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Emergency Budget:

Its payback time

In a controversial “emergency” Budget on 22 June 2010 aimed at reducing the UK’s spiralling debts, Chancellor of the Exchequer George Osborne announced sweeping – and contentious – cuts in spending on benefits and public services, accompanied by higher taxes.

VAT is set to rise from 17.5% to 20% from 4 January 2011, and the increase is expected to raise £13bn of additional revenue by the end of 2011. Capital gains tax has risen from 18% to 28% for higher-rate taxpayers. However, the personal income tax allowance will increase in April 2011 by £1,000 to £7,475, removing 880,000 people from the income tax system.

The Chancellor instigated average real budget cuts of 25% to most government departments over four years. From April 2011, the basic state pension will rise in line with earnings, prices or 2.5% – whichever is the largest.

The threshold at which employers begin to pay National Insurance will rise from April 2011 by the rate of inflation plus £21 per week. Meanwhile, corporation tax will be reduced in 2011 to 27%, and then by 1% every year until it reaches 24%. Turning to the financial sector, the Government is set to introduce a bank levy that it expects to raise £2bn per year. It will apply to UK banks, building societies and the UK operations of overseas banks, but will not apply to smaller banks.

A rise in capital gains tax (CGT) was a key tenet of Liberal Democrat policy. In order to address the discrepancy between the top rate of CGT (18%) and the top rate of income tax (50%), a rise to 40% or even 50%, plus a significant reduction in the annual exemption had been mooted. As it was, Chancellor George Osborne was more measured in his actions.

In the end, CGT was raised to 28% for higher rate tax-payers and maintained at 18% for everyone else. Osborne suggested any further hike would serve to reduce the yield to the Exchequer from CGT rather than increase it. He also maintained the annual exemption at £10,100, adding this would rise with inflation each year as before.

Although this was a lighter increase than expected, many were disappointed the Chancellor did nothing to adjust the regime for assets held over the longer term. However, he specifically noted the reintroduction of taper relief and/or indexation would prove too complicated.

As a result, many of the tax planning measures used pre-Budget will now be even more important: Using the annual exemption each year, plus that of a spouse, rather than crystallising a large gain in a single year can help mitigate CGT. Equally, investors should ensure they have made prudent use of the principal private residence relief for their main property.

Assets held within SIPPs and ISAs are exempt from CGT, so it is worth investing up to the annual contribution limits. Also, given the discrepancy between the CGT rate for lower and higher rate taxpayers, deferring a sale may be worthwhile if someone is moving from being a higher rate taxpayer to a lower rate taxpayer – for example, on retirement.

By maintaining a substantial differential between CGT and Income Tax the Chancellor has left open tax planning strategies particularly for higher rate taxpayers to reduce the total tax bill that they would otherwise pay.

Reaction to the Budget was mixed, with the Confederation of British Industry hailing it as “the UK’s first important step on the long journey back to economic health”. For its part, the Institute for Fiscal Studies described the Budget as “a mixed bunch of positive reforms, backward steps and missed opportunities.”

As always, the truth is somewhere in-between.





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