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UK Pre-Budget Report Mostly Fine Print - Few Horrors

by Jason Gorringe,, London

11 December 2003

In the UK's annual 'pre-budget' report yesterday, Chancellor Gordon Brown increased forecasts for public sector borrowing to GBP37bn this year, but said that growth would be 2.1% per cent in 2003, and 3-3.5% in both 2004 and 2005. He announced measures to simplify corporation tax, including a proposal to allow companies who adopt international accounting standards not to have to submit a second set of accounts.

Among a host of detailed measures, some of the more interesting proposals for business are as follows:

  • The launch in spring 2004 of a first round of Enterprise Capital Funds, based on the US Small Business Investment Companies model;
  • proposals to improve Venture Capital Trusts (VCTs) and the Enterprise Investment Scheme to make them more attractive to investors, including a temporary stimulus to VCT fundraising in light of recent market weakness;
  • changes to the R&D tax credits schemes to give companies effective, targeted support for research and development while reducing their compliance costs, giving business additional certainty and making decisions easier;
  • an increase in the small and medium sized company thresholds to the maximum permitted under EU law, doubling the amount of investment qualifying for the 40 per cent plant and machinery first year allowances and providing a cash flow boost to smaller businesses of almost GBP400 million over the next 3 years; and
  • a discussion paper on the tax treatment of fees and subscriptions to professional and other approved bodies, to establish the scope for this system to make a greater contribution to the wider training and skills agenda.

Said the Treasury:

The definition of R&D for tax purposes is being simplified. A draft new definition is being published today and the views of business will be sought before it comes into force. This clearer definition will reduce companies’ compliance costs by making it easier for them to decide at the outset whether their activities will qualify for the credit. The definition of qualifying costs is also being clarified and widened to include materials consumed, software, water and fuel used directly in the R&D. In addition, the Government will continue discussions with business to understand whether any direct costs are outside the currently proposed change and how any such costs might be brought within the schemes while minimising compliance burdens and cost effectively supporting R&D. The Government will introduce changes to ensure the credit is available where large companies subcontract to non-corporation tax chargeable entities and will make minor changes to ensure that staff costs for benefits in kind do not qualify for the credit.

The paper sets out proposals to remove, from 6 April 2004, the current capital gains tax deferral relief for investments in Venture Capital Trusts (VCTs) and replace it with an enhancement, of equivalent value, to the incentives to invest through income tax relief. In light of the recent relative weakness of the VCT market, the paper also sets out proposals to provide a temporary stimulus to VCT fundraising for a period of two years. The Government’s favoured option is a temporary increase in the value of income tax relief from 20 per cent to 40 per cent, with the value of the additional 20 per cent paid directly to the VCT rather than the investor. Subject to discussion with the industry, the Government also intends to increase to ?200,000 from 6 April 2004, both the annual investment limit for VCTs and the threshold for income tax benefits under EIS.

The Treasury also announced the extension of relief for the expense of managing investments to companies that do not qualify as investment companies, removing outdated and unnecessary restrictions that currently cause some companies to adopt uncommercial structures in order to obtain relief; and reform of the transfer pricing and thin capitalisation rules and a package of measures to mitigate the impact of the extension of the current rules particularly for smaller businesses.

Changes to the tax rules for offshore funds will allow a wider range of investments in offshore funds to meet the rules for “distributor” status. The Government intends to introduce changes in the 2004 Finance Bill to the taxation rules for offshore funds. These will amend the rules that determine whether investments in offshore funds can be treated as investments in “distributing” funds, so that UK resident investors in offshore funds will, in a wider range of circumstances, be charged to tax in the same way as an investor in an equivalent UK fund.

From 6 April 2004 the tax rate paid on the income and capital gains of trusts will increase from 34 per cent to 40 per cent (and the corresponding dividend trust rate from 25 per cent to 32? per cent). This removes a distortion that provides avoidance opportunities for some higher rate taxpayers, but will not affect the position of tax payers not liable at the higher rate who receive income from a trust, who will continue to be able to reclaim any excess income tax paid by the trustees on their behalf. With immediate effect, the capital gains “gifts relief” legislation will be amended to counter tax avoidance schemes that involve the transfer of assets into a trust. Draft clauses for this change are being published today on the Inland Revenue website together with draft Explanatory Notes. This legislation will be included in Finance Bill 2004.

Action will also be taken against avoidance of the Inheritance Tax rules for Gifts with Reservation, where the former owner continues to enjoy the benefits of ownership of an asset. Finance Bill 2004 will legislate to impose a charge on the benefit gained from using the asset, following consultation on the detailed workings of this measure.

"Film Tax Relief," said the Treasury, "has encouraged a substantial amount of investment in UK films, much of which occurs because the investors enjoy immediate tax relief on the purchase or production of the film with the expectation that they will pay tax on income received from the film in subsequent years. However, the tax avoidance industry has marketed schemes to allow investors to convert the tax deferral into a permanent tax advantage. From today, where an investor exits from a film business in a way that gives rise to an unwarranted tax advantage, they will be subject to a charge that will remove the advantage."

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