Chancellor gives Scots little cheer

Published on Saturday 12 December 2009 13:31

WILL a public sector squeeze combined with higher taxes for small businessmen and further restrictions on the pensions industry announced by Chancellor Alistair Darling in the Pre-Budget Report have a disproportionately significant impact on Scottish individuals and the economy?

Scotland has more small businesses proportionately than the rest of the UK and while there was good news in the Pre-Budget Report for small companies where profits of up to 300,000 will be taxed at 21 per cent until March 2011, there was much less cheer for Scotland's self-employed businessmen.

From 6 April 2012, an extra 2 per cent in national insurance contributions could be due – 9 per cent on profits between 6,285 and 43,875 and a further 2 per cent above that, compared to the current charges of 8 per cent and 1 per cent respectively. While 2012 may seem a long time away, the profits subject to the new rates can be earned up to a year earlier because of the way the tax system translates profits for accounting periods into profits taxable in each tax year. Allowing for the new 50 per cent tax rate, 52 per cent of profits over 150,000 made by the self-employed will disappear into the tax coffers.

National insurance was also on the Chancellor's agenda. All employers, whether incorporated or not, are now looking at a 1 per cent increase in charge on their wage bill from 6 April 2012. So there is little doubt that small business will find itself squeezed in the months ahead, and there may be an impact on employment when the new rates come in.

As predicted, the spotlight was also on the financial sector – a key employer in Scotland. The most obvious hit was the bank payroll tax which the Chancellor hopes will limit banking bonuses over 25,000 by subjecting them to a 50 per cent tax take. Certainly a headline grabber, the full scope of the new rules and who they will apply to is not yet clear and only time will tell if this measure will have real impact. The ramifications could also be wider – large bonuses could well have been responsible in the past for fuelling the property bubble and the cost of property, but the converse is also true. Lack of bonuses may equally well prolong the property slump. According to some figures, house prices in Scotland have fallen by 6.3 per cent in the last year.

The less obvious tax impact on the financial sector – and other higher earners – were the changes made to the pension tax relief regime with immediate effect from 9 December. From that date anybody whose income exceeds 130,000, either in this tax year or in the last two years, may have a tax charge on the pension contributions they make. This is an extension of the special annual allowance charge (better known as the anti-forestalling charge) introduced in the spring budget from 22 April 2009.

In working out the income limit it is important to remember that it is broadly income as adjusted for tax purposes but before any deductions are made for pension contributions. That includes adding back any employee pension contributions made to a pension which are deducted from salary by the employer under a net pay arrangement.

If the income limit is not exceeded in any of the three years there is no special annual allowance charge. If the income limit is exceeded and non-regular pension contributions (including employer's contributions) are in excess of 20,000 the charge may apply. Regular monthly or quarterly contributions for example at an unchanged level since 22 April 2009 are likely to be unaffected but one-off payments in excess of 20,000 attract a charge. Exceptionally the limit of permitted pension contributions can be increased to 30,000 if there is a history of infrequent contributions averaging this level measured over the three tax years to 2008/09.

For 2009/10 the special annual charge is 20 per cent of the excess pension contributions but from 6 April 2010 it changes to 0 per cent for a basic rate taxpayer, 20 per cent for a 40 per cent taxpayer and 30 per cent for a 50 per cent taxpayer so that the effect is to restrict the overall tax relief on pension contributions to basic rate only.

The regime changes further on 6 April 2011 and the precise detail is under consultation. In the meantime only a few individuals affected will find it cost effective to make additional pension contributions. For the financial services sector this means that there is likely to be a significant drop in funds contributed to personal pension plans, further impacting this sector.

It is not just higher earners who need to worry about the new pension rules – Scotland's largest employer, the public sector, has also experienced a pincer-like effect. Public sector workers face a below inflation pay rise of 1 per cent for two years from 2011 – but like everybody else they are also facing an increase in their national insurance contributions of 1 per cent, so they will share the private sector worker's pain in reduced take home pay.

The Chancellor announced that those earning more than 100,000 in the public sector will pay more towards their pension value. Typically a public sector pension arrangement works by individuals accruing pension rights based on their salary and length of service. Usually the pension rights are also linked to inflation. The pensions are met on a pay-as-you-go basis and no contributions are made by the state employer to a pension scheme. The cost of these pensions to the public purse is huge and the Chancellor stated that "by 2012 contributions by the state to public service pensions for teachers, local government, NHS and the civil service will be capped – saving around 1bn a year".

What this means for top civil servants and public sector employees in Scotland is far from clear. Consultation is under way on how the new pension rules will apply to private sector defined benefit pensions so that the cost of providing them can be converted into figures to which the new restrictions on tax relief can be applied. The big issue is whether similar rules will apply to public sector pensions. The cost of providing pensions is increasing, regardless of which sector the individual works in. This is broadly because people are living longer. To avoid an increasing burden on taxpayers, the real options are: lower benefits; retiring later; higher personal savings; and higher individual pension contributions.

While overall the tax changes are less radical than many feared, it is clear that they are less than helpful to many individuals in the Scottish economy in particular.

&#149 Valerie Smart is a director of PricewaterhouseCoopers, Edinburgh