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An Insight to Tax Changes by Finance Act 2008

In this, the first of two articles, Steve Collings looks at the fundamental changes to income taxes and business taxes brought about by Finance Act 2008 which will be examined by ACCA from June 2009.  The second article will look at the changes to capital gains tax, inheritance tax and the residency and domicile legislation as well as the new powers HMRC have under their new penalty regime in respect of the administration of taxes.

Finance Act 2008 received Royal Assent on Monday 21 July 2008 which completed the legislative implementation of the Government’s Pre-Budget Report and Budget announcements as it became the Finance Act 2008.

Students studying for tax papers that begin to examine under Finance Act 2008 in 2009 need to understand the fundamental changes that Finance Act 2008 brings in respect of major taxes.  The taxes affected are:

• income taxes;
• business taxes;
• capital gains tax;
• inheritance tax;
• residency and domicile; and
• new powers HMRC have under their new penalty regime.

Income Taxes

The main changes to this income tax is the controversial abolition of the 10p starting rate.  The Government introduced this and at the same time reduced the basic rate band from 22% to 20%.

Because of the controversy (and pressure to the Chancellor) this decision caused, the Chancellor announced on 13 May 2008 that a compensatory increase in personal allowance be introduced.  The change here was that the personal allowance was increased by £600 to £6,035 which effectively gives an extra £120 to basic rate taxpayers.  The position of higher rate taxpayers is not affected by this change because the threshold for 40% tax has been reduced to £34,600.

Increasing the personal allowance had the advantage of being simple, capable of being backdated to April 2008 and relatively easy and quick to deliver.  However it is an expensive measure because it is not targeted and benefits many people who had not lost out from the tax rate change in the first place.  The measure itself is based on the average loss and as a result, a large number of people were not compensated – these were taxpayers on the lowest incomes.

Students should be aware that the changes brought in by Finance Act 2008 now mean that the personal allowance and the National Insurance Contributions primary threshold are no longer aligned so take care with this new ‘anomaly’.

Savings income: new starting rate

Whilst Finance Act 2008 abolishes the 10% starting rate, it introduces a new 10% starting rate for savings and starting rate limit for savings.  For 2008-09, the starting rate limit for savings will be £2,320.  The Income Taxes Act (‘ITA’) sets out different types of income, which are not separately defined in the ITA but broadly covers ‘earnings’ such as pensions, taxable social security benefits, trading profits and income from property.  The next slice is savings income which broadly covers bank and building society interest.  Dividend income is the top slice of income.  Finance Act 2008 does not make any amendments to these rules.

Should an individual’s non-savings income exceed the new starting rate limit for savings, then the starting rate for savings will not be available for the savings income.  The individual’s savings income will be charged to tax at the 20% basic rate up to the basic rate limit of £34,600.  This is unchanged from the way in which savings income was taxed in Finance Act 2007.  However, should an individual’s non-savings income be less than the starting rate for savings limit, then the savings income will be taxable at the 10% starting rate for savings up to the limit.

Students should be aware that banks and building societies will automatically deduct tax at a rate of 20% from the interest paid to a taxpayer.  Therefore if a taxpayer is entitled to have any of their savings income taxed at 10%, they will be able to claim some tax back.  Remember, companies will still receive their interest ‘gross’ i.e. with no tax deducted.

Illustration

Bill has earnings of £6,600 and savings income of £4,000.  Bill’s personal allowance is £6,035, so:

Total income £10,600
Personal allowance   (£6,035)
Taxable income £  4,565

In this illustration, Bill’s personal allowance is all used against his earnings of £6,600 so only (£6,600 - £6,035) £565 is taxable.  The rest of the starting rate limit (£2,320 - £565) = £1,755 can be used against savings income as calculated below:

Earnings £565 x 20% = £113.00
Savings £1,755 x 10% = £175.50
Savings £2,245 x 20% = £449.00
Total tax   £737.50

Bill’s bank will have deducted tax from his interest at 20% so they will have taken £800 from him (this is also known as tax being ‘deducted at source’).  As Bill is due to pay £737.50 in tax but the bank has deducted £800, then he can claim a repayment of tax from HMRC amounting to £62.50.

Cars and fuel

Where a car is made available for an employee’s private use, a taxable benefit arises under ss. 114 and 120 of Income Tax (Earnings and Pensions) Act 2003 (‘ITEPA’).  Company car tax was reformed in April 2002 and is now calculated by applying the appropriate percentage to the list price of the vehicle.  The appropriate percentage is related to the CO2 emissions of the car and ranges from 15% to 35% (in 1% increments).  Cars that can be driven on alternative fuels such as Liquified Petroleum Gas (LPG) attract a discount from the appropriate percentage rate.

Post 6 April 2008, there is a 2% discount from the appropriate percentage rate for cars that have been manufactured to run on ‘E85’ fuel.

An additional taxable benefit arises under s149 ITEPA 2003 if the employee receives free or subsidised fuel for private use in a company car.  The company car fuel benefit tax charge was reformed in April 2003 to align with the environmental principles of the company car tax system.  Since April 2003, the fuel benefit charge has been calculated by applying the company car tax appropriate percentage (based on the CO2 emissions) to a set figure known as the ‘multiplier’.  For 2008-09 the multiplier figure for the company car fuel benefit tax charge will be increased to £16,900.

Gift Aid: transitional relief

Finance Act 2008 supplements current Gift Aid legislation for charities and Community Amateur Sports Clubs (CASCs) as a consequence of the reduction of the basic rate of income tax from 6 April 2008.

The Finance Act 2008 requires HMRC to pay a transitional relief supplement to charities and CASCs based on qualifying Gift Aid donations shown on claim form ‘R68’ if the claim is allowed.  The relief for claims made before the date of Royal Assent of Finance Act 2008 and Appropriations Bill will be paid separately by HMRC without the need for an additional claim by charities or CASCs.

The rate of the transitional relief supplement will be 2% and will be applied to qualifying donations made in the years 2008-09, 2009-10 and 2010-11. The relief is calculated by grossing up the donation by the sum of the basic rate and the rate of supplement.  The amount of relief due is the difference between that figure and the amount of the donation grossed up at the basic rate of tax.

Charities and CASCs will be eligible to receive payments of the Gift Aid transitional relief in respect of Gift Aid repayment claims allowed by HMRC providing that the claim on form R68 is made:

• for charitable trusts up to two years after the end of the tax year to which the claim relates; and
• for charitable companies or CASCs, up to two years from the end of the accounting period to which it relates.

Students should be aware that the amount of transitional relief will be limited by the amount of qualifying donations, so will increase or decrease as levels of qualifying Gift Aid donations received by a charity increase or decrease.

Business Taxes

Lots of changes in business taxes!! The headline rate of corporation tax has been reduced to 28%.  The small companies rate is increased to 21% which was expected to rise to 22% in 2009-10 but in his Pre-Budget Report 2008, the Chancellor announced that this increase was to be deferred by a year in light of the current economic climate.

The main change brought about by Finance Act 2008 is a major recast of capital allowances, including the phasing out of industrial/agricultural buildings allowances and reducing the main rate of allowance on plant and machinery from 25% to 20%.  There has also been an introduction of the Annual Investment Allowance which grants a 100% allowance on the first £50,000 of plant and machinery investment.

Corporation tax rates

The rates of corporation tax are as follows for 2008-09:

Small companies rate: 20% profits of £0 - £300,000
Marginal relief: £300,001 - £1,500,000
Main rate: 28% profits of £1,500,001 or more

The small companies’ rate of corporation tax has increased from 20% to 21% in 2008-09.  The fraction used in smoothing the difference between the main rate of corporation tax and the small companies’ rate (marginal small companies’ relief) is 7/400 for 2008-09.  Remember the above limits are all reduced accordingly if the company has ‘associated companies’.

Annual investment allowance

Finance Act 2008 gives us an Annual Investment Allowance (AIA) for the first £50,000 of a business’s expenditure on most plant and machinery each year.  The new AIA is available to:

• any individual carrying on a qualifying trade (including trades, professions, vocations, ordinary property business and individuals having an employment or office);
• any partnership consisting only of individuals; and
• any company (subject to the limitations described as follows).

The AIA will have effect for most plant and machinery expenditure, but certain exceptions that applied to first year allowances also continue to have effect for the purposes of AIA.  The main exception is the expenditure on cars.  Unlike SME first year allowances, the AIA is available for expenditure on long-life assets and assets for leasing.

The tax savings which can be made by reducing business profits are potentially high.  Timing is important if a company is planning additional expenditure on equipment or premises so if you are being asked any sort of ‘planning’ questions concerning whether you would advise a client to incur the expenditure on or after 1 April (corporation tax) or 6 April (income tax) then remember that timing is crucial.

Eligible expenditure incurred on or after 1 April 2008 will attract AIA for companies and on or after 6 April 2008 for businesses under the charge to income tax.

Where businesses spend more than £50,000 in any chargeable period, any additional expenditure over and above the £50,000 limit will be dealt with in the normal capital allowances regime, entering either the special rate or main pool, where it will attract writing down allowances (WDA) at the appropriate rate.

Students should take care where a chargeable period is more or less than a year.  The maximum allowance is proportionately increased or reduced.  However, where a business has a chargeable period that spans 1 April 2008 (for corporation tax purposes) or 6 April 2008 (for income tax purposes) the maximum allowance is calculated as if the chargeable period began on either 1 or 6 April 2008 (depending on whether a business is charged corporation tax/income tax respectively).  Consider the following example:

A company with a chargeable period from 1 January 2008 to 31 December 2008 would calculate its maximum entitlement to an AIA for that chargeable period based on the period from 1 April 2008 to 31 December 2008.  Its maximum allowance for the transitional period would therefore be 9/12 x £50,000 = £37,500.

Students should also be aware that the AIA complements, but does not replace, any of the existing 100% FYA schemes.  Expenditure that qualifies for 100% allowances under separate capital allowances (for example Research and Development Allowances or Business Premises Renovation Allowances) are unaffected by the introduction of the AIA.

Plant and machinery rate changes and the new special rate pool

Finance Act 2008 reduces the main rate of writing-down allowances (WDAs) for new and unrelieved expenditure on general plant and machinery (including cars) allocated to a pool from 25% to 20%.

Conversely, the Act also increases the rate of WDA on long-life assets from 6% to 10%.  Any unrelieved expenditure in the long-life asset class pool will, for chargeable periods starting on or after the operative date, be allocated to a new 10% ‘special rate’ pool.  Long-life asset pools will cease to exist for all accounting periods starting on or after the operative date.

For businesses whose chargeable period spans 1 April for corporation tax or 6 April for income tax, a ‘hybrid’ rate will have effect for unrelieved expenditure in any pool, including single asset pools.  There are two hybrid rates:

• one for any expenditure that qualified for WDA at 25% under the old regime; and
• the other for any expenditure that qualified for 6% under the old regime.

The hybrid rate is arrived at by calculating the proportion of a chargeable period falling before the change date and the corresponding proportion falling after the change date.  Consider the following example:

A company’s chargeable period began on 1 January 2008 and ends on 31 December 2008, one quarter of that period would fall before the date of the change (i.e. 1 April 2008) and three-quarters would fall after that date.  The calculation of the hybrid rate on the main rate of WDAs would therefore be calculated as follows:

91 days / 366 days x 25% = 6.22%
Plus 275 days / 366 days x 20% = 15.03%

Therefore the hybrid rate for the transitional period = 21.25%.

Where the chargeable period of a business begins on 1 April 2008 (corporation tax) or 6 April 2008 (income tax), any unrelieved expenditure in the long-life asset pool immediately before those dates will be transferred to the new special rate pool and will qualify for 10% WDAs.  However, when the chargeable period of a business spans those operative dates, the following transitional provisions are triggered:

• no new expenditure incurred on or after 1 / 6 April 2008 is to be allocated to the long-life asset pool – it must be allocated to the special rate pool;
• a hybrid rate will have effect for existing expenditure in the long-life asset pool for the whole of that transitional chargeable period; and
• at the start of the next chargeable period, all unrelieved expenditure in the long-life asset pool will be transferred to the new special rate pool.

Small plant and machinery pools

Finance Act 2008 allows a business to claim a plant and machinery WDA of up to £1,000 where the unrelieved expenditure in the main pool or the new special rate pool is £1,000 or less. The measure is a permanent feature of the plant and machinery code and will have effect for both the main 20% pool and the special rate 10% pool.  Students should be aware that this new measure will not have effect for any expenditure in ‘single asset’ pools as they have special rules that bring them to an end at a specified time.

Companies will not have to claim the maximum allowance in respect of the balance in their small pools.  Companies with a main or special rate pool of £1,000 or less can claim less than the whole residue if they prefer – it’s all down to tax planning.

Industrial and agricultural buildings

In his 2007 Budget, the Chancellor announced the gradual withdrawal of IBAs and ABAs over four years as follows:

• in 2008-09 or financial year 2008, a business will be entitled to 75% of the WDA;
• in 2009-10 or financial year 2009, a business will be entitled to 50% of the WDA; and
• in 2010-11 or financial year 2010, a business will be entitled to 25% of the WDA.

Illustration

A company has a chargeable period which commences on 1 January 2008 and ends on 31 December 2008.  Its annual entitlement to IBAs will be made as normal and that amount will then be time-apportioned.  If we consider that we have already calculated the annual amount to be £46,000 the time apportionment calculation would be as follows:

1 January 2008 to 31 March 2008 = ¼ x £46,000 x 100% = £11,500
1 April 2008 to 31 December 2008 = ¾ x £46,000 x 75% = £25,875
Year end 31 December 2008 = total IBAs deductible = £37,375

Then

1 January 2009 to 31 March 2009 = ¼ x £46,000 x 75% = £8,625
1 April 2009 to 31 December 2009 = ¾ x £46,000 x 50% = £17,250
Year end 31 December 2009 = total IBAs deductible = £25,875

Conclusion

The 2007 Finance Act which was examined up to the December 2008 session was half the size of Finance Act 2008.  Finance Act 2008 affects almost all taxpayers and so brings with it huge changes which will have a significant impact on the examination of tax papers being examined under Finance Act 2008 for the first time.

My next article is going to look at the significant changes in Capital Gains tax, residence and domicile and the new powers HMRC now have with their new ‘penalty regime’.

Steve Collings FMAAT ACCA DipIFRS is Audit Manager at Leavitt Walmsley Associates (http://www.lwaltd.com) and a partner in AccountancyStudents.