What will be in this year’s Budget?

16 March 2010

VAT and capital gains tax (CGT) are considered to be the frontrunners for tax hikes in what could be Alistair Darling's last Budget next week.

Further tweaks to pensions higher-rate tax relief and a clampdown on converting income into capital in order to pay less tax could also be announced on 24 March.

“A VAT rise must be top of the agenda, but perhaps not introduced until later in the year,” comments Richard Mannion, national tax director at Smith & Williamson. “Every 1% increase in VAT brings in just under £5 billion per year, making this a tempting option.

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The average rate of VAT in the European Union is almost 20%, and the UK has the third lowest standard rate of VAT.

However, the downside of raising VAT is that it could dampen consumer spending and would add to the already rising cost of living.

George Bull, head of tax at Baker Tilly, says the government should be too concerned about these negative impacts.

“We changed VAT twice in 13 months recently, and it actually wasn't too hard for the industry, and retailers and customers weren't too sensitive to it,” he explains. “I'm not sure we'll see VAT changed in next week's Budget, but it could be raised in the second Budget this year, after the general election.”

Bull predicts Darling will move the standard rate of VAT from 17.5% to 20%, while the reduced rate could rise from 5% to 8%.

The government might reduce the rate of VAT on selected goods and services, as a sweetener to any rises. Following the European Council's decision to allow more items in the reduced rate, France moved restaurant meals into its reduced VAT rate - but the UK has yet to make any moves.

Services like renovations and repair work could be moved into the lower rate, according to Bull. The UK building industry is already lobbying for such a move, saying it will create thousands of jobs for the sector.

Capital gains tax

A change in capital gains tax (CGT) is also widely tipped to be in Darling's red box. The rate of 18% looks at odds with the forthcoming top rate on income tax of 50% so there may be moves to raise CGT to help close up the gap.

Mannion believes CGT could even increase from the start of the new tax year on 6 April.

However, Bull is crossing his fingers that the Treasury doesn't go so far as to completely align CGT with the highest rate of income tax. “I hope we will not see a kneejerk response of CGT matching income tax. I hope it will just be a moderate increase.”

What he does see, however, is some anti-avoidance measures introduced to stop people converting income gains into capital.

“The 32% difference in CGT and income tax is huge, and if you can convert income into capital you're onto an absolute winner,” says Bull. “We haven't seen any anti-avoidance rules come in yet, but then the 50% income tax rate hasn't arrived yet. It's highly probable the Treasury will soon announce some rules.”

Mannion agrees there will be a renewed emphasis on rooting out tax avoidance, and we may see salary sacrifice schemes under the spotlight too.

Meanwhile, insurer and pension provider Skandia is concerned the government will go further in its restrictions on higher-rate tax relief on pensions.

It warns that the restrictions for those earning more than £130,000 may not be the final goal for phasing out higher-rate tax relief.

Colin Jelley, the firm's head of financial planning, says the next target could be incomes of more than £100,000 and higher-rate tax relief could eventually be banned. History shows that governments have previously restricted tax relieves to basic-rate taxpayers - for example mortgage interest relief and the married couples' allowance.

He recommends higher-rate taxpayers consider paying in maximum pension contributions before the Budget next Wednesday (25 March).

In terms of what savers and investors would like to see in the Budget, the restoration of dividend tax credits and raising the inheritance tax threshold to £1 million were the favourite changes according to a Brewin Dolphin poll of its clients.

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