Keiron Root looks over the details of Gordon Brown’s final Budget and discusses what it could mean for your taxes and investments. 8 May 2007 So, after much speculation, Gordon Brown delivered what is almost certain to be his final Budget speech on 21 March with his customary mixture of earnest economic theory and theatrical political showmanship. And while the headlines were dominated by the announcement that the basic rate of income tax was going to be cut to 20 per cent (albeit not until next financial year and accompanied by the abolition of the ten per cent starting rate), the devil was, as usual, in the detail.
But once the dust had settled on the forward setting of tax bands and the increases in the prices of petrol, alcohol and tobacco, what were the specific implications of the Budget for investors? Although areas such as VCTs or the taxation of investment gains could not compete for space on the front pages with the 20p tax rate, there are a number of areas within the Budget statement that will affect the way in which we invest.
Inheritance tax
The Chancellor made much of his commitment to increasing the threshold at which inheritance tax (IHT) is paid to £350,000 for the tax year 2010/11, claiming that this would help keep the vast majority of people outside the IHT net. Apart from being one of a number of long-term commitments on taxation that will seriously reduce his successor’s – whoever he or she may be – room for manoeuvre, this well-publicised development is less generous than the Chancellor seems to think.
The main reason that increasing numbers of estates are burdened with IHT is the dramatic rise in property values in many parts of the country, which has occurred over the past 20 years. Brown argues that by increasing the threshold at which IHT becomes payable from the £285,000 that applied in the 2006/07 tax year to £350,000 in four years’ time (an increase of some 22.8 per cent) he is taking more estates out of IHT.
But while this increase may be well ahead of anticipated inflation (even as measured by the Retail Prices Index), it is unlikely to be anywhere near enough to cope with house price inflation. Future movement of house prices is notoriously difficult to predict, and there are a number of different measures of the rate at which house prices have actually risen, but one of the most widely used house price indicators recently has been the monthly index produced by Halifax.
Moreover, in the period before the Budget, the Halifax index was showing one of the more conservative rises, with average house prices increasing at 9.9 per cent per annum for each of the previous three months. Taking this as a basis for future projections – and it doesn’t seem an unreasonable rate of growth for this purpose – the IHT threshold would have to increase to £415,000 in 2010/11 just to keep pace with where it is now, as the table below indicates. It looks like Mr Brown has not been quite so generous after all.
Also, the day after the Budget statement, HMRC confirmed that gifts by parents and grandparents to children under 18 would not be subject to a new IHT charge under the provisions affecting trusts introduced in the 2006 Budget, but would be treated in the same way as gifts to adults.
Provided the gift is outright and not subject to any form of contingency or trust, there is no tax payable if the donor survives seven years from the gift. If the donor dies within seven years, there will still be a charge, as with adults. Emma Chamberlain, chairman of the Chartered Institute of Taxation’s Capital Taxes Sub-Committee, comments, ‘HM Revenue & Customs (HMRC) has given a clear response to the questions that have been raised, and so those who are happy to make outright gifts to children can do so without incurring any extra IHT penalty. The gifted property will, however, be part of the child’s estate, so he or she will be able to take over the property at 18, and if he or she dies the property will pass according to his will or intestacy.’
However, she adds, ‘Parents may of course decide to be careful before allowing a large sum to be held by young children in such an unrestricted way and may prefer to impose some controls so that the child cannot obtain unrestricted access at 18, even if this involves paying more IHT.’
AIM portfolios
As we explained in last month’s magazine, the opportunity to use business property relief attaching to certain qualifying shares listed on the Alternative Investment Market (AIM) to mitigate IHT liabilities has led to the increasing use of AIM investments for IHT planning in recent years.
There was some alarm when the Budget statement was published including a proposal that HMRC would be able to designate, as a recognised stock exchange, any exchange that was recognised by the Financial Services Authority (FSA). On the face of it, this would have included AIM, which is recognised by the FSA, and such recognition would have meant that AIM-listed stocks would no longer be regarded as “unlisted” and, therefore, no longer qualify for business property relief.
With commendable speed, the Treasury issued a statement that there is no intention to include AIM within these provisions. Therefore, companies listed on AIM will continue to be treated as unquoted for the purpose of the Enterprise Investment Scheme (EIS), Corporate Venturing Scheme (CVS) and Venture Capital Trust (VCT) legislation.
Richard Hoskins of Noble Fund Managers, observes, ‘Given the changes that have been made in tax law over the last few years, investors have become increasingly worried about whether their tax planning strategies will be scrapped, especially with retrospective effect. Investors should remember there is a tax planning risk with any tax-efficient investment.
‘The most important consideration is: “Why is the Treasury giving tax breaks?” They are given to compensate investors for the higher risk of investing in qualifying investments. Schemes that don’t expose investors to any investment risk will be first on the Chancellor’s list to scrap. If you pick a fund manager that not only follows the letter of the law but the spirit of the law, you are perhaps less vulnerable to changes in tax law.’
Enterprise Investment Schemes
A number of changes were announced relating to both EIS and VCT investments, the general tenor of which is to continue to focus these investment vehicles on the very smallest companies.
EIS-approved funds that closed on or after 7 October 2006 will have 12 months in which to invest 90 per cent of the money raised, as opposed to the previous limit of six months, which should make it easier for such funds to meet the qualifying conditions for EIS investments.
At the same time, EISs may in future only invest in companies or groups that have no more than 50 full-time employees at the date of issue of shares to EIS investors. Similarly, an investee company may receive no more than £2 million from EIS investors or, indeed, from a combination of tax-incentivised and state-sponsored investment schemes, such as VCTs, in any 12-month period. If the limit is exceeded, none of the shares or securities within the issue that causes the condition to be breached will qualify.
The EISA, the umbrella body for managers of EISs, observes, ‘These changes are aimed at targeting relief to smaller companies in line with EU state aid provisions. They will affect share issues by EIS companies because they are now more restricted as to the size of a company that will qualify than they were by the gross assets test. HMRC estimates that 30 per cent of existing EIS companies would not qualify under these proposals.’
Venture Capital Trusts
These restrictions in terms of the number of employees and the size of investment also apply to investments made by VCTs after 6 April 2007. However, there was also some positive news for managers of VCTs, in that there is a proposal to disregard a disposal of a qualifying holding for a period of six months, providing that the investments were held for at least six months.
The idea is to give VCTs more flexibility to reinvest or distribute the proceeds of their investments, although it is accompanied by suggestions that this will replace the provision allowing such funds to be held in non-interest-bearing accounts, as is the current practice. EISA also points out that ‘as it will apply from 6 April 2007, VCTs will need to have had at least 70 per cent of their investments in qualifying holdings at 5 April 2007, subject to the disregard provision for funds raised in the last three-year period’.
The reaction from VCT managers to a further restriction of the investments available to them was predictable. F&C Management’s head of communications, Jason Hollands, fumes, ‘The changes announced last year have already had the impact of significantly reducing the amounts raised by VCTs this year. One had hoped the Chancellor would revisit those decisions in view of this. Instead, we get a further squeeze, albeit blamed on Europe, which will shut the door on many companies that would benefit from VCT funding and, in doing so, create jobs.’
The European angle is a reference to the fact that the Chancellor justified this particular change by referring to recently updated EC guidelines on state aid for business. But Hollands concludes, ‘Rules have been relaxed to help ensure VCTs don’t inadvertently lose their tax status
by temporarily falling below the requirement to have 70 per cent of their assets in qualifying companies after three years, but these latest changes to VCTs come just a year after previous tightening, which saw the size of company eligible for VCT funding almost halved while tax reliefs on VCTs were reduced.’
