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Meeting the planned level of public expenditure and recouping funds lost from a projected decrease in VAT receipts may require the chancellor to consider some compensating tax increases. However, this must not preclude the imperative to introduce certain overdue tax cuts and simplifications to benefit both businesses and individuals.

The chancellor should also address in his pre-Budget report his position on the need for a cut in the main rate of corporation tax from 30% to, say, 25%. The 30% rate is beginning to look high and the chancellor should consider reducing this over the course of this Parliament in order to restore the UK’s historic competitive position.

Our predictions for the pre-Budget report are:

Tax increases

With public expenditure estimated to rise by double the inflation rate, from £519 billion for 2005/06 to £549 billion for 2006/07 (HM Treasury), the chancellor may be tempted to increase VAT rates to align the UK with a number of other European Union members. Currently the UK VAT rate stands at 17.5% compared to 19.6% in France, 20% in Italy and 21% in Ireland.

Similarly, the chancellor may be considering increasing employers’ and employees’ National Insurance Contributions, however this could well have a negative effect on employment.

Inheritance Tax

The chancellor is unlikely to change significantly the Inheritance Tax or Stamp Duty Land Tax systems or thresholds, but it is possible that the seven year survivorship rule for inheritance tax will be extended to ten years, thereby capturing inheritance tax over a longer period.

It will be difficult for the chancellor to raise the inheritance tax rate or lower the threshold as these moves would be very unpopular. As the price of the average home in the UK is now close to £200,000, many homeowners are set to be caught in the inheritance tax net.

A-Day

The chancellor may tighten legislation regarding investments that can be made in pension funds. We are concerned that the changes in pension rules from next April may encourage people to include, misguidedly, some inappropriate investments in their pensions.

UK - REITs

The chancellor has already indicated that he will make an announcement on UK Real Estate Investment Trusts in the pre-Budget report. We think it is likely he will give details for the roll-out of UK-REITs, which could be in place as soon as Spring 2006. We also think the chancellor may introduce legislation ensuring that non-UK resident investors continue to pay tax on their UK-REIT property source income.

Research and Development

The chancellor is unlikely to announce any significant new Research and Development measures in the pre-Budget report, however a continued interest in this area is expected.

European Court of Justice

Once again the chancellor is expected to follow his usual precedent of making no reference to tax case law decisions of the European Court of Justice in his pre-Budget report. If he makes an exception, it could be to mention the recent Halifax opinion given by the Advocate-General of the European Court of Justice for the pending judgement. This opinion appears to develop a general principle of anti-avoidance which the Treasury would find helpful.

Community Investment Tax Relief

As the purpose of the Community Investment Tax Relief (CITR) was to encourage community investments in disadvantaged areas, the investment opportunity should be sufficiently attractive to individual investors and financial institutions compared to alternative tax favoured investments such as Venture Capital Trusts (VCTs).

We hope the chancellor will look at simplifying CITR and aligning it with VCTs by increasing the tax credit to 40% of the amount invested in the first year with no relief available in subsequent years. This will bring only a modest additional cost to the Exchequer but could kick-start the creation of funds to deliver this important incentive.

Venture Capital Trusts

The very attractive current income tax break of 40% on Venture Capital Trusts (VCTs) was announced for two years and is scheduled to end in April 2006. No replacement measures have been announced as yet, but the chancellor has a number of options. A possible option would be to reduce the Income Tax break but introduce Inheritance Tax benefits. This would give VCT shareholders business property relief status. The benefit would be that if an individual held the shares for at least two years it would fall outside their estate for IHT purposes hence avoiding an IHT liability at death.

Non-Corporate Distribution (NCD) Rate

The chancellor may announce an increase in the non-corporate distribution (NCD) rate if the result of the Arctic Systems case, due to be heard in the Court of Appeal on 29 and 30 November, proves unfavourable to the Treasury.

In this case, one spouse chose to take a very small salary from the company profits and instead took most of the profits in the form of dividends paid to both himself and his wife. Dividends are currently taxed at a lower rate than income thereby reducing their tax bill significantly.

If the judgement were to be in favour of Arctic Systems, one way the Treasury could block the perceived loop-hole created would be to increase the NCD rate. This would, however, affect many other companies not involved in such arrangements.

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