Understanding the philosophy behind tax changes

While it is the tax changes themselves that grab the headlines, understanding the policy and philosophy underpinning them is essential


tax changes

Tax and tax changes are always big news but it got even bigger recently with the outing of the so-called Paradise Papers. 

I know you will be reading this after the Autumn Budget speech and I will probably have to wait another year now before marketing can begin but I really think that the idea of a Budget Advent Calendar might take off.

Each window would have a tax change risk on the outside, depicting the “pane” of taxation (sorry), and inside would be a legitimate strategy for minimising or circumventing that risk. The perfect pre-Budget gift for all self-respecting advisers to send to their clients.

Tax is always big news but it got even bigger recently with the outing of the so-called Paradise Papers – the latest leak to the press on how the mega rich and famous hold and invest vast sums offshore.

As with last year’s Panama Papers leak, the documents were obtained by the German newspaper Süddeutsche Zeitung, which called in the International Consortium of Investigative Journalists to oversee the investigation. The Guardian is also among the organisations investigating the documents.

Complex structures
Without going into too much detail, many of the stories focus on how politicians, multinationals, celebrities and high-net-worth individuals use complex structures of trusts, foundations and shell companies to protect their cash from tax officials or hide behind a veil of secrecy.

While some of what the papers reveal will involve structures designed to hide sums from taxation in jurisdictions in which the provider of funds has a tax connection, it will also be highly likely many of the actions taken are legal and permissible.

Of course, it will all depend on the detail and significant attention will undoubtedly be given to the richest and most famous individuals and multinationals. In the case of the latter, the old trick of booking profits through low-tax jurisdictions and, as a result, paying a small rate of corporation tax in relation to profits generated is one that will continue to be subject to great scrutiny.

But aside from what may emerge from the detail of this latest exposé, it is important advisers considering an offshore solution for a client make it clear such a product is not automatically subject to challenge.

There are perfectly legitimate (mundane, even) offshore solutions in the mainstream of UK financial planning: offshore bonds, offshore funds (reporting and non-reporting) and even offshore trusts are clearly provided for in the legislation. So make sure clients are wary of the somewhat sensationalist press on this area of taxation.

Direction of travel
If you want to get a considered view on the factors influencing the direction of travel for taxation, you could do worse than spend a little time looking at what the Institute for Fiscal Studies has to say.

Each year, about a month before the Budget, the IFS publishes a Green Budget examining the economic and fiscal background to the Chancellor’s announcements. The Spring Budget edition ran to over 300 pages, with contributions from not only the IFS but Oxford Economics and the Institute of Chartered Accountants in England and Wales as well.

Before the Autumn Budget, the IFS alone published a less wordy version of its normal report. Entitled Autumn 2017 Budget: Options for easing the squeeze, it looks back at March’s Budget, what has happened since and the Chancellor’s resulting policy options on tax, welfare spending and public service expenditure.

This background should have provided some useful understanding of the economic and policy factors underpinning some of this week’s Budget announcements.

The IFS started by noting that the March Budget was presented alongside an assumption that government borrowing for 2016/17 would be £51.7bn (after adjustments). In the spring, the Chancellor was aiming for two longer-term goals:

1. The structural deficit – i.e. the core government deficit ignoring any temporary strength or weakness in the economy – should be below 2 per cent of national income in 2020/21.

2. The deficit should be eliminated by the mid-2020s.

The Office for Budget Responsibility’s calculations at the time suggested the first of these was something of a certainty, while the second was less so – and conveniently outside its standard five-year forecast period.

The latest estimate for the 2016/17 deficit is now £45.7bn, £6bn below the March figure. The IFS estimated that for 2017/18 the deficit “might come in at around £51bn, or around £7bn lower than forecast” in March.

Like the OBR, the IFS does not expect the rosy picture from the first six months to be repeated in the next six. The reason for the difference is that in 2016/17 the Treasury benefited from one-off balance payments due on the large dividend payments made in 2015/16, ahead of increased rates of dividend taxation.

There are perfectly legitimate (mundane, even) offshore solutions in the mainstream of UK financial planning. So make sure clients are wary of the somewhat sensationalist press on this area of taxation 

This is something many advisers will have been aware of and even implemented themselves in relation to their own business. Remuneration planning remains an important facet of the overall financial planning strategy for SMEs and one advisers should be centrally involved in with the business’ accountants.

Decreasing the deficit
The IFS has some interesting figures showing what has happened since 2007/08 (pre-crisis) to 2017/18. Government borrowing, as a proportion of national income, is virtually the same: 2.8 per cent in 2007/08 against an estimated 2.9 per cent in the current year. En route borrowing reached 9.9 per cent in 2009/10, which marked the peak effect of the financial crisis.

Over the 2007/08 to 2017/18 period, spending is up 0.5 per cent of GDP, while government receipts (primarily taxes) have risen 0.4 per cent. But this does not tell the full story.

Between 2007/08 and 2009/10, spending rose by 6.1 per cent and receipts dropped by 1.1 per cent, whereas since 2009/10 spending has fallen by 5.6 per cent and receipts have risen by 1.4 per cent (roundings creep in here for those keeping count).

Money Marketing’s Budget round-up

Thus, bringing the deficit back to pre-crisis levels has been 80 per cent achieved via expenditure cuts. This helps to explain why there are growing calls for an increase to government spending, despite the March Budget’s plan of £24bn in further cuts by 2020/21.

Last month, the OBR said it will be cutting its assumption about productivity growth in its Autumn Budget numbers and the IFS has examined what this might mean for public finances.

It has set out three different scenarios, from a “moderate” downward adjustment in line with the Bank of England’s current estimates to a “very poor” scenario in which output per hour grows by just 0.4 per cent a year.

All other things being equal, only the moderate scenario keeps finances firmly on track for 2020/21 under the 2 per cent borrowing target. The middle “weak” scenario wipes out half of the headroom in the March Budget, leaving a 1.5 per cent deficit, while in the “very poor” scenario borrowing is over 2.5 per cent. Thus, the OBR’s productivity growth decision was said to be a key point to watch on 22 November.

Ease the squeeze
It is interesting to see what the IFS stated in relation to what options Chancellor Philip Hammond had open to him:

“…given that this is the first Budget since a general election, we might have expected some tax rises to be announced this time around. However, the Chancellor must balance the needs of the economy, strains on public services and other pressures with the costs of having higher debt. Much of the public debate in the lead-up to the Budget has been about ways to ease the squeeze rather than options for reducing borrowing, and any takeaway measure would have to pass a vote in the House of Commons – no small challenge given current parliamentary arithmetic.”

In terms of specific tax changes, the IFS states “a 1 percentage point increase in all income tax rates, or all employee and self-employed NICs rates, would each raise around £5.5bn. And either would do so in a progressive manner – i.e. the takeaway would, on average, represent a larger share of the incomes of higher-income households than of lower-income households.” However, it then said, with more than a tinge of regret I suspect, “In practice, these options appear politically infeasible.”

Corporation tax in particular was in the IFS’ sights, with the 2020 cut to 17 per cent coming at a cost of £5bn. The IFS stated that maintaining the 19 per cent rate would still leave the UK with the lowest headline rate in the G20. Especially given the continuing Brexit uncertainty, maintaining at least an attractive corporation tax rate seems essential to competitiveness.

In its conclusion, the IFS stated: “When faced with similar changes in forecasts, his [the Chancellor’s] predecessor tended to offer small giveaways in the short term, with a medium-term takeaway offsetting only a relatively small proportion of the overall downgrade.”

The final sentence is perhaps the most telling: “Given all the current pressures and uncertainties – and the policy action that these might require – it is perhaps time to admit that a firm commitment to running a budget surplus from the mid-2020s onwards is no longer sensible.”

While it is the actual tax changes that tend to grab the headlines, understanding the policy and philosophy underpinning them is essential. Having the back story facilitates more informed conversations with clients and other professionals about tax changes, their drivers and appropriate planning to improve financial wellbeing.

Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn



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