Taxing question

Richard Stratton and Michael Mitchell look at the tax changes made in gordon brown's budget, and how they will affect the work of solicitors

Last week's Budget had a sting in the tail.

The centrepiece was the increased funding for the health service.

This came at a price of an additional 1% national insurance contribution (NIC) from 2003 for employers, employees and the self-employed on all earnings above the NIC threshold.This is the sort of increase in NIC for the self-employed that had been anticipated for a number of years.

Gordon Brown, the Chancellor of the Exchequer, was quick to claim that this will be offset or eliminated for many by the system of tax credits, with the child and working tax credits being introduced from 2003.This year there was much speculation prior to the Budget that anti-avoidance legislation would be introduced to counter stamp duty saving schemes on property sales.

This has proved to be correct and there are three sets of measures.The first prevents the reduction in the rate of stamp duty through placing property within a corporate wrapper.

If a property is transferred to a company using intra-group relief and the transferee company leaves the group within two years, the stamp duty relieved is clawed back.Pre-Budget relief was available to reduce the rate of duty from 4% to 0.5% where an undertaking is transferred by one company to another in consideration, substantially, of the issue of non-redeemable shares.

This relief was used to transfer UK land to a company where there were arrangements to sell the consideration shares received.The duty relieved will be clawed back if the undertaking transferred included land and within two years control of the transferee company alters; the relief will not be available if the transferee company is under the control of a third party at the time of the transfer and there are arrangements for the third party to acquire the consideration shares.These changes take effect for transfers after 23 April unless the contract was entered into before Budget day.The second set, immediately applying from Royal Assent, includes provision to counter schemes (such as the split legal and beneficial ownership scheme) which 'rest on contract'.

Stamp duty will be chargeable on these contracts, reversing the normal rule, where the value of the property exceeds 10 million.

In addition, penalties for late stamping for property transfers executed outside the UK will run from 30 days after execution.The objective of the third set is to change by the end of 2003 stamp duty on land and buildings into a direct self-assessed tax which will one day be collected electronically in conjunction with e-conveyancing.

A consultation paper exists and further consultation is expected.The tax will become one on transactions in land, triggered by receipt of consideration in money or money's worth.

Transfer documents will be irrelevant, with returns required instead; interests in certain property vehicles will be subject to the charge.The good news is that as a result of this process, stamp duty will be limited to shares and securities (SDRT), and land and buildings.

Intellectual property fell out of charge in 2000, goodwill will cease to be subject to stamp duty from 23 April this year and debts from the introduction of the new regime will follow next year.There is one high-profile change to the capital gains tax regime.

This is the reduction in the holding period before the maximum taper relief for business assets becomes available.This period is now two years, after which a top-rate taxpayer will pay only 10% on his gains.

After a single year's holding period, the effective tax rate will halve to 20%.A number of technical changes to the capital gains tax (CGT) regime have been announced.l It will be possible to opt out of incorporation relief.

This will be useful for traders who sell their businesses within two years of incorporation and so before they have become entitled to full business assets taper relief.

By opting out of incorporation relief, they will pay CGT on tapered gain on the disposal of the business but will benefit from a higher base cost in the shares in the company.l Same-day acquisitions of shares.

The changes announced deal with the situation where various options are exercised on the same day but with different grant dates and therefore different exercise prices.

On a subsequent sale, the shareholder will have the option to identify the shares sold with whichever of two groups of shares acquired on the same day gives rise to the smaller gain.l 'Securities' and taper relief.

The Inland Revenue had already announced a relaxation in its interpretation so that securities that came within the broad definition of 'securities' for capital gains tax purposes will also be treated as qualifying as 'securities' within the slightly different definition which applies for taper relief purposes.

This change is now being legislated although uncertainty remains about the possible application of some of the related anti-avoidance provisions.l Corporate reconstructions and exchanges of securities.

By legislating the effect of statement of practice 5/85, the Revenue hopes to avoid the situation which arose in Fallon and Kersley v Fellows, [2001] STC 1409; shareholders avoided tax by claiming that a reorganisation which the Revenue had treated as a tax-free reorganisation was in fact taxable and therefore gave them an uplifted base cost.l Trading losses will now be set off against capital gains in a more flexible way and, instead of the maximum relief being limited to the amount of the post-taper relief gains, it will now be limited by reference to the amount of the pre-taper relief gains.

This could be a significant improvement.l Taper relief anti-avoidance provisions.

The taper clock was reset where there had been a material change in the nature of a close company's activities.

The provisions could work unfairly in a number of circumstances.

The proposed new provision, which simply excludes inactive periods from the holding period for taper relief purposes, is likely to produce much fairer results.l Personal losses and attributed trust gains.

Capital gains attributed to a settlor from a settlor-interested trust can now be offset by losses realised by the settlor from person assets.

This is a welcome relief.l Some taper definitions have been revised.

In particular, the Revenue has recognised the need to define 'trading company' by reference to its activities, not its purposes.The Chancellor has, again, left the inheritance tax regime unscathed.

The nil rate band threshold is raised to 250,000, sufficient to exclude 96% of all estates from inheritance tax but still low enough to ensure that anyone who owns even a comparatively modest house is likely to have a taxable estate.An important change is that the effect of the decision in Melville and others v Inland Revenue Commissioners [2001] EWCA CIV 1247 has been reversed.

Powers over trust property (for example, powers of revocation or general powers of appointment) will not be treated as part of the power holder's free estate.

This is a welcome change and will prevent what could have been some significant unfairness and complexity.While there has been much speculation about the possible elimination of inheritance tax planning by means of post-death variations of wills, it is significant that the Chancellor's only action has been to make the process simpler by eliminating the need to make an express election and send it to the Revenue in order to take advantage of the provisions.As a new incentive to encourage taxpayers to give to charity, from 2003 it is to be possible for donations to be made directly through the taxpayer's self-assessment return, for a taxpayer to nominate a charity to receive all or part of any tax repayment which is due to them and for higher rate taxpayers to carry back a proportion of their gift aid relief (18%) to the previous year.

From 2002 individuals or companies can obtain relief for gifts of land or buildings to charityThe pace of change for corporation tax remains unabated.

The relief on gains arising on the disposal of substantial shareholdings (10% or more held for at least 12 months in a two-year period ending with the disposal when both company sold and company selling are trading or in a trading group) takes effect from1 April 2002, as does the regime which gives tax relief for the cost of intangible assets based on the amortisation in the accounts.The changes to loan relationships derivative contracts and foreign exchange are to take effect for accounting periods beginning on or after 1 October 2002.

As a result of the introduction of the relief for disposals of substantial shareholdings and the consultation on small businesses there is to be consultation this summer on whether other gains of companies should be brought into an income tax regime, whether for companies the schedular system should be rationalised and whether investment and trading companies should have similar treatment.

And from 1 January 2003, branches of overseas companies are to have attributed to them a share of the company's capital, so as to limit the amount of debt that they can have and resultant interest deductions.There is to be further relaxation in the withholding tax regime.

From October 2002 (in addition to the existing exemption for payments to other companies liable to corporation tax), companies will not have to deduct tax from interest, royalties, annuities and annual payments paid to bodies that are exempt from tax such as pension funds.UK companies will be able to make royalty payments gross where they reasonably believe that the non-resident will be able to reclaim the tax under a treaty.Financial dealers will be assimilated to banks in that they can pay interest gross in the ordinary course of business, but will be subject to the deposit takers regime and deduct tax on interest payments to individuals.There are welcome changes relating to the administration of the VAT system which will benefit smaller firms, many of which take effect from 25 April 2002.

The VAT registration threshold has been increased from 54,000 to 55,000 while an optional flat rate scheme, which it is estimated will reduce compliance costs by 1000, is being introduced.

Firms will be able to opt to participate in the scheme after 1 May 2002 if their annual taxable turnover is up to 100,000 and total annual turnover is up to 125,000 (including the value of exempt and/or other non-taxable income).

There will no longer be any need to record all details of invoices issued or purchase invoices received to calculate the amount of VAT due.This Budget also simplifies the treatment of bad debts by removing the need to send letters to debtors to advise them that a claim for bad debt relief is being made.Richard Stratton is a partner at City firm Travers Smith Braithwaite and Michael Mitchell is a partner at fellow City firm Withers LLP.

Both are members of the Law Society's tax law committee