UK Budget A Mixed Bag For Investors
Friday, March 26, 2010

Chancellor Alistair Darling announced few giveaways in the 2010 budget speech to the House of Commons on March 24, in what is being seen as a 'steady-as-she-goes' pre-election statement.

There were some measures of interest to investors, savers and property buyers. These included a doubling of the lifetime limit for entrepreneurs’ relief to GBP2m, an increase in the annual amount that can be saved tax-free in an Individual Savings Account from GBP7,200 to GBP10,200, and the removal of stamp duty land tax on the purchase of a house valued up to GBP250,000 for first-time buyers in an attempt to stimulate the property market.

However what the Chancellor giveth, he usually takes away by announcing offsetting measures elsewhere in the tax system or by strengthening anti-avoidance provisions. And true to form, this is just what Chancellor Darling has done.

Darling claims that the stamp duty move will take 90% of first-time buyers out of this tax net, but doubts are already surfacing as the exact definition of a first-time buyer. He has also decided to pay for this measure by increasing the rate of stamp duty on property bought for more than GBP1m to 5%, so investors at the higher end of the property market will not be helped. The inheritance tax threshold has also been frozen for four years at GBP325,000 in a bid to claw back some more revenue from the estates of middle England. In addition, penalties for anyone connected with an undisclosed offshore bank account will now face penalties of up to 200%.

One must also not forget that the 50% top rate of tax, announced by the Chancellor in last year's budget, commences from next month on incomes above GBP150,000 per year, while those earning more than GBP100,000 will see their annual tax allowances phased out. Furthermore, restrictions on pension tax relief will be introduced next year for those earning more than GBP130,000 per year.

While the sound of pips being squeezed cannot be heard just yet, Darling has clearly established that he expects the wealthy to shoulder most of the burden of getting the UK out of the fiscal mess caused by the bankers (plus ten years of heavy government borrowing). Uncertainty as to who will win the forthcoming general election is also causing some anxiety among investors.

“The limited nature of today’s announcement immediately raises the question of when the real changes will be made," commented Louise Somerset, Tax Director at RBC Wealth Management, following the budget speech. "Wealthy taxpayers are unlikely to look at this Budget as being as bad as it gets, and I expect to see plenty more clients wanting to act in the next few months to lock in current tax rates before things possibly get worse.”

“After the election CGT is likely to be a target for any Chancellor, and we expect to see rates rising over the next few months.  Most of my clients have resisted the urge to sell assets to try to lock in the 18% CGT rate so far, but I expect to see the pressure increasing over the next few months," Somerset continues. “The current difference between income tax rates of up to 50% and capital gains tax at 18% is now so significant that many people will be putting a great deal of energy into ensuring they realize capital gains rather than income.  It isn’t easy to do this, but if you can, the savings are obvious.”

Somerset also says that her clients are giving "mixed signals" about their intentions as the reality of the 50% tax rate begins to bite. "The combination of higher taxes and the annual GBP30k remittance charge is certainly sending some of the higher earning non-doms out of the country," she explained. "Recent reports show a 25% reduction in the number of non-doms moving to the UK.  This is not wholly tax driven, but a fear of high taxes is certainly a factor.” 

The government has also missed an opportunity to clarify the laws over UK residence, another cause of great uncertainty among highly mobile entrepreneurs. Recent case law suggests that one has to completely sever ties with the UK to escape the UK tax net. However, this is not just something that affects the mega-rich, as ordinary workers with links to the UK are also finding themselves on increasingly uncertain ground.

“It was not surprising that there are no announcements about residence or domicile in the Budget, but it is disappointing," Somerset noted. "The concept of residence in particular is currently so confused that it is very difficult for anyone entering or leaving the UK to know where they stand. This goes against the basic principle that taxpayers should have certainty about their affairs."

On another note, the Chancellor gave something of a boost to the UK funds industry by announcing that HM Revenue and Customs will work with the industry to amend the fund-specific Schedule 19 Stamp Duty Reserve Tax (SDRT) regime. 

This tax affects only UK-authorized funds and is in addition to SDRT paid on funds' acquisitions of UK equities.  In particular, it is currently paid by UK funds investing in other funds, even where those other funds are not invested in UK equities.  It is this element of the tax that is to be removed, which will enable UK-domiciled funds to compete on a level playing field with offshore funds. 

"We welcome this news,"  commented Julie Patterson, Director of Authorized Funds & Tax at the Investment Management Association, the trade body for the UK funds industry. "The amendment of Schedule 19 SDRT will remove a current unfairness.  This, coupled with the introduction of tax-transparent contractual funds, will enable the UK to compete as a domicile for the new UCITS master-feeder structures and for hedge funds coming onshore."

The budget had no noticeable impact on sterling, but its impact on Labour’s chances in the election is being closely watched by the financial markets.  

Phil McHugh, senior executive dealer at leading foreign exchange firm Currencies Direct, said: “Sterling was unmoved by a highly political Budget which highlighted the clear policy differences between Labour and the Conservatives over how and when to institute public spending cuts."  

“The announcement that government borrowing forecasts are being revised downwards, while good news, covers over a deeper concern that the level of borrowing remains exceptionally high and there are no clear plans on how the deficit will be cut," he continued. "The financial markets proved this point today by selling the euro aggressively following the rating downgrade on Portugal’s long term default rating from AA to AA-."

“Realistically the markets did not expect clarity on cutting the deficit today, instead there is far more interest in the effect of this Budget on Labour’s prospects in the polls; a hung Parliament being a worst case scenario for sterling,” McHugh added.