Introduction

This year's Pre-Budget Report had more advance publicity than most of its predecessors. Some commentators forecast that it would be as long as a normal Budget speech. In the event it lasted only 35 minutes, but contained a wide range of announcements. The Treasury also issued several important papers, including the latest rounds of consultation on both pension tax reform and corporation tax reform.

Once again the Chancellor was forced to raise his borrowing estimates, with the 2003/04 requirement up by £10bn to £37bn from his 2003 Budget figure and £26bn higher than the projection in last year's Pre-Budget Report. The Chancellor is projecting next year's government borrowing to be £31bn.

Rising borrowing meant that tax cuts were never very likely in this year's Report. With a general election possibly no more than 18 months away, significant tax increases have been largely limited to a revised treatment for trusts.

Tax Allowances and National Insurance Contributions (NIC)

The basic personal allowance and starting point for national insurance contributions will rise in 2004/05 to £4,745. The rates of employer's, employee's and class 4 NICs will stay unchanged, following the 1% increase that took effect in April 2003. The flat rate of NIC for the self-employed will rise to £2.05 a week for 2004/05. A full list of the 2004/05 income tax allowances and NIC rates is set out at the end of this summary.

Tax Credits

The baby addition and family element of Child Tax Credit will each remain at £545 in 2004/05 and the first and second income thresholds of £5,060 and £50,000 (at which tax credits start to be withdrawn) will also stay unchanged.

The main working tax credit elements will rise in line with inflation.

Corporation Tax

Draft legislation has been published on transfer pricing and thin capitalisation in response to Inland Revenue defeats in the EU courts. Transfer pricing concerns the prices companies use for intra-group transactions. Thin capitalisation refers to parent company financing of subsidiaries that relies on a high level of debt and minimal equity. The thin capitalisation rules will be repealed from 1 April 2004 and amendments made to the transfer pricing regime to enable it to undertake the same role. An exemption for small and medium sized businesses is designed to ensure that 95% of businesses do not have to consider transfer pricing when making a tax return.

From 1 April 2004 corporation tax relief will be extended to the expenses of managing investments for all companies, rather than just investment companies as at present.

Small and Medium Companies

Regulations that are due to come into force in January 2004 will amend the Companies Act 1985 definition of small and medium businesses. The new definitions will take effect for a company's first accounting period beginning on or after the date that the regulations come into force.

The changes double the previous turnover and balance sheet thresholds and have a number of implications, eg no independent audits will be required for companies with turnovers of not more than £5.6m and more companies will benefit from the higher first year capital allowances that are available to small and medium sized businesses.

Research and Development (R&D) Tax Credits

The definition of R&D for tax purposes is to be simplified. A new draft definition has been published which widens the scope for qualifying expenditure to include materials consumed, software, water and fuel directly used in R&D.

Construction Industry Scheme (CIS)

In the 2003 Budget the Chancellor announced that a new CIS would be introduced in April 2005. The launch date has now been deferred to April 2006.

VAT Flat Rate Scheme

New lower rates for the VAT flat rate scheme will be introduced from 1 January 2004. The rates will be between 2% and 13.5% and will be discounted by a further 1% for newly registered businesses.

Pensions

The long awaited second consultation paper on the tax reform of pensions has been published. The lifetime limit remains at the originally suggested level of £1.4m, but it is proposed to reduce its impact in three ways:

• The 'recovery' charge tax rate on funds that exceed the lifetime limit will be reduced from 33¹/3% to 25%, making the maximum effective rate 55%.

• Any excess over the lifetime limit may be drawn as a taxable lump sum rather than applied to purchase pension benefits.

• The transitional treatment will be made more generous for those who stop accruing pension before the reform is introduced, whether or not they have reached the lifetime limit.
  

The National Audit Office is to review how many people will be affected by the £1.4m ceiling and report back before the next Budget. If the government decides to go ahead with the proposals, they will take effect from April 2005.

There are a number of other detailed changes and clarifications to the structure outlined in the first paper, including:

• A proposal that the £200,000 annual contribution limit will not apply in the final year in which a pension is vested in full.

• For valuing defined benefit (ie final salary) scheme pensions, a 20:1 factor should be used at retirement and 10:1 factor for pre-retirement.

• The maximum level of withdrawals under income drawdown will be 120% of what could be generated by an annuity. The minimum will be £1 a year or any higher amount required by the DWP. Death benefits before age 75 under income drawdown will be the full return of fund, less a flat 35% tax charge.
  

Childcare Costs

From April 2005, there will be an income tax and NICs exemption for employer-contracted childcare and childcare vouchers of up to £50 a week for any employee. Some aspects of the rules for tax relief on childcare will also be relaxed.

Anti-Avoidance Measures

A number of anti-avoidance measures were announced, mainly targeting the use of trusts.

From 6 April 2004, the tax rate for income and capital gains received by trusts will rise from 34% to 40% (for dividends the rate will rise from 25% to 32.5%). From 10 December 2003, CGT holdover relief for gifts will be denied for transfers to trusts in which the settlor has an interest (including trusts in which the settlor subsequently becomes interested). From the same date private residence relief will be denied where trusts are used to avoid CGT on residential property. After consultation, the Finance Bill 2004 will include legislation to prevent avoidance of the inheritance tax gifts with reservation rules.

With effect from 10 December 2003, the films tax relief rules are amended to prevent the operation of 'exit schemes', which have sought to give the investor immediate tax relief without the corresponding future tax liability.

The Gift Aid rules will be revised in the Finance Bill 2004 to prevent certain heritage and conservation charities granting free day admission in return for a Gift Aid donation.

The Finance Bill 2004 will also include measures to ensure that the right amount of tax is paid on profits extracted by owner managers of small incorporated businesses.

Offshore Funds

Legislation will be introduced in the Finance Bill 2004 to amend the definition of 'distributing' offshore funds. This will mean UK investors in a wider range of offshore funds will be taxed in the same way as investors in UK (onshore) funds.

ISAs and Sandler Stakeholder Products

All the proposed Sandler medium term stakeholder products will be regarded as qualifying investments for the ISA stocks and shares component when they come into being in April 2005. At the same time the current £1,000 ISA insurance component will disappear. From 2005/06 investors in mini-ISAs will be able to invest up to £4,000 in a stocks and shares mini-ISA.

Venture Capital Trusts (VCTs) and Enterprise Investment Scheme (EIS) Companies

In a paper published alongside the Pre-Budget Report, the government proposes to remove capital gains tax deferral relief for VCTs from 6 April 2004. From the same date the government also plans to increase tax relief for VCT investments for two years from 20% to 40%, the extra 20% being paid directly to the VCT rather than the investor. Subject to consultation, the annual investment limit for VCTs and EIS companies will also rise to £200,000.

Real Estate Investment Trusts (REITs)

A consultation paper will be published in the 2004 Budget on the appropriate structure for a tax transparent property investment trust, similar to US REITs. The structure will aim to give investors the same tax treatment as would apply if they were the direct owners of the trust's property.

Housing

Two interim reports on the housing market were published. The first, which was issued on 9 December, examines the UK mortgage market. A second, issued on 10 December, looks at housing supply and demand in the UK.

Income Tax — Personal and Age-related Allowances
2004-05

* Married couple's allowance given at the rate of 10%

National Insurance Contributions

Links

http://www.hm-treasury.gov.uk/pre_budget_report/prebud_pbr03/prebud_pbr03_index.cfm
http://www.inlandrevenue.gov.uk/news/index.htm

Please note: This summary has been prepared very rapidly and may contain errors for which we cannot be responsible.