

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Seeding Relief stopped

Stamp Duty Seeding Relief (SDSR) was ended in the Budget. In 2003 Stamp duty land tax legislation was introduced stating that land purchaser must pay 4% stamp duty. However, an exemption - SDSR - was available for investors selling or transferring commercial property into a unit trust.

Unfortunately in HM Revenue & Customs eyes it would appear that this exemption has been abused, with investors selling properties to off-shore vehicles, therein saving themselves the trouble of paying stamp duty forevermore. The Treasury reckons it has lost out on around £500m in tax.

Karen Wagg of Royal London Asset Management said, "Unfortunately this will put a stop to plans for new property schemes, or at least for those asset managers with plans to launch such a vehicle at some point this year or next. The Stamp Duty Seeding Relief enabled such schemes to get off the ground, by making it feasible for assets to be transferred from another portfolio without the pain of losing 4% of value to the tax man.

"This portfolio seeding offered asset managers a ready made portfolio, money in the portfolio and a track record, all quite vital for property funds. Without this assistance it will be difficult for Managers to offer property unit trusts to investors. Yes, REITS have been given the green light by Gordy in the same budget, but the asset management community is still concerned that the REIT legislation is more emmental than cheddar, with too many legislative holes for investor comfort."

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EIS schemes get "riskier"

EIS schemes attract money from personal investors into small companies. Up to now there has been an income tax break of 20% of the amount invested for sums up to £200,000 per year. Gordon Brown announced the annual limit will be increased to £400,000 from 6 April 2006.

For wealthy investors looking for speculative opportunities this could be interesting - but it's probably a very small number of people affected. For investors with large capital gains, the CGT deferral has not been changed. Such people could always shelter an unlimited amount and the new rules now give them double the income tax relief - provided they still have income tax liabilities against which to set the relief. The carry back of up to £25,000 to the previous tax year's income for investments made in the first six months of a tax year is also doubled to £50,000.

However, EIS capital raising will be hit by the reduction in the size of companies that are eligible. Up to now a 'gross assets test' of £15 million has applied. But EIS shares for which an investor subscribes after today, 22 March 2006, the limit is halved to only £7 million before the investment or £8 million afterwards. This is the same restriction that applies to VCT shares issued after 6 April.

David Knight, Research Director at BDO Stoy Hayward Investment Management Limited said, "These changes make EIS investment much riskier - recent EIS successes have included Gerry Anderson's Captain Scarlet TV series and The Capital Pub Company 1 and 2 EISs. These EISs resulted in substantial businesses that look to be successful. The Treasury no doubt applauds their enterprise, but considers that these big deals divert funds from even more deserving entrepreneurs. We think this will simply reduce the overall money flowing into EIS - a regrettable move.

"There does not appear to be a reduction in the minimum holding period for EIS shareholders to retain their income tax benefit - this is still three years even though the equivalent for VCTs has been extended to five years. Leaving this alone is important as many EIS investments should mature by three years and locking investors' capital up in risky business for longer than three years would have been a real blow."

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Self assessment deadline to be shortened

From 2008, self-assessment taxpayers could be required to file their returns as much as four months sooner than the current deadline of 31 January.

HM Revenue & Customs has accepted the recommendations of a review by Lord Carter of Coles that taxpayers should file their paper returns by 30 September each year, or online returns by 30 November. However, there are (so far) no plans to bring forward the payment deadline from 31 January, although there will be a consultation on how to implement the changes from 2008.

A Revenue spokesman said, "We are not looking to align the payment dates. Lord Carter did recommend that we should set up an online payment facility. So, people could file their online return, then stay online and use the payment facility. But the money would not be taken until January 31. It means they don't have to worry about having to send a cheque."

However, the temptation for the taxman to align filing and payment dates is clear - a move that could result in a big bill for taxpayers in any transitional year.

Employers and financial institutions that supply data for self-assessment returns will also come under extra pressure to get the data out sooner to help taxpayers meet the new deadlines. Now, P11D forms do not have to be supplied until the end of July but this would leave taxpayers just a few months to gather all of the necessary documentation to support their self-assessment tax return, which may be over-optimistic.

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Computer scheme crashes

The Chancellor scrapped the tax breaks for businesses that loan PCs to employees. From the start of the new tax year (6 April 2006) businesses that loan PCs to their staff for personal use at home will face a tax charge of up to £200 per employee as well as national insurance.

The change effectively kills the Home Computing Initiative (HCI) which had allowed companies to offer PCs on loan to staff as a tax-free benefit, with the fee deducted from their salary each month. However, existing HCI schemes started before 6 April 2006 will not be subject to the new tax rules and will still be able to claim it as a tax break.

It appears that HCI has become a victim of its own success. Around 500,000 people have bought laptops and PCs tax-free through their employers. Take-up has risen from 380 companies in 2004 to 1,250 in 2005, with the Treasury missing out on around £300m in tax over the next three years.

No mention of the scheme's closure was made in the Chancellor's speech, but like many unpalatable measures in the past it was revealed in the accompanying press notices.

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