Darling's high-wire act

Published on Saturday 5 December 2009 13:13

WHEN Alistair Darling stands up on Wednesday to deliver what is likely to be his ultimate Pre-Budget Report (PBR), "tax" will be the much-dreaded buzzword.

The Chancellor is being forced to deliver his statement during the worst recession since the Second World War. Against that backdrop, he has no option but to walk a treacherous tightrope between raising revenues to repair public finances and the need to maintain the UK's position as a desirable place to do business.

He is in the unenviable position of facing the most difficult set of economic circumstances for any Chancellor since the 1940s. Projected fiscal deficits for 2009/10 and 2010/11 are expected to be revised upwards from 175 billion to well in excess of 200 billion, largely down to the massive bail-out operation the government has embarked on to save the banks.

Darling has to ensure that the UK remains competitive in global markets, protect any fragile economic recovery and boost public confidence by showing that the government is capable of paying off the public debt without over-burdening businesses and consumers.

With a general election looming before June, this will be one of the final chances the beleaguered Labour government has to show that it can balance the books. It is, therefore, not surprising that experts are warning that increases in a number of taxes could be set out by Darling this week. However, an immediate increase in taxes would slow recovery from recession, so accountants expect changes to be deferred until after the general election.

David Glen, tax partner at PricewaterhouseCoopers (PWC), says: "The timing is tricky with taxation. Alistair Darling can't launch into tax-raising right now as there's a danger of setting back recovery. But whoever comes in at the next election is going to face the same problem."

The 2009 budget announced significant tax increases for the future, many of which take effect next year. These include the new 50 per cent income tax rate for higher earners and the removal of personal allowances for those with incomes above 100,000.

Commentators say that what businesses need more than anything is certainty on what fiscal burdens they will be facing over the next few years. They need that certainty to have the confidence to invest in the future and help kick-start economic growth. So, what will Darling deliver for consumers and firms when he steps up to the dispatch box at 12.30pm? And Scotland on Sunday tells you whether his announcements are likely to receive a "thumbs up", "thumbs down" or reaction of indifference from businesses.

VAT

UNLESS Darling announces otherwise, VAT will return to 17.5 per cent in January following a temporary reduction to 15 per cent announced in last year's PBR. This cut was designed to ease the burden on cash-strapped consumers at the height of the recession.

Ernst & Young (E&Y) says the increase could be postponed for a further three months, given the need for continued economic stimulus.

However, many experts expect Darling to unveil a double-whammy for businesses and consumers by announcing a further increase to 20 per cent – or even more – from July next year or January 2011.

Graeme Crawford, tax partner at E&Y, says: "From a retail perspective, all eyes will be on the VAT changes because consumer spending is still quite soft and there is still a lot of uncertainty to cope with, including unemployment. Consumers are being canny."

And David Glen of PWC refers to the "infamous" leaked document that said an increase to 20 per cent could be on the cards. PWC has calculated that the Treasury has to raise taxes of 13bn a year and each 1 per cent increase in VAT brings in about 4.5bn.

John Cairns, head of tax at accountancy firm BDO, says VAT is one of the biggest revenue raisers for the government. It could be regarded as less unsavoury than other tax increases as its burden is spread across the entire population, so each individual pays a relatively small amount.

He says: "The impact of a VAT increase would be more apparent than real. It takes a little from a lot of people. If you were going to buy a car at 23,000 and the VAT went up by 2.5 per cent, it would only cost you another 500. It wouldn't necessarily put you off buying it. Also, items like food and children's clothing are exempt."

However, certain types of businesses – notably financial services – would suffer because European legislation dictates that they have to absorb the increase themselves rather than pass it on to customers.

INCOME TAX

OPINION is divided on whether income-tax rates will be increased as a revenue generator. The balance is swaying in favour of the status quo given the fact the 50 per cent rate for higher earners comes in next year.

Derek Henderson, head of tax at Deloitte in Scotland, says: "Increasing income tax on the higher paid looks counter-productive. The Treasury believes that it will collect just 30 per cent of the theoretical yield from the 50 per cent rate. Encouraging tax planning and emigration isn't a great economic strategy."

Darling could increase the basic rate of income tax and reverse the 2008 reduction. A 1 per cent increase in basic rate yields about 4.5bn.

However, the impact on someone with average earnings of 25,000 is nearly four times as much as a 1 per cent increase in VAT making a hike in basic rate income tax unlikely.

BDO's John Cairns warns that increasing basic rate income tax would be political suicide since Labour has always declared that would never happen.

CAPITAL GAINS TAX

THERE has been speculation that CGT could increase from 18 per cent, bringing it closer to higher-rate income tax, but opinion is balancing in favour of no change being made.

CGT is a relatively small earner – it is forecast to bring in 2.2bn – and a higher rate could lead to a brain drain of entrepreneurs from the UK.

John Cairns of BDO says: "There are fewer capital gains being made now anyway as values have been falling. An increase in CGT would just be political gesturing."

Graeme Crawford of E&Y says: "Entrepreneurs create wealth and employment. CGT was 10 per cent, it went up to 18 per cent and there are predictions that it could go to 25 per cent or 30 per cent. A lot of entrepreneurs are talking about moving abroad. Scotland is a very entrepreneurial marketplace and we need to keep those entrepreneurs in Scotland."

David Glen of PWC says that entrepreneurs who start businesses tend to be in it for the long term and a reward when they sell is that CGT is lower than income tax. If CGT is too high, he warns that entrepreneurs will be discouraged from starting new ventures and will emigrate to avoid tax altogether.

CORPORATION TAX

CORPORATION tax could offer one ray of light for businesses.

Experts say Darling could give companies an early Christmas present by reducing corporation tax from 28 per cent to 25 per cent to take account of the collapse in revenues and to help the UK compete with other European countries for inbound investment.

John Cairns at BDO says the UK used to be one of the most competitive nations when it came to corporation tax but this has changed over the years and the government may want to regain some ground.

ANTI-AVOIDANCE MEASURES

DARLING could seize the opportunity to cloak tax rises with an announcement of new and tougher anti-avoidance legislation, Barbara McQuillan, tax partner at Henderson Loggie warns.

"Can it be a complete coincidence that the Chancellor will deliver his Pre-Budget Report on 9 December which is also United Nations' International Anti-Corruption Day," says McQuillan. She says that many smaller, owner-managed businesses may be unexpectedly hit by increased regulation because of the "big stick" approach the government takes to anti-avoidance. "Rules are really aimed at the aggressive end of the market, but they inadvertently impact businesses which are just trying to get on and pay their taxes. We already have a very complex tax system. The government is using a sledgehammer to crack a nut and it's causing a burden for businesses."

She says the government may see anti-avoidance legislation as a way to collect additional taxes without having too much of an adverse affect on votes in advance of the general election.

Options for the government include a general anti avoidance rule (GAAR) which has been threatened in the past. McQuillan says that runs the risk of unintentionally catching genuine businesses. Another possibility is a targeted anti-avoidance rule (TAAR), which could impede business activity, according to Henderson Loggie.

NATIONAL INSURANCE CONTRIBUTIONS

EXPERTS warn that the Chancellor may try to generate more revenue from NI by increasing the upper earnings limit or contribution rates.But Graeme Crawford of E&Y says Darling may defer the expected increase in the NIC rate to give businesses a helping hand to start re-employing as they prepare for the upturn.

WEALTH TAX

DAVID Glen of PWC says: "From the leftfield we might see a 'wealth tax'." France imposes this on anyone with net assets of ?790,000 or more. He adds that it could prove popular with some voters who think the wealthy should take a higher share of the tax burden. However, it could also force higher-earners and successful entrepreneurs out of the UK.