Pre-Budget Report analysis: What is the real tax impacts for Scotland and Scottish businesses?

Scotland might be forgiven for being in low spirits after Argentina blocked the way of Jason White’s men to a rugby world cup semi-final on Sunday. This doesn’t seem to have affected Alistair Darling, as the Chancellor delivered his first Pre-Budget Report (PBR) as there seemed to be precious few fiscal “drop goals” in Scotland’s direction. In particular, concerns have been expressed in Scotland on the spending side – but what about the tax side? What will be the real impact of the PBR in Scotland and for Scottish businesses in particular?

It was always likely that, after the recent issues around the tax treatment of private equity (PE), there were going to be changes to the rules. There had been real concern in the PE and venture capital (VC) community that much of the return on the deals – particularly the ‘carried interest’ – would be brought wholly within the employment income net and therefore subject to PAYE income tax at 40%, together with national insurance contributions (NICs – 1% for employees and 12.8% for employers).

The fact that the capital treatment on gains realised by PE/VC and management team executives, and on the realisation of their investments, will be maintained, albeit at the new, higher 18% rate after next April has brought perhaps a collective sigh of relief. While it could have been worse, whether this new higher rate will cause PE business to relocate outside the UK remains to be seen.

If the Chancellor’s new Capital Gains Tax (CGT) rate for PE seems reasonable, the greater concern is whether this move will have any adverse affects. The single 18% tax rate, applying across the board to individuals, trustees and personal representatives, will remove complexity and be good news for some – for example owners of second properties who will see their effective tax rate cut when they come to sell.

But, on the other hand, many entrepreneurs will see their rate of tax nearly doubling from the existing 10% on any business sale. This increase will also catch employees who have shares in their employer (though many will sidestep the increase by keeping disposals under the CGT annual exempt limit). And shares in AIM companies – well represented in Scotland – will lose the CGT advantage that classed them as business assets and fall into the general 18% pack rate.

It is hoped new CGT system has not gone so wide of its mark as to dampen the spirits of Scotland’s entrepreneurs, the very same spirit which taper relief was originally designed to promote. No doubt some in the business community will recall retirement relief – which exempted many small businesses from CGT on selling up – abolished when taper relief was introduced.

Many small businesses will also be disappointed with the confirmation from the Chancellor that the moves to reverse much of the effect of the ‘Arctic Systems’ decision (on the extent to which husband and wife companies could split income between them) are to go ahead. There is a real danger that in an effort to levy a penalty on ‘income shifting’, we will find rules coming that are even more complex to administer. At least we are to have consultation and hopefully that will give opportunities to emphasise the need to have simple, workable rules that do not demotivate the sort of seedcorn businesses that Scotland needs to flourish.

The Chancellor has made a start on his aim of simplifying the tax system and so reducing administrative burdens. One is aimed at inbound investors with HM Revenue & Customs (HMRC) establishing an Advance Agreements Unit (AAU) to provide a range of services including: rulings across all taxes where there is uncertainty as to the application of existing law to the specific transaction; a one stop shop to co-ordinate responses from different parts of HMRC; and a fast track towards agreement in time-pressured situations. There are also to be moves to streamline some of the operation of the PAYE/NIC system – something that all employers will welcome if real simplification dividends can be delivered.

Scotland’s oil and gas sector is likely to be worst affected by the proposed changes to the operation of the non-domicile and residence rules. Many workers are able to take advantage of non-domicile status not to pay tax on non-UK income. Whilst the modernisation of these rules is long overdue, the concern is that the way the change is being effected – to impose an annual £30,000 tax charge on an individual after seven years’ residence – will cause a number of long-established workers to depart or simply ask their employers to cover their extra tax bills.

The wealth and expertise brought by overseas workers to the Scottish economy must not be underestimated, as there is a real risk of a net loss if expats find the UK, and Scotland in particular, a less attractive place to come and work and, above all, invest.

There is a veritable raft of consultations in progress, including the changes to the capital allowances system and on the taxation of foreign profits of companies in the UK. Discussions on the latter began in June this year, with scores of businesses formally responding in mid-September. The absence of any announcement on the subject by the Government today leaves international businesses in Scotland unsure as to the Government's intentions, and is somewhat inconsistent with the desired objective of increased certainty for business in relation to their taxation affairs.

And finally …the Chancellor’s real attempt at an up and under was arguably the inheritance tax (IHT) changes. It is unlikely that the residents of Edinburgh’s leafier suburbs will be celebrating in light of the changes announced to IHT, given that the effective combination of the separate IHT thresholds for married couples and civil partners is likely to have little or no impact on their overall position – from two single £300k thresholds to one total £600k threshold.

So, in summary, has this PBR been a success, or has the Chancellor dropped the ball for Scottish business?

Contact details
Email: Rhona Irving
Tel: +44 (0)131 260 4011