Ernst & Young: Some tough choices

After several years of defending his management of the UK economy, this could well be the pre-Budget report in which the chancellor finally has to admit that fiscal tightening is a necessity. It is far more likely, however, that he will attempt to bolster revenue by announcing a series of complex measures under the auspices of ‘reform’ or ‘anti-avoidance’.

With consumer confidence being a real concern for the chancellor, he is unlikely to make any sudden movements when it comes to the taxation of individuals. In fact, he is far more likely to stand up with a package of measures that, despite being little more than inflationary increases, will allow him to talk at length about his support of the elderly, the young and those on low incomes.

- The standard personal allowance is likely to be increased by the rate of inflation as will the various rate bands and the national insurance thresholds.

- The increase in personal allowances for those over 65 may be set at an amount that is nominally higher than inflation. This is likely to be accompanied by the continuation of the £200 winter fuel payments for the elderly (the ‘winter warmer’).

- Following a year of questionable publicity on the issue, the chancellor may be forced to make some sort of statement on tax credits. He will undoubtedly reiterate the benefits of the current system but may well add an announcement of a review of the regime with a view to simplification or rationalisation.

- Inheritance tax remains the one major tax not to have been reformed by this chancellor but any changes in the pre-Budget report are likely to be confined to a consultation exercise. The current system under which a gift is not subject to inheritance tax if the donor lives for a further seven years after it is made (known as a potentially exempt transfer), which in practice only really helps the rich, could be up for review although it is likely that any changes here would be accompanied by a series of reliefs.

- Any budgetary shortfall that the chancellor needs to cover is likely to come from a series of measures that will be perceived to hit those who can afford to pay. An example would be the development land tax to target those who own land that has increased in value following the grant of planning permission. It is questionable, however, whether the chancellor would introduce such an unpopular measure at this stage.

- Tax relief (particularly eligibility for enterprise investment scheme and venture capital trust relief) for those who have invested in the Alternative Investment Market (London’s stock market for growth companies) may be restricted to investment in smaller companies

This all leaves the chancellor with no real alternative other than to attempt to raise revenue from businesses:

- The consultation on small business taxation which was announced last year should have reached a conclusion, and we may well see a further ‘tightening’ of the regime for owner-managers, potentially undermining the chancellor’s enterprise agenda.

- The larger corporate tax reform programme seems to have lost real impetus both from business and the Government - yet with policy experts from the old Inland Revenue and HM Customs and Excise now formally inside HM Treasury this is a good time for fresh thinking.

- We expect yet more anti-avoidance measures reflecting the disclosures made to HMRC, and stamp duty is likely to feature since it has only recently been brought within the regime. Inheritance tax could also be brought within the disclosure regime.

- One sector will see some movement, however. The Gambling Act comes into force in 2007 and will impact both the physical and online gambling sectors. It would be irresponsible to leave the tax implications until the last minute and the chancellor is expected to pre-empt the Act and provide certainty for operators by announcing a reform of the gambling tax regime in this pre-Budget report.

- On the plus side, the chancellor is likely to reinforce his commitment to research and development by announcing the enhancement of the tax credit to provide support to the emergence of a new group of world leading innovative firms.

- The chancellor is under increasing pressure to follow up on the consultation on real estate investment trusts (REITs) so may use the pre-Budget report as the vehicle for announcing the implementation of a new regime.

Economic pressure means that the chancellor is performing a balancing act with the need for revenue on one side and the competitiveness of UK businesses on the other. To date, he has just about managed to stay on track but introducing more anti-avoidance measures in this pre-Budget report could push more businesses to consider investing or relocating outside of the UK. The chancellor has some very difficult decisions to make before he stands up to give his speech.