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Tax policy documents (and my thoughts) and Covid-19 150 150 AJ

Tax policy documents (and my thoughts) and Covid-19

HM Treasury and HMRC have set out new timelines for tax policy consultations and other work in the light of the current Covid-19 crisis. As I comment further below, this is welcome news but I would have gone much further…

In summary:
• There will be a three-month extension to many consultation deadlines to give stakeholders time to submit their views
• The extension will ensure that those facing Covid-19 disruption will have a chance to have their say on possible tax changes
• Despite the extension of publication deadlines, due to Covid-19, the government remains committed to all planned reforms

The government is extending deadlines to ten consultations and calls for evidence currently underway by three months and also a short delay to the publication of other documents announced at Budget 2020.
The extension will give all stakeholders, who are facing disruption due to COVID-19, more time to submit their views and allow them to fully engage with these documents and contribute to the tax policy making process.

The government says it is grateful for responses already received, and would welcome further early responses from stakeholders where possible, to support its continuing consideration of these issues.
The Financial Secretary to the Treasury Jesse Norman said:

“Consulting on tax policy is crucial to good tax law. And a good consultation makes sure everyone with an interest in the subject has an opportunity to have their say.
That is why we are extending these deadlines. The government is very grateful to the stakeholders who have already responded to these documents. But it is also acutely aware that there may be others who want to contribute but cannot do so because of the current situation with Covid-19. This extension should help them to do so.”

Alongside the consultation extensions, the publication of some documents announced at Budget 2020, including work on tax conditionality and a consultation on stronger penalties for tobacco tax evasion, will be pushed back until the Autumn. And the government will set out in due course when it will publish other tax policy documents, including the consultation on aviation taxation and a call for evidence on disguised remuneration schemes.

Is the delay long enough though? It’s claimed that an extra three months should allow sufficient time for engagement, whilst still enabling the government to deliver important tax policy changes within the current fiscal timetable. I disagree. We’ve already had the farce of a Budget, which within days proved to be a complete fiction as the economic rulebook was re-written almost overnight. How can we possibly say with any certainty, within the next three months, what the economic situation will be? Surely it would be far better to simply ditch all the proposed changes and start again from scratch.

We know there will have to be a re-writing of the tax code. It’s obvious. We will all have to pay more taxes. Ways of working will change beyond recognition, as they already have done. That will make current plans for off-payroll working completely redundant. The distinction between earned and unearned income will have to go, as will the discrepancy between capital gains and income.

But that’s for another day and I will be writing more on that over the coming weeks.

For what it’s worth, though, whilst the government continues to try and pretend that fiscal and economic life can go on much as before, here is a full list of the extension announced.

Full List of Extensions
The deadlines for responses to the following tax policy documents will be extended for three months, to allow stakeholders to engage fully with these documents and to contribute to the tax policy making process. However, the government encourages early responses from stakeholders where possible, to support its continuing consideration of these issues:
• Plastic Packaging Tax: Policy Design – now closing on 20 August 2020
• Preventing abuse of the R&D tax relief for SMEs: second consultation – now closing on 28 August 2020
• Tackling Construction Industry Scheme abuse – now closing on 28 August 2020
• Notification of uncertain tax treatment by large businesses – now closing on 27 August 2020
• Vehicle Excise Duty: call for evidence – now closing on 3 September 2020
• Call for evidence: raising standards in the tax market – now closing on 28 August 2020
• Consultation on the taxation impacts arising from the withdrawal of LIBOR – now closing on 28 August 2020
• Hybrid and other mismatches – now closing on 29 August 2020
• Tax treatment of asset holding companies in alternative fund structures – now closing on 19 August 2020
• Consultation: HMRC Charter – now closing on 15 August 2020

Budget Commentary 150 150 AJ

Budget Commentary

This was the first Budget of the new government, the first Budget for 18 months, and the first Budget of the new Chancellor, Rishi Sunak. It followed a Bank of England interest base rate cut from 0.75% to 0.25% (50 basis points) announced earlier in the day.

Whilst the first Budget of a new Parliament usually sets the tone for the next few years, often gets rid of “bad news” well before the next election, and possibly takes some longer-term decisions that will gradually impact over the lifetime of the Parliament, this one was focused on one main issue – the coronavirus impact which the Chancellor went straight into in his first sentence. But the Chancellor also said that the Budget would deliver on the change that was promised at the General Election and was a Budget for prosperity. He then set out massive spending plans and promises. I will leave it to you to work out how this is all going to be paid for!

As always, much of the tax detail was not announced and was only apparent when reading the Treasury Press Releases and other documents which were released as soon as the Budget Speech ended. But the real detail will not be known until the Finance Bill is published on Thursday 19 March. From a first look, however, other than the measures discussed below there is very little to get excited about and certainly no major surprises.

This summary focuses on the key tax changes and does not consider the public spending and investment announcements that were made (and there were many of them!).

Here are the key points which we know so far.

The headlines (further detail below)

  •  Entrepreneurs’ Relief major change.
  •  R&D tax credit PAYE cap delayed until 2021.
  •  Off-payroll working/IR35 to proceed with effect from 6 April 2020.

Help for businesses in response to coronavirus

  •  “Time to Pay” service to be ramped up with immediate effect to ease burden for businesses affected by COVID-19, which may be able to agree a bespoke Time to Pay arrangement. To ensure ongoing support, HMRC have made a further 2,000 experienced call handlers available to support firms when needed.
  •  New temporary coronavirus business loan scheme.
  •  Business rates for this year to be abolished for many businesses in the retail and leisure sector.
  •  Any business eligible for small business rates relief will get £3k cash grant as a one-off payment

Entrepreneurs and innovation

  • Major reform to Entrepreneurs’ Relief (ER). Lifetime limit on gains eligible for Entrepreneurs’ Relief to be reduced from £10 million to £1 million from today (ie with immediate effect). This will affect all eligible CGT disposals carried out from today. Whilst this is unwelcome, and fails to address the structural complexities of ER, it is a “quick fix” way of addressing many of the concerns and pressures that the Chancellor faced. It is claimed that 80% of those using the relief will be unaffected.
  •  Review of the Enterprise Management Incentive Scheme (EMI) to see whether more companies should be able to access it.
  •  Research & Development Expenditure Credit (RDEC) rate to increase from 12% to 13% from 1 April 2020.
  •  Consultation on whether expenditure on data and cloud computing should qualify for R&D tax credits.
  •  SME R&D scheme PAYE cap to be delayed until 1 April 2021 (was to be 1 April 2021). Consultation on the design of this to ensure that eligible businesses are not penalised.

Business tax

  •  Corporation tax rate to remain at 19% (as expected).
  •  Structures and buildings allowance to rise to 3% from 1 April 2020.
  •  Reforms to Intangible Fixed Assets regime.
  •  Off payroll working/IR35 proceeds from 6 April 2020 subject to some minor changes.

Personal taxes

  •  Savings tax and ISA limits unchanged.

Anti-avoidance

  •  Extra funding for HMRC to secure £4.7 billion of additional revenue over period to 2024-25.

Duties

  • All alcohol and fuel duties frozen.

Other issues

  •  Additional 2% SDLT for non-residents purchasing residential property in England and NI from (1 April 2021).

Our immediate thoughts

This was a Budget full of spending promises but very light on tax policy changes or addressing some of the complexities/inequalities in the tax legislation.

Changes to Entrepreneurs’ Relief were expected, but the proposal is a very crude attempt to address the issue. Whilst we have yet to see the small print of the Finance Bill, at this stage it appears that little has been done to make the relief easier to understand and qualify for. Maybe, with only £1 million of relief now available, the Chancellor didn’t think that detailed legislative changes were necessary. To put this into context, the relief is now only going to be worth £100,000 maximum (10% x £1 million). In my view, this is hardly an incentive to take entrepreneurial risk. Far better, in my opinion, would have been a reintroduction of some form of retirement relief which rewarded longer-term investment in entrepreneurial businesses.

Another missed opportunity is in the area of R&D tax credits. Whilst the delay to the introduction of the PAYE cap is welcome, ditching the idea completely and increasing the rate of enhanced relief from 130% to 150% would have been far more welcome.

As for off payroll working/IR35, we appear to be stuck with it, subject to some minor tinkering.

Given the times that we’re in I was maybe hoping for too much. Perhaps the Autumn Budget when, hopefully, COVID-19 is not so high on the agenda, will be the time for more radical legislative change. Let’s hope so.

And as a final point, what about life after Brexit (remember it?!). It was barely mentioned…

11 March Budget predictions 150 150 AJ

11 March Budget predictions

On 11 March, Sajid Javid will present his first Budget as Chancellor of the Exchequer, which will also be the first Budget in nearly a year and a half. It’s also the first Budget presented by a government with a sizeable majority in Parliament for a decade or so.

The first Budget of any new Parliament is normally the one where the Chancellor has the political capital to make some major reforms, as it gives, potentially, five years to major on the welcome news and five years for people to forget the bad news!

What can we expect?

We don’t yet know what sort of Chancellor Mr Javid will be; more like George Osborne who liked to pull rabbits from hats, or more like Philip Hammond who adopted a cautious approach of announcing, investigating, and only then implementing changes.

Encouraging business investment will be high on the Chancellor’s agenda and it has already been announced that the rate of research and development expenditure credit (RDEC) will increase from 12% to 13%. But I’m hoping that the proposed re-introduction of the “PAYE cap” for SMEs claiming repayable R&D tax credits will not be implemented. Equally, the Structures and Buildings allowance will be increased from 2% to 3% to encourage businesses to start building new business facilities. And will the Chancellor finally make large scale investments in green technology?

Tax raising measures

There will, of course, be tax raising measures although, as usual, most are likely to be portrayed as action to prevent tax avoidance and refocus incentives.

Capital Gains Tax and Entrepreneurs’ Relief

I hope not, but I fear that there will be significant changes to Capital Gains Tax (CGT), with a review of Entrepreneurs’ Relief (ER) having featured in the pre-election material of the Tory party, with an increasing amount of speculation that ER might be reformed or even abolished at the Budget.

CGT is often perceived as a tax on the wealthy and increases in CGT rates may well be popular amongst the newly converted Conservative voters in former Labour strongholds. At 20%, the headline rate of CGT is fairly low, although the 28% headline for residential property is more significant. My prediction: a flat rate of CGT at 30% with a modification of ER or the re-introduction of Business Asset Taper Relief (remember it?) to tax long-term entrepreneurial gains at a lower rate (maybe 15%?).

Some taxpayers may be considering triggering gains, looking to lock into current regimes ahead of the Budget announcements, or otherwise ahead of the tax year-end.

Off-Payroll Workers

Another area in which change is rife is off-payroll working – freelancers and the so-called gig economy. The latest planned changes to the so-called IR35 rules (extending to the private sector the rules introduced for public sector workers a couple of years ago) are subject to a recently announced review. The review is due to be finished by mid-February and any changes arising are likely to feature in the Budget in time to be implemented by the scheduled change date of 6 April 2020. Those working on a non-employed basis certainly need to keep appraised of developments and the likely changes they are going to face in the new tax year, although current thinking is that the scheduled changes will not be altered significantly, and contractors will need to prepare for the new regime.

Tax Avoidance

This has been a recurrent topic in recent Budgets, and one could be forgiven that tax avoidance is the answer to the former PM’s “money tree”. Immediately after the election, we saw the publication of the loan charge review and HMRC’s surprisingly swift response to it. Most of the changes recommended will need to be legislated, so are likely to feature in the Finance Bill.

My wild cards

Let me pull two rabbits out of the hat. Both are ripe for changes for differing reasons.

Inheritance tax: an all-party parliamentary group of MPs has recently recommended major reforms to inheritance tax (IHT) – and echoed comments from the Office of Tax simplification last year that IHT is far too complex and outdated. The Chancellor might choose to increase the basic relief (the nil rate band) but collect more tax in the long term by removing/restricting complex reliefs (the main residence nil rate band, exemption for gifts out of income, business property relief qualifying rules etc.). My prediction: a flat rate of IHT on both lifetime and death disposals with no nil rate band, no reliefs, and no complex anti-avoidance rules such as the gifts with reservation or pre-owned assets test.

VAT: EU membership has prevented us from doing very much with VAT. Now “this thing has been done” we can be more flexible with VAT. Not a prediction but my wish: Varying rates of VAT, so, for example, a rate of 25% on “luxury” items, 15% on normal items, zero% on essentials such as light, heat, food, children’s clothing etc.

As always, we will be analysing the Budget speech and the press documents that are released by the Treasury the moment the Chancellor sits down, and posting our analysis soon after the end of the speech.

Retirement relief to Entrepreneurs’ Relief – the next stage of the journey?… 150 150 AJ

Retirement relief to Entrepreneurs’ Relief – the next stage of the journey?…

When I started my career in tax, we had Retirement Relief; very few people will remember it. Then we had Business Asset Taper Relief; some of you will remember that. Now we have Entrepreneurs’ Relief; but for how much longer?

According to a recent article in The Times, this “loophole” (really? It is a Government incentive backed by comprehensive legislation) has “scandalised tax experts for years” and cost the exchequer more than £2bn each year.

For the uninitiated, Entrepreneurs’ Relief effectively reduces the rate of capital gains tax (CGT) on the disposal of qualifying businesses and business assets to 10%. It is designed to encourage enterprise, entrepreneurship and risk-taking. It helps people to recycle businesses, to bring in new management with fresh ideas, to breed a generation of serial investors (the lifeblood of many early-stage businesses) and to take risks that they might otherwise not be minded to take. It breeds multiple Dens of Dragons!

But is the relief now too generous? Many people think it is. I don’t.

Those who criticise it take the “fat cat” view on life. They think that all it does is reward the wealthy who have already made their riches and doesn’t really encourage entrepreneurship. Really? What about all the new jobs it creates, with the associated tax-take for the exchequer. What about the VAT and duties it generates? What about the physical and mental well-being it engenders in people involved with a thriving, new, exciting business?

Some people go as far as to say that the tax system shouldn’t have a part in rewarding and incentivising entrepreneurship? Fine, if we want a nation of 9-5 workers, and to rapidly fall away as a nation fit to compete on the world stage.

Whatever/whoever is in power in government in the months ahead, examine the system by all means. But please don’t make hasty decisions. Consider it in the round, along with incentives such as SEIS/EIS, R&D tax credits, Patent Box, EMI share schemes, IHT Business Property Relief etc.

It would be a disaster if misinformed, politically ideology led to hasty and misguided decisions on fiscal policy.

Tax policy – some personal thoughts and interesting statistics… 150 150 AJ

Tax policy – some personal thoughts and interesting statistics…

What do politicians want to do with tax? They want to raise revenue to fund public spending and they want to use tax policy as a political carrot. Clearly the two completely contradict each other.

Most people don’t like paying tax. It’s the nature of my work that a lot of people ask how they can “get round the system” or “isn’t there a way I can do this tax-free”? My answer is always that I will help them to ensure that they pay what is rightly due, that I will ensure that all reliefs and allowances are claimed, and that where there’s more than one way to do things, I point out the most tax-effective way. That’s where my tax planning ends.

Personally, I consider it a privilege to pay tax. Why wouldn’t I? And I’m going to risk my clients’ wrath by saying that I think I should pay even more tax than I currently do. Yes, I’d notice it. Yes, it would hurt. But equally, I can afford to do so, even if it means making some sacrifices. Many people don’t have that luxury, though.

So, where do our taxes go? As the economy has grown, so has the tax-take. In 1980 the tax receipts were some £69bn. This year the tax-take will be almost £770bn, an increase of well over 1000%, and well in excess of the compounded rate of inflation. The bulk of our tax comes from three sources: income tax, VAT and national insurance. Over 40% of our entire tax-take comes from taxes on personal income (income tax and NICs). This is somewhat higher than the OECD average and many of our key trading partners such as France and Germany.

But as the nature of trade and work changes, some of these taxes might be vulnerable. Self-employment, less spending on luxury items, a move to a more digital economy: all these could potentially erode our tax base.

I’m not a politician, but there’s much for the politicians to be worried about. There needs to be transparency, scrutiny, accountability, and most importantly a long-term view. At the moment a day seems a long time in politics. Should we be worried?…

The tax gap – and the next PM wants to cut taxes further… 150 150 AJ

The tax gap – and the next PM wants to cut taxes further…

HMRC has recently published the 2019 edition of Measuring tax gaps which shows estimates of tax lost in 2017/18. Worryingly, the “gap” for 2018/18 is estimated at £35 bn, or 5.6% of total tax due. The 2017/17 figure was £33 bn (5.7%), so little progress has been made in reducing this.

How does this fit, then, with our next PM’s wish to cut taxes? A 14th-Century Islamic scholar, Ibn Khaldun, was the original tax-cutter. He argued that lower taxes stimulate activity, which creates wealth and that generates more tax receipts. This is the concept behind the Laffer curve. Some 500 years after Khaldum’s first postulation, Art Laffer, the American economist, picked up the theme during the Nixon administration. He explained that there is an optimal rate of tax somewhere between zero (where no tax would be collected) and 100% (which would deter anyone from work and hence raise nothing either). The simplicity of this logic stuck and became the theoretical foundation for reforms by both Ronald Reagan and Margaret Thatcher.

The Laffer curve is clearly enjoying a revival today. When President Trump slashed taxes in the US, the Treasury secretary claimed “the tax plan will pay for itself in economic growth”. Now, it appears, our next UK PM wants to do the same thing.

There’s a big problem though. In order to be effective, you need to know where the Laffer curve peaks – and no one does! It moves around according to the sophistication of tax lawyers and accountants, social mores, and perhaps, most importantly, the effectiveness of the tax system in collecting the taxes due.

So, we’ve completed a virtuous circle!

If we look at the 2018/18 tax gap, the largest share is due to income tax, NICs and CGT at £12.9 bn. This includes £7.4 bn in respect of self-assessment of which £4bn is attributable to the self-employed. The VAT gap is £12.5 bn whilst corporation tax accounts for £5.2 bn.

Demographically, the largest culprit is small businesses, followed by large businesses, mid-sized businesses and finally, individuals.

Behaviour-wise, criminal activity amounts to £4.9 bn, the hidden economy and tax evasion accounts for £3 bn and £5.3 bn respectively. Avoidance accounts for £1.8 bn.  Errors and mistakes amount to a staggering £9.8 bn.

So, what are my conclusions about both the tax gap and tax rates in general?

  • Tax evasion and illegal activities account for seven times as much as tax avoidance. The focus should, therefore, be on reducing the former and not making the tax system even more complex by addressing the latter which also has the knock-on effect of penalising many innocent and commercially-driven decisions.
  • Make the tax system simpler. If so much is lost due to mistakes, making the system even more complex is simply daft.
  • Address practice, not theory. The Laffer principle is a great hypothesis, but impossible to get right.
  • And finally, on a personal note, let’s stop being greedy and pay our taxes (the correct amount – not more or less) with good grace, thankfulness, and optimism (hopefully not mis-founded) that they will be used wisely.
Innovation – why we’re missing a trick… 150 150 AJ

Innovation – why we’re missing a trick…

Innovation – why we’re missing a trick for early-stage financing

There’s a market failure in financing early-stage technology companies. Anyone who watches “Dragons’ Den” will know there’s a fine balance between risk and reward, but for early-stage technology companies, a number of factors combine to make this an extremely tough area. The thoughts and solution outlined below are the result of input from several authors experienced in the creation of innovative technology-based companies, an important component in creating a robust future economy.

We argue that there could be a government intervention-based solution that is easy to implement, could provide positive returns to both Government and the entrepreneurs, ultimately benefiting the UK economy as a whole and ensuring that the UK remains at the forefront of innovation.

The key issue is ‘liquidity’; to be more precise the key problem is absence of liquidity for the high-risk entrepreneurs, management teams and angel investors that create new innovative companies. That is, early-stage investment funds and management teams become locked in to their investments, often having to wait a decade or more to secure any return.

Recycling the entrepreneurs and skilled early-stage management teams is critical for optimising the growth of new innovative companies, as is the ability for investors with specialist early stage capability to realise gains quickly in order to re-invest in further new opportunities.

The proposed solution is a government-backed fund that is structured to provide the opportunity for these key individuals and investors to do exactly that – realise gains and move on to the next opportunity.

Here are some of the elements that combine to create the market failure:

  1. Investment Managers specialising in genuine early-stage investment are becoming increasingly rare; they find it more profitable to come in when the technology has been proven, markets established and the commercial risk diminished. As a result, there are strong motivating forces at work driving those early-stage investment houses that are successful to move up the food chain to make larger Series A investments, and so on.  These economic drivers act to erode the availability of expert early-stage investment in the UK.
  2. The returns for specialist early-stage investors historically have not been very good.
  3. Although various mechanisms exist to enable very early investors and management teams to realise value, e.g. requiring existing shareholders and/or incoming new investors being offered the opportunity to buy out the early stage investors and at market value, they are rarely practiced.
  4. Early-stage investment funds often lack the scale to continue investing in their portfolios and there is uncertainty as to follow-on funding.
  5. Due diligence costs for early-stage investments are often just as large as later stage ones, and what actually is the due diligence performed on?
  6. Incoming late-stage investors usually insert ‘cascade’ structures that wipe out earlier funders (mitigated if the new fund provides support to the early stage investors to follow their investments).
  7. There’s a scarcity of high-quality, industry experts who have the managerial experience to steer start-up companies through early investment rounds and towards revenue generation.  This issue is a particular problem outside of the key technology clusters such as London, Oxford and Cambridge.
  8. Specialist start-up management teams, critical to establishing a robust company, but often not the right fit for later stage companies will need to be replaced by managers with other skills-sets as the business matures. But the incoming management will want a slice of the cake and would probably be unconcerned about the impact of diluting or even eliminating their predecessors’ rights.  These situations can result in the acrimonious removal of the early-stage management teams as ‘bad leavers’ who lose their stock options entirely.  This will clearly impact on the motivation of such management teams to recycle their skills in other early-stage opportunities that emerge.

A Possible Solution

A Government-backed fund, operating under specified conditions, to reward both early-stage investors and associated management teams for taking those very high early-stage risks could release these skills and capabilities to be recycled more efficiently. The same mechanism could be used to enable early high-risk investors / management to follow on their investment as an alternative. To some extent tax-favoured Venture Capital Schemes such as SEIS and EIS address this, but they have their limitations.

We propose a more fundamental solution, being a government supported fund mechanism. The fund would not only incentivise more early-stage activity but would also create a return to government over the long term. The fund would acquire an equity position but at a discounted value, i.e. it could buy early investor / management equity at a discount or, in the event the fund enabled an early investor to follow their investment the same discounting mechanism would be obtained by the supported investors / management agreeing to pass on a % of the economic value of any equity they dispose of in the future.

When the fund operates to buy equity, there would need to be clear 3rd party, independent validation of the value of any equity that is acquired, i.e. at the point of a new round of investment where unconnected parties are defining the value of the shares.  A Government-backed fund could buy early stage investors out at a clear discount (10%, 20%, 50%) without any State Aid issues and the % discount could be tuned to drive investment to the regions. Investment gain would be subject to corporation tax. The same mechanism could be used to reward management which of course would be subject to income tax or capital gains tax

Summary

In conclusion, the market failure in early-stage technology investment is not simply an aversion of technological risk or the traditional low return but rather is compounded by the lack of liquidity for all parties involved and the risk that early investors / managers will be ‘squashed’ by later stage investors and management teams. A mechanism for addressing this market failure has been proposed which is not only State Aid compliant but which can also be tuned to incentivise regional development. The liquidity created in both cash and (now) experienced management teams could be transformational.

It sounds easy; it is easy. If structured carefully it could provide positive returns to both Government and the entrepreneurs, ultimately benefiting the UK economy as a whole and ensuring that the UK remains at the forefront of innovation. bidi-

Spring Statement 2019 – the headlines 150 150 AJ

Spring Statement 2019 – the headlines

Short and to the point. What else could the Chancellor do with so much political and structural uncertainty surrounding this statement?

He said that the UK economy continues to grow, with wages increasing and unemployment at historic lows, providing a solid foundation on which to build Britain’s economic future.
With borrowing and debt both forecast to be lower in every year than at last year’s Budget, the Chancellor set out further investments in infrastructure, technology, housing, skills, and clean growth, so that the UK can capitalise on the post-EU exit opportunities that lie ahead.

Here are the key points:

  •  Growth forecast cut for 2019 to 1.2%
  •  UK will grow 1.4% in 2020, as previously forecast
  •  Chancellor to chair roundtable on minimum wage on productivity
  •  Borrowing to be £3bn less than forecast
  •  £37bn National Productivity Fund
  •  Landing paper cards to be ended for visitors from some countries
  •  £3bn for affordable homes
  •  end of fossil-fuel heating systems in all new houses from 2025
  •  Free sanitary products in schools in England next year
  •  Audit committees to review late payments
  •  Chancellor says no deal Brexit short-term hit to the economy
  •  UK to cut tariffs in no-deal Brexit

The Chancellor also confirmed that the Government will hold a spending review which will conclude alongside the Budget. We had expected much more on this now, but political uncertainty has dictated otherwise! This will set departmental budgets, including 3-year budgets for resource spending, if an EU exit deal is agreed. Ahead of that the Chancellor announced extra funding to tackle serious violence and knife crime, with £100 million available to police forces in the worst affected areas in England and Wales.

The Spring Statement is an opportunity for the Chancellor to update on the overall health of the economy and the Office for Budget Responsibility’s (OBR) forecasts for the growth and the public finances. He also updates on progress made since Autumn Budget 2018, and launches consultations on possible future changes for the public and business to comment on. The Spring Statement doesn’t include major tax or spending changes – these are made once a year at the Autumn Budget.

Tech and the new economy

Budget 2018 included significant additional support for cutting-edge science and technologies that will transform the economy, create highly-skilled jobs, and boost living standards across the UK. Today the Chancellor:

• welcomed the Furman review, an independent review of competition in the digital economy, which has found that tech giants have become increasingly dominant. The Chancellor announced that the government will respond later in the year to the review’s calls to update competition rules for the digital age – to open the market up and increase choice and innovation for consumers

• has written to the Competition and Markets Authority (CMA) asking them to carry out a market study of the digital advertising market as soon as is possible. This was a recommendation of the Furman Review

• committed to funding the Joint European Torus programme in Oxfordshire as a wholly UK asset in the event the Commission does not renew the contract, giving the world-leading experts working at the facility certainty to continue their ground-breaking fusion energy research

• invested £81 million in Extreme Photonics (state-of-the-art laser technology) at the UK’s cutting-edge facility in Oxfordshire

• boosted the UK’s genomics industry with £45 million for Bioinformatics research in Cambridge

• announced £79 million funding for a new supercomputer in Edinburgh – five times faster than existing capabilities – whose processing power will contribute to discoveries in medicine, climate science and aerospace, and build on previous British breakthroughs including targeted treatments for arthritis and HIV

• research institutes and innovating businesses will benefit from an exemption for PhD-level occupations from the cap on high-skilled visas from this autumn. Overseas research activity will also count as residence in the UK for the purpose of applying for settlement, meaning researchers will no longer be unfairly penalised for time spent overseas conducting vital fieldwork

The Budget – a missed opportunity for incentivising IP creation? 150 150 AJ

The Budget – a missed opportunity for incentivising IP creation?

Why do businesses create IP and what additional help do they need to encourage this? Incentives come in various forms, monetary or non-monetary, and they tend to be applied to induce product-orientated development ideas, which can be used in combinations of new and existing technologies and resources (Schumpeter,1934, writing in the Theory of Economic Development, published by Harvard University Press, Cambridge, MA).

But why are incentives needed? The reason is ‘risk’. Governments need to encourage companies to take risks to establish new products, new markets, and thus boost the economy. Without appropriate incentives, many companies will elect not to risk the uncertainty about the outcome of innovation. An innovative development may fail and even if it succeeds it may well take considerable time before the company can monetarise (earn money from) the new activity. Without government incentives the innovation needed to drive the economy forward by, for example, creating and using new IP, will be compromised as many companies will simply not take the risk.

So what forms of incentives currently exist and why, in our view, are these completely insufficient to maximise the potential of our innovation and IP creation leading to scaleable multi-national companies?

A significant barrier to IP creation is the raising of start-up and follow-on funding. Whilst there are reasonable incentives for early-stage individual investors (Seed Enterprise Investment Scheme [SEIS], Enterprise Investment Scheme [EIS] and Venture Capital Trusts) these incentive mechanisms are largely used by ‘smaller investors’, i.e. individuals who can support the very early stages of a company but do not have the ‘deep pockets’ to follow their positions as a successful company grows and needs further investment. This leads to a position where new, ‘larger investors’ are required to underwrite the subsequent funding rounds and, in many cases, this can create problems.

The larger investors can demand, and be successful, because the company needs the investment, a preferential position, e.g. via share class and associated rights, compared to the early (high-risk) smaller investors. The result; many would-be early-stage high-risk investors are put off making investments as they fear being ‘squashed’, i.e. being disadvantaged, by the later stage investors. The point where new relatively significant levels of investment is required to support exciting and scaleable companies, particularly technology-based companies, can be a failure point as the clash between the high-risk small investor and the more risk-averse large investor is not satisfactorily resolved.

This failure can result in the immediate collapse of the company but, more typically, results in shoe-string financial models where the small investors struggle-on; a pitfall that compromises economic growth. That is, the small investors continue to support the company as best they can but momentum and opportunity are lost. This scenario may simply lengthen the time the company takes to fail, or creates a company that, whilst it may survive, may never realise its original potential. So, can appropriate incentives be created that encourage yet more early-stage high-risk investors and avoid, mitigate or minimise the failure point described?

Analysing the issue suggests there is the possibility to design appropriate incentives. The objective is to create a smooth and as non-contentious a transition as possible from small, early-stage companies, that can thrive on hundreds of thousands of pounds to a rapidly-growing scaleable company that needs many millions of pounds of investment. One part of the equation is to encourage early-stage high-risk investment from all investors be they small or large. In the event larger investors are part of the initial investment they will have the ability to follow their money and resist any new investor demands for a preferred position. Larger funds typically take the view that the work involved in getting a £50k to £200k investment in place is as much work as placing a £5M investment and thus the effort and resources required to operate as a true early-stage investor simply are not worth the bother.

True early investment can lead to a higher per share return in the long term but if one has the muscle to buy in at a later de-risked stage and get a preferred position, vis-à-vis getting money out before others, why even bother looking at the early high-risk stage? So, to incentivise all investors who invest at the early-stage, perhaps a mechanism whereby capital gains on shares acquired in the initial round of investment (e.g. defined as the first £500k of investment) acquired shares is subject to a greatly reduced tax rate; perhaps 0%. This idea could be expanded to different levels of total investment, e.g. CGT rates of 5%, 10%, 15% and then ‘normal’ rates to apply to, for example the £0.5-10 M, £10-20 M ranges of investment. This increases the value of the early stages of investment and deals with the final level of return. Another way to attract the larger investors at the early-stage might be to introduce the equivalent of EIS and SEIS for larger corporates. It would not be difficult to introduce some form of corporate venturing tax break that encourages the largest companies to invest in early-stage venturing. It wouldn’t be complicated, nor indeed very costly in terms of tax revenue lost, to simply permit an additional tax deduction for investment by large corporates into smaller enterprises, rather like the current R&D tax credit regime for SMEs.

The mechanisms described above still fails to address the possibility that at a 2nd, 3rd or higher investment round the large investors could act together and form a structure that ‘squashes’ small investors with original ‘ordinary shares’. Tackling this could be possible if the tax breaks suggested above were only to apply to any CG arising from the disposal of shares that are equivalent in all respects to the ‘ordinary shares’ held by smaller investors. In addition, tax rules for any capital realised from shares that have any form of preferred position could be subject to a capital gains rate above the ‘normal’ rate, e.g. by a factor of 1.5 (a 50% uplift). Together the mechanisms, a mix of incentive to encourage early-stage high-risk investment and disincentive to create structures that ‘squash’ smaller high-risk investors, could drive behaviours that maximise economic outputs.

Investment in developing technical innovations, i.e. the creation of intellectual property (IP) could be further incentivised (de-risked) if some form of exemption was granted for the gains made when selling IP. The corporate tax substantial shareholding exemption (SSE) goes some way to providing this but it requires careful upfront tax planning and does not always sits comfortably with the company’s overall corporate structure and objectives.

The R&D tax credit system for SMEs has been a powerful and welcome incentive for over 15 years now. It is still unduly complex and many smaller companies still have the perception that it is hard to claim. Further simplification of this is required. The R&D tax credit regime for large companies needs to be far more generous. It seems anomalous that SMEs can claim a tax credits of 130% of qualifying expenditure whereas the benefits to large corporates is only 30%. Maybe there is a perception that large corporates do not need any tax break but the numbers do not back this up. There has been nowhere near such an increase in spending on R&D by large as there has been by SMEs since the R&D tax credit regime was introduced.

So, in a nutshell, the Budget was a missed opportunity. None of the suggestions above really cost very much in terms of tax revenue but the introduction of any of the would be a welcome boost to creation of IP and the chances of successfully scaleable growth by UK business.

The Budget 2018 150 150 AJ

The Budget 2018

Lots of small changes. Many one-off giveaways. Lots of headline-grabbing announcements. Legislative tinkering.

The Chancellor “Austerity is coming to an end but discipline will remain”.

So, the Budget was earlier than we were expecting, to avoid clashing with the final stage of Brexit negotiations in November. Of course, this is the final Budget when the UK is part of the European Union, so how the economy is prepared for the UK’s exit featured significantly in the speech.

Arguably, the nature of any deal struck with the EU – or the failure to reach any kind of deal – would have a much bigger impact on the nation’s finances than anything Mr Hammond has said in the Budget. The Chancellor has effectively said that in the event of a “no deal Brexit” then this Budget will be “torn up” and he will have to start again.

Much of what is detailed in Philip Hammond’s speech and in the red book has already been announced. We know that the government has committed to funding an extra £20billion for the NHS by 2023, and the Chancellor today announced a new, special allocation of funds for mental health crisis support. The PM has said that the borrowing cap for local councils wanting to build new homes will be scrapped. And there have been a lot of other Treasury announcements in recent days: potholes (£420 million), interest-free loans etc etc….

The main spending review will occur in the Spring and the outcome will be announced in the Spring statement. However, a few immediate plans were announced in the Budget, including £650m for local council social care, an immediate £1billion for defence, a one-off cash injection for schools, and £160 million for immediate counter-terrorism police resourcing.

Some basic background facts

A total of 31 million people pay income tax in the UK: 18 million men and 13 million women.
Some 25.6 million of these taxpayers pay income tax at the basic rate.

The amount earned a year before this basic rate of income tax is paid – called the personal allowance – stands at £11,850.

The current rate of corporation tax is 19% and is set to fall to 17%.

Here are the main headlines from both the speech and the small print subsequently issued (there’s lots of it, and we cover only the main points of direct relevance here).

Technology, innovation and entrepreneurship

  • A new “2% digital services tech tax” for global business with global profits in excess of £500 million. Note that this is not a digital tax on consumers but designed to stop multi-national established tech-cos from diverting real economic profit offshore. It’s quite a big deal for the UK to go alone on this without OECD/G20 cooperation.
  • Re-introduction of a PAYE limit for loss-making SME payable credit R&D Tax Relief with effect from 1 April 2020. This is to stop large R&D claims being made where little is paid by the companies in PAYE and to target some specific tax avoidance schemes. The payable R&D credit will be limited to three times the company’s total PAYE and NICs liability for the year.
  • CGT Entrepreneurs’ Relief was expected to be targeted. Thankfully it has not been abolished, but the holding period to obtain relief is being increased from 12 months to 2 years for disposals made on or after 6 April 2019. This will have an impact on shares held directly and on shares acquired through the exercise of EMI options. It has been confirmed that the changes made in 2017 to prevent the loss of ER up to the point when dilution takes a shareholding below 5% will not be affected. Under those rules, relief will be able to be made on gains up to the point when the shareholding was diluted to below 5%. (See also below under tax avoidance.)

My view: Could be better, could be worse. Nothing huge to discourage innovation and entrepreneurship but no great incentives either.

Businesses

  • No change to the planned reduction in the main corporation tax rate to 17%.
  • A new structures and buildings allowance and a temporary increase in the Annual Investment Allowance from £200K to £1million for two years from 1 January 2019.
  • Capital allowances special rate to reduce from 8% to 6% from April 2019.
  • Corporate capital losses to be treated in same way as trading losses, with a 50% loss-use restriction but with a £5million de minimis limit.
  • Subject to consultation, the introduction of targeted relief for the cost of acquired goodwill.

Personal taxes

  • Personal tax allowance and higher rate threshold to be increased so as to reach manifesto commitments by 2019, a year earlier than expected. The PA will be £12,500 and HRT will be £50,000.
  • Off-payroll working (“IR35”) changes to mirror those introduced for the public sector. The onus will be on the organisation to operate it. Effective from 2020 with exemptions for small organisations.
  • No significant changes to pensions and savings taxes.

VAT

  • Despite widespread predictions, the VAT threshold will not be reduced until at least April 2022.

Tax avoidance

Another raft of measures aimed at tackling tax avoidance and abuse, including:

  • Entrepreneurs’ Relief: as well as the current requirement on share capital and voting rights, from 29 October 2018 the shareholder must also be entitled to at least 5% of the distributable profits and net assets of the company.
  • Rules to counter profit fragmentation (extension of transfer pricing rules).
  • Consultation on a new market value rule for consideration liable to SD and SDLT.

What next?

We expect the Finance Bill (the draft legislation which Parliament will debate) to be published around 7 November.

When is the next Budget? It should be at about the same time next year, but lots can happen before then…..

There is the spring statement, usually in late February or early March, which updates the state of the nation’s finances.

There is always the chance of a mini-Budget, or a major financial statement of some kind, if and when a Brexit deal is announced.

If you need help or clarification…. Please speak to me

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