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Last Updated: Wednesday, 21 March 2007, 15:44 GMT
Who will pay for the tax cut?
Analysis
By Anne Redston
Fellow of the Chartered Institute of Taxation

Anne Redstone
Tax expert Anne Redstone

This budget represents the biggest shake-up to the tax system for twenty years.

Gordon Brown announced significant and radical changes to income tax, personal allowances, small business taxation and investment reliefs.

Everyone's tax position will change - and as the overall package is roughly revenue neutral - so there are losers as well as winners.

It will also take some time before the full implications and interactions of the many changes become clear.

Income tax

The biggest Budget surprise was the cutting of the basic rate of income tax from 22% to 20% and abolition of the 10% band on non-savings income.

From April 2008 there will be only two tax rates for most income, 20% and 40%.

This is an important and welcome simplification of a very intricate system, although the retention of the 10% rate for savings income is a new complexity.

However, it is not all good news.

The more income you have in the basic rate band, the more you will benefit from the 2% reduction in basic rate.

Thus, those on low incomes who currently enjoy a 10% rate on earnings or other non-savings income, will suffer an increase in their tax bills - unless they can benefit from the increases to working tax credits.

People on the cusp of the higher rate band will have an increase in the threshold at which the higher rate becomes payable, but not until 2009.

Pensioners

Pensioners on low incomes will be sheltered from the full impact of the abolition of the 10% band, as the higher personal allowances for pensioners are also being increased.

But here again the position is not straightforward.

These higher allowances only available in full to pensioners on incomes up to a threshold - for 2007-8, for example, single pensioners aged between 65 and 74 will not receive any of the higher rate of personal allowances if their income is above 25,830.

The threshold for 2008-9 has not yet been determined.

So pensioners on middle to higher incomes may suffer from the cut in the 10% band but not have any compensating increase in their personal allowances.

Small business

Most businesses in Britain are small, and their proprietors have been dealt a heavy blow in this budget.

In his speech Mr Brown focused on the reduction in main Corporation Tax rate from 30% to 28%.

However, he also announced an increase to the small companies' Corporation Tax rate.

From April this year the rate will go up to 20%, rising a further 1% a year in the next two years until it reaches 22% in 2008 in April 2009.

Small businesses which invest in capital assets up to a value of 50,000 will however be able to benefit from a new "annual investment allowance (AIA)."

This is effectively a 100% capital allowance.

This AIA does not, however compensate for the increased tax rate - because under the current regime there is also 100% tax relief on capital assets - it is just available over a longer time period.

Thus the new AIA only provides a cash-flow benefit, and thus does not compensate for the real increase in tax rates.

Small businesses have thus swapped 3% of their profits in exchange for faster relief on capital expenditure.

The change does however encourage businesses to invest rather than withdraw funds from the business - and this is definitely one of the government's objectives in making this change.

Contractors

From 6 April there will also be new taxes on managed service companies (MSCs): these are packaged companies provided and run for individuals by an external firms.

HM Treasury estimates that there are at least 240,000 people, mostly contractors, who are working in this way.

In the Pre-budget report last December, the government announced new legislation under which all those working through these arrangements will have to pay the same National Insurance Contributions and tax as employees.

The Budget resolution laid today is, however, not the same as the draft legislation in the PBR- it aims to make it more difficult for the providers of these arrangements to avoid the new charge.

Property owners

As a result of these new rules, contractors who are working through these arrangements are likely to see their tax and National Insurance increasing significantly - in some cases by as much as 50%.

Many people who own properties abroad do so via a company. Under current tax law, they could suffer a heavy tax charge meant for employees enjoying free holidays in a house provided by their employer.

This Budget makes the welcome announcement that these rules will be disapplied for most people who invest in their own properties overseas via a company.

Conclusion

Some key areas of the tax system are now simpler than previously - notably tax bands and capital allowances, and this is welcome.

But this is not a tax-cutting budget, but a redistribution of income from some sectors, such as most small businesses, towards poorer families.




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