Memorandum by the Institute of Chartered
Accountants in England and Wales (ICAEW)
INTRODUCTION
The Tax Faculty of the ICAEW welcomes the opportunity
to submit evidence in response to the Sub-Committee's 2008 inquiry.
Details about the Institute of Chartered Accountants
in England and Wales are set out in Annex 1.
Overall, the Institute is most concerned about
the absence of sound tax policy formulation in the months preceding
the 2008 Budget. Both the Capital Gains Tax (CGT) and residence
and domicile proposals in particular inadequately preserved the
reasonable expectations of taxpayers, did not benefit from the
proper consultation, and did not achieve an effective balance
against fairness concerns. The Institute also believes that the
intended revenue raising product of measures proposed as within
a "simplification programme" undermines public and stakeholder
support for the simplification agenda.
The Institute believes that several measures
can be taken at this stage, detailed below, to ensure more effective
tax policy outcomes.
EXECUTIVE SUMMARY
— We are concerned about the way in
which the CGT flat-rate was introduced and believe that tax policy
formulation needs to be improved, incorporating a balance against
fairness and the need for consultation and preserving the reasonable
expectations of taxpayers. The policy formulation of the CGT flat-rate
failed these requirements.
— CGTis designed to increase revenue
yield. The ICAEW believes that a tax simplification programme
should be broadly revenue neutral.
— The ICAEW believes that the "Entrepreneurs'
relief" limit should be indexed in line with inflation and
would benefit from alignment with the pensions lifetime limit.
The limit should in any event be kept under review to see whether
it discourages investment by serial entrepreneurs.
— Residence & domicile proposals
now place a fundamental importance on establishing whether a person
is resident in the UK for tax purposes. This highlights the fact
that the existing residence test, which is based primarily on
old case law and HMRC practice, no longer provides a satisfactory
basis for establishing liability to UK tax and introduces a level
of uncertainty that places the UK at a disadvantage as compared
to our international competitors.
— The domicile and remittance rules
announced in the 2007 Pre Budget Report demonstrate further lack
of adequate tax policy formulation and consultation.
— We continue to have concerns about
the draft clauses of residence and domicile proposals. The legislation
is highly complicated, much of it is incomprehensible and we think
that taxpayers will find it hard to comply with these rules, thus
undermining the culture of good tax compliance that is fundamental
to the UK system.
— ICAEW believes that the overall changes,
as opposed to the Budget Red Book projections, will result in
a net loss of revenue to the UK due to unforeseen and unanalysed
behavioural impacts.
— Many non-domiciles affected by the
changes will not be particularly well off and may not even realise
that they face an increased tax bill in the UK. The ICAEW remain
of the view that the de minimis should be set at a higher level.
— We remain concerned that HMRC will
also need extra resources to implement and monitor the proposed
changes at a time when HMRC's budget is being cut in real terms
over a three-year period.
— a detailed review of the various
schemes in existence and whether they are cost-effective in generating
successful investment in growing businesses that would not otherwise
have been made;
— that there should be a survey of
EIS investment levels pre and post the FA 2006 changes; and
— there should be a more general review
of investment tax incentives including details of the schemes
and their success in increasing investment, their costs to the
Exchequer, how EU state aid rules are likely to impact on them
and whether there is a principled ease for change.
CAPITAL GAINS
TAX AND
ENTREPRENEURS' RELIEF:
CLAUSES 6 AND
7, SCHEDULES 2 AND
3
CGT simplification
The move to a flat-rate CGT is a potentially
welcome simplification, but we are concerned about the way in
which the flat-rate was introduced and believe that tax policy
formulation needs to be improved. Tax simplification is not a
principle that can be considered in isolation: it needs to be
considered within a broader framework of principles which we have
identified as the ten tenets (set out in the Annex 2). In particular,
tax simplification needs to be balanced against fairness and the
need for consultation.
The rate of CGT is ultimately a political question
for the Government. Whilst any tax simplification is likely to
produce winners and losers, this measure was designed to increase
the yield from CGT. We think that from a public perception viewpoint,
a tax simplification programme should be seen as broadly revenue
neutral. It will be more difficult to pursue a tax simplification
programme in consultation with stakeholders if the perception
is that one of the main drivers to the programme is raising revenue
rather than making the UK tax system more straightforward and
competitive.
The change will create a considerable number
of business losers. In particular, many businesses and employee
shareholders who previously would have qualified for the 10% CGT
rate will not qualify for entrepreneurs' relief and will therefore
face an 18% CGT rate rather than a 10% rate.
Preserving reasonable expectations
We think it is important for the integrity of
the tax system that it should respect taxpayers' reasonable expectations.
When taper relief was introduced in 1998, the existing entitlement
to indexation was preserved, which was a measured and reasonable
transition to the new taper relief system. The blanket withdrawal
of indexation and taper relief fails to respect this need.
The need for wide consultation
In view of the fundamental change which is proposed,
this measure should have been first subject to wide consultation.
This principle of full consultation on all proposed policy changes
is reflected in the Code of Practice for consultation for the
Revenue departments, which states that The Govemment intends
to consult on tax policy matters wherever it is reasonable to
do so.
The Code sets out four benefits arising from
consultation, namely that it:
— allows a national debate to take
place on the major tax policy decisions that affect all taxpayers;
— enables everyone to have a better
understanding of the likely impact of proposals on businesses
and individuals;
— enables Ministers and officials to
consider the merits of alternative suggestions, or whether the
Government's proposals can be improved in the light of comments
made; and
— improves the quality of any resulting
draft legislation, in particular by ensuring that it works in
the real world.
We believe that the proposed CGT reforms clearly
met the criteria for consultation and that a full public consultation
would have provided all four of the benefits set out above. We
accept that there may be some times when consultation is not appropriate,
and the Code sets out four possible areas:
— where there is a significant risk
of forestalling;
— which are market sensitive and could
lead to significant temporary distortions in taxpayers' and market
behaviours;
— where it is necessary to act swiftly
(eg to take anti-avoidance measures); and
— where policy develops significantly
in the period between the pre-Budget Report and the Budget proper.
We appreciate that a major reform CGT is market
sensitive and is likely to lead to significant distortions, but
we do not think that these concerns were sufficient to outweigh
the benefits that would have arisen if there had been proper consultation
beforehand.
Clause 7 and Schedule 3
These enact the new "entrepreneurs' relief",
which was announced on 24 January 2008. This relief, which is
based upon the Capital Gains Tax (CGT) retirement relief rules
which were phased out beginning in 1999, provides that gains of
up to £1 million on the disposal of all or part of business
are taxed at an effective rate of 10% rather than 18%. We recognise
that the £1 million limit is a policy decision and understand
the rationale for it. However, given that the new relief is aimed
at entrepreneurs rather than business people looking to retire,
we are concerned that the £1 million limit will not necessarily
encourage "serial" entrepreneurs to reinvest in new
businesses. We think that the limit should be indexed in line
with inflation and to simplify matters there would be some logic
in aligning it with the pensions lifetime limit. The limit should
in any event be kept under review to see whether it discourages
investment by serial entrepreneurs.
We appreciate that this new relief includes
a number of welcome simplifications as compared to the old retirement
relief rules, but those rules were not without problems and many
of these are re-enacted in the new relief. The rules for partnerships
and companies are not identical, with the latter being generally
more restrictive in that the shareholder must be an officer or
employee and own 5% or more of the voting rights. We question
whether the old retirement relief restrictions on personal holding
companies are still appropriate, particularly given the advent
of LLPs as an alternative business structure.
The legislation reintroduces the "whole
or part of the business" test that was such a problem for
retirement relief for unincorporated businesses. This contrasts
with the position for shares and securities where it seems that
any disposal, however small, can qualify.
The 12 month ownership compares favourably with
the ten year ownership period for retirement relief. Nevertheless,
it would have been simpler if the definition had been aligned
with the substantial shareholding exemption. This allows for any
12 month period within the previous 24 months. This change would
mean that there was one common definition and would allow slightly
more flexibility to a taxpayer who is in the process of extracting
himself from a business.
Restriction on let property (section 169P)
The rules will operate to deny relief for associated
disposals in circumstances where we think it should be available.
The point is best illustrated by using an example which was set
out in a document which was published on Budget Day providing
examples of how the new relief would work in practice.
Example
Mr R has been a member of a trading partnership
for several years. He leaves the partnership and disposes of his
interest in partnership assets to the other partners, realising
gains of £125,000, all of which qualify for entrepreneurs'
relief. He also sells the partnership office building which he
owned outright, but let to the partnership, realising a gain of
£37,000. The disposal of the office building is "associated"
with Mr R's withdrawal from the partnership business, and the
£37,000 gain therefore also qualifies for entrepreneurs'
relief (assuming there is no restriction on the amount of the
gain qualifying for relief as a result of non-qualifying use).
Our understanding is that entrepreneurs' relief
will only be available in relation to the office building if it
was let "rent-free" to the partnership for the whole
of the period of ownership. The problem is that even if rental
arrangements are changed from 6 April 2008 and any property is
let rent-free, the test of whether the asset was an investment
is by reference to the complete period of ownership, which will
include any period of ownership prior to 6 April 2008. It therefore
seems to us that the requirement to include the period of ownership
prior to 6 April 2008 will restrict the availability of relief
even if the taxpayer seeks to amend the position for the future.
We appreciate that this provision is subject to a "just and
reasonable" test but we believe that the period of ownership
prior to 6 April 2008 should not be taken into account for these
purposes.
Disposals by trustees—section 1.69J
In relation to disposals by trustees, it is
necessary for the company to be the qualifying beneficiary's personal
company, ie the beneficiary needs to own 5% or more of the company.
This seems unduly restrictive given that the beneficiary may not
own shares personally in the company and we think that the provision
should be amended and that the condition is by reference to the
shares owned by the trustees.
RESIDENCE & DOMICILE:
CLAUSE 22, CLAUSE
23 AND SCHEDULE
7
Clause 22, Periods of residence
The clause amends the way in which days of presence
are counted for determining the amount of time spent in the UK.
Given the fundamental importance of establishing whether a person
is resident in the UK for tax purposes, this change highlights
the fact that the existing residence test, which is based primarily
on old case law and HMRC practice, no longer provides a satisfactory
basis for establishing liability to UK tax. Current HMRC practice
in this area is unclear, often ambiguous and highly uncertain
in application. The result is that individuals can be present
In the UK without knowing if they are or are not tax resident.
The lack of certainty puts the UK at a disadvantage as compared
to our competitors.
The explanatory notes state that the Finance
Bill change was introduced because "the UK was out of step
with ... its international partners". However, the more important
reason the UK is out of step is because it is one of very few
developed countries that does not have a statutory test. We believe
that there are suitable models of statutory residence tests that
the UK could use to develop its own rule. A suitable example is
the Irish statutory residence rule, which was first introduced
in 1994 (subsequently consolidated in 1997) and which we understand
works well although we recognise that it is (by UK standards)
quite generous. An alternative less generous model is the US residence
test.
CLAUSE 23 AND
SCHEDULE 7, REMITTANCE
BASIS
The drafting of the legislation
The reform of the domicile and remittance rules
was announced in the 2007 Pre Budget Report (PBR). Whilst reform
of these rules was expected, as with the CGT changes described
above we are concerned at the approach adopted to tax policy formulation
and think that it needs to be improved in consultation with stakeholders.
More time should have been given to consult on any proposed policy
changes and then an adequate transitional period given so as to
ensure that taxpayers' legitimate expectations are respected.
In addition to the increase in tax charges on
non-domiciles, the proposals impose potentially onerous new compliance
requirements on many non-domiciles. Many of the original proposals.also
imposed tax charges which went against the legitimate expectations
of taxpayers, although we recognise that many (although by no
means all) of these concerns have been addressed in the draft
legislation. However, a significant part of the legislation remains
unfinished even though it comes into effect on 6 April 2008. We
do not think that this is a satisfactory situation and it certainly
does not provide certainty. We remain of the view that it is unfair
to taxpayers not to have deferred the implementation of these
aspects of the legislation until 5 April 2009.
We continue to have concerns about the draft
clauses. The legislation is highly complicated, much of it is
incomprehensible and we think that taxpayers will find it hard
to comply with these rules, thus undermining the culture of good
tax compliance that is fundamental to the UK system.
The economic justification for change
We remain concerned that the changes will result
in a net loss of revenue to the UK. Whilst the Budget Red Book
predicts that the changes will increase revenue, we remain concerned
that no economic and sensitivity analyses have been prepared to
support the change and that behavioural impacts will result in
the opposite effect to that intended.
The impact of the changes on "ordinary"
non-domiciles
The focus of these changes is on extracting
more tax from the "super rich" but the need to formally
claim the remittance basis and the loss of personal allowances
and the CGT annual exemption will increase the tax rate on all
non domiciles, many of whom will not be particularly well off
and who may not even realise that they face an increased tax bill
in the UK.
The increased administration burdens
In addition to the increased tax charges, the
changes will also impose significantly higher administrative burdens
and associated costs on many non-domiciles. This is because they
will now need to take advice on their UK tax position and they
may now need to complete a UK tax return whereas currently many
non-domiciles do not need to do so. The raising of the de minimis
limit from £1,000 to £2,000 announced in the Budget
was a welcome announcement and this will help to alleviate some
of the compliance burdens, but we remain of the view that the
de minimis should be set at a higher level.
We remain concerned that HMRC will also need
extra resources to implement and monitor these changes and that
the strains that will be imposed could be considerable at a time
when HMRC's budget is being cut in real terms over a three-year
period.
ENCOURAGING ENTERPRISE:
CLAUSE 28, CLAUSE
29 AND SCHEDULE
11
These schemes are aimed at encouraging investment
but we are not convinced that taken as a whole they are as effective
as they once were and that the changes in this Finance Bill are
unlikely to improve the attractiveness of the schemes.
We also note that EU state aid approvals for
EIS and VCTs are still being sought and there must be some doubt
as to whether these will be forthcoming or whether further changes
might still need to be made to make the schemes acceptable (or
indeed whether state aid approval is refused).
We believe that the halving of the gross assets
limits in 2006 so as to comply with EU state aid rules have generally
rendered these schemes much less attractive than hitherto. Anecdotal
evidence suggests that few investments are made using EIS and
we suspect that the increase in the limit from £400,000 to
£500,000 will have little practical effect. It would be useful
if the Government made a survey of EIS investments before and
after the 2006 changes as we believe that this would identify
more clearly the reduction in the number of EIS investments.
The list of excluded activities is also extensive
and again EU state aid rules are merely likely to restrict further
the activities that qualify. In this context we note that shipbuilding,
coal and steel production are now also excluded activities for
the purposes of the EMI scheme (see clause 30). Our conclusion
is that investment reliefs such as these are likely to remain
under pressure at the EU level and that the continued attractiveness
of these schemes in encouraging general investment is likely to
be limited.
More generally we are concerned that:.
— there are too many investment schemes,
leading to confusion;
— they are too restricted in terms
of investment limits and activities;
— the detailed rules are too complicated,
thus adding to the complexity of the tax system at a time when
the government is committed to simplifying the tax system; and
— they are too vulnerable to challenges
under the EU state aid rules which are likely to preclude addressing
the above issues.
The studies and consultation documents are useful
but we think that the time has come for a more general review
of tax incentives for investment and, in particular:
— a detailed review of the various
schemes in existence and whether they are cost-effective in generating
successful investment in growing businesses that would not otherwise
have been made;
— what are their costs to the Exchequer;
— how the EU state aid rules are likely
to restrict any schemes;
— whether there are other more cost
effective ways of encouraging investment that do not fall foul
of state aid rules; and
— whether there is a principled case
for simplifying or even abolishing these schemes whilst improving
the general climate for business investment.
April 2008
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