2006 BUDGET REPORT SUMMARY

• Personal tax

• Employment issues

• Corporate & Business Tax

• Capital taxes and Trusts

• VAT, Excise & other duties

• Anti-Avoidance Measures

• Miscellaneous

Corporate and Business Tax

Corporation tax rates

A starting rate of corporation tax of 0% was introduced in 2002 and applies to companies with taxable profits of £10,000 or less. Companies with profits between £10,000 and £50,000 enjoy a marginal relief from the small companies rate of 19%. The zero rate was introduced to encourage the creation of small businesses and to allow them to grow.

In 2004, the government thought the system was being ‘abused’ and introduced a ‘non-corporate distribution rate’ of 19% on profits that were distributed by companies.

The result has been a complex system and the government has concluded that many self-employed and employed people are still being advised to incorporate simply to reduce their tax and national insurance liabilities.

The government has therefore decided to replace the non-corporate distribution and zero rates with a new single banding. This is set at the current small companies rate of 19% on profits up to £300,000. The new rules take effect from 1 April 2006.

Tax relief for cars

A consultation document has been issued on tax relief for expenditure on cars. It concludes that the main problems with the current system are almost entirely associated with the special treatment for cars over £12,000. A range of options are suggested so that compliance costs associated with the current regime can be reduced for businesses.

A proposed regime also needs to be consistent with environmental objectives such as a reduction in CO2 emissions.

The favoured proposal is for the introduction of a single new car pool with a reduced rate of capital allowances. There will be a range of first year allowances depending on the car’s CO2 emissions.

Leased plant and machinery

Currently a lease of plant and machinery is treated as the hire of an asset:

• the lessor brings in the rentals arising under the lease as income and can claim capital allowances in respect of its expenditure on the asset and

• the lessee deducts the amount of the rentals payable over the life of the lease.

Provisions are being introduced, effective from 1 April 2006, to align the tax treatment of leased plant and machinery with that of other forms of finance. Where leases function essentially as financing transactions the new regime will allow:

• the lessor to bring in only the finance element of the rentals as income

• the lessee a deduction only for the finance element of the rentals

• the lessee an entitlement to capital allowances.

The new rules will not apply to certain shorter leases (including all those where the term does not exceed five years) so the majority of leases will be unaffected by the changes.

Capital allowances

To ensure that small businesses are provided with incentives to invest for growth, the government will increase the first year capital allowances on plant and machinery from 40% to 50% in the year from April 2006.

Comment: A 50% rate of first year allowances was available to small businesses for expenditure incurred from April 2004 for one year. It has been reintroduced to mitigate the effect of the extension of the 19% corporation tax rate.

Research and development (R&D) credits

In 2000, an R&D tax credit was introduced for small and medium-sized enterprises (SMEs). This enables SMEs to claim tax relief on 150% of qualifying R&D costs. Companies without profits can take the relief up front as a payable R&D tax credit. They can surrender the loss attributable to the R&D and receive a cash payment of £24 for every £100 spent on qualifying R&D. The scheme was extended to large companies in 2002 enabling them to claim tax relief on 125% of qualifying R&D costs although the cash repayment option is not available to them.

The government intends to provide additional support to firms with between 250 and 500 employees through R&D tax credits. The support will be subject to the outcome of state aid discussions with the European Commission and further details will be published later this year.

Two changes are being made in the 2006 Finance Bill:

• an expansion of qualifying costs to include payments to clinical trial volunteers

• a harmonisation of time limits and claims procedures across both the payable tax credit and the enhanced relief.

Income recognition and accounting standards

UITF 40 ‘Revenue recognition and service contracts’ was issued in March 2005. It was intended to give guidance on income recognition for contracts for services such as those rendered by accountants and solicitors. In brief, it requires income to be recognised as a contract for services progresses and affects accounting periods ending on or after 22 June 2005.

This means that many businesses will recognise income before an invoice has been issued to a customer and therefore before payment has been received. This change may create a one-off uplift in profit, referred to as ‘adjustment income’.

The government will legislate in the Finance Bill 2006 to enable most businesses affected by the March 2005 changes in the income recognition rules to spread any extra tax charge over three years. Those businesses most severely affected will be able to spread the charge over six years.

The final details will not be available until the Finance Bill is published. However it is expected that businesses will need to calculate their ‘adjustment income’ and one-third of this will be taxed in the first year, ie for the first accounting period ending on or after 22 June 2005. A further one-third will be taxed in each of the next two years.

Where the taxable profits are low relative to the adjustment income the spreading period could extend to six years. Each year, one-third of the ‘adjustment income’ will be compared with one-sixth of the taxable income for that year. The extra taxable income for that year will be restricted to the lesser amount. There will be a sweep up of any amount not yet charged at the end of the six year period.

UK Real Estate Investment Trusts (UK-REITs)

The government will include legislation to establish UK-REITs in the 2006 Finance Bill. The proposals include the following key features:

• the regime will be open to UK resident companies, that are listed on a recognised stock exchange

• the majority of the UK-REIT’s activity must relate to qualifying property letting business (at least 75% by reference to its income and assets)

• companies that meet the UK-REIT eligibility criteria will not pay corporation tax on qualifying property rental income or qualifying chargeable gains

• UK-REITs will be required to distribute at least 90% of the tax exempt profits each year

• dividends paid out of the tax exempt profits will be treated as property income in the hands of the shareholders.

It is expected that shares in UK-REITs will be eligible to be held in an Individual Savings Account, Personal Equity Plan or Child Trust Fund.

Comment: UK-REITs have been considered as a means to improve the efficiency of both the commercial and residential property investment markets by providing liquid and publicly available investment vehicles.

Companies can elect to join the regime with effect from 1 January 2007. They will pay an entry charge of 2% of the market value of their investment properties at the date they join the regime.

Comment: The intention of the conversion charge is to ensure no overall loss of revenue from the introduction of UK-REIT legislation.

Film Tax Relief

In the 2005 Budget the Chancellor announced an extension to the current tax reliefs for low budget films until 31 March 2006.

The government has now given details of the proposed new tax incentives for British films. The legislation will be published in the 2006 Finance Bill.

The regime will only apply to ‘film production companies’. These are companies which have an active involvement in the process of film making.

Partnerships can no longer become involved in film production to shelter their members’ income from tax.

Green Landlord Scheme

Landlords are to be encouraged to invest in the energy efficiency of their properties through a Green Landlord Scheme. The government will continue to explore reform of the existing wear and tear allowance, which was originally given to compensate landlords for the use made by tenants of the furnishings in the property. It is proposed that the allowance should be made conditional on the energy efficiency level of the property.

Group relief

A group company can claim to set the losses of another group company against its profits, thereby reducing the amount of corporation tax it pays. However this only applies if the two companies are UK resident or carrying on a trade in the UK through a ‘permanent establishment’.

As a result of a tax case heard in the Court of Justice of the European Communities, legislation is being introduced to extend the group relief loss rules. The losses of foreign subsidiaries of UK parent companies, where the subsidiaries are either resident in the European Economic Area (EEA) or have relevant losses in a permanent establishment in the EEA, may be relieved against UK profits. However relief is only available where all possibilities of relief have been exhausted and future relief is unavailable in the country where the losses were incurred or in any other country.

The extension applies from 1 April 2006.

Comment: The main scenario in which the extension will prove useful is where the foreign subsidiary goes into liquidation so the loss cannot be used against potential future profits.

Trading activities of a charity

Charities are exempt from tax on trading profits so long as the profits are applied solely to charitable purposes. The exemption applies either where:

• the trade is exercised in carrying out a primary purpose, such as the provision of residential care for the elderly, or

• the work of the trade is mainly carried out by the beneficiaries of the charity.

The exemption does not apply if part of the trade is not within the primary purpose or where the trade is partly (but not mainly) carried on by beneficiaries of the charity.

Measures will be introduced to provide relief on the profits that can reasonably be attributed to the part of the trade that is carried on for a primary purpose or that is carried out by the beneficiaries of the charity.

The new relief will apply for chargeable periods commencing on or after 22 March 2006.

Comment: Charities which have a small non primary purpose trade may already be exempt under legislation introduced in 2000.

[Back to top]

Disclaimer - for information of users
The Budget proposals may be subject to amendment in the Finance Act. You are therefore advised to contact us before taking any action as a result of the contents of this summary.