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Employment & Benefits UK Budget Alert

June 22, 2010
Oliver Brettle, Nicholas Greenacre, Euan Fergusson, Stephen Ravenscroft

Introduction
The UK Chancellor of the Exchequer, George Osborne, announced earlier today in his first Budget speech on behalf of the new Coalition Government a number of changes which will directly affect individual UK taxpayers and businesses. We have summarised below some changes which are likely to be important for UK resident individuals and their employers. The information set out in this note remains subject to further parliamentary approvals and consents and is intended for information purposes only.

Increased Rate of Capital Gains Tax
With effect from 23 June 2010, UK resident individuals with total taxable income and gains after all allowable deductions exceeding the upper limit of the basic rate income tax band (£37,400 for 2010-11) will be subject to a higher capital gains tax rate of 28% on all taxable gains. The existing capital gains tax rate of 18% will continue to apply to basic rate taxpayers.

There are two notable exemptions to this: (i) the trustees and personal representatives of deceased persons will be subject to a flat 28 per cent rate for capital gains tax, and (ii) the existing entrepreneurs relief will continue to attract an effective rate of capital gains tax at 10%. It is proposed to increase the lifetime limit, in certain circumstances, for entrepreneurs' relief from £2million to £5million.

Enterprise Management Incentives (EMI)
A minor, but welcome confirmation has been made to proposals announced in the March 2010 Budget governing the operation of EMI share plans intended to allow greater opportunities for international companies to grant EMI options to UK employees provided at least one company in the group that is carrying on a "qualifying trade" (within the meaning of the legislation) has a "permanent establishment" in the UK.

Whilst companies will still have to meet other criteria, including continuing to carry on a "qualifying trade", these changes continue to be good news for international companies with gross assets of less than £30 million, and fewer than 250 employees. EMI options carry highly favourable tax treatment.

National Insurance Contributions
The 1% increase in the employer and employee rates of National Insurance Contribution (NICs) previously announced by the Labour Government, the employer part of which was referred to by the Conservatives on the "jobs tax", will take effect as planned in April 2011. However, the effect of the employer rate rise will be mitigated by increasing the threshold for employer NICs by £21 a week above indexation.

Reduction in pensions tax relief for high earners to stay, but hopefully with a simpler statutory mechanism
Prior to the April 2009 Budget of the Labour Government, tax relief at up to 40% was available for pension contributions up to a maximum of 100% of net relevant earnings, subject to a cap (the "annual allowance") of £245,000 per annum. From 6 April 2011, the relief available to payers of the new 50% top rate of income tax (also announced in the April 2009 Budget) was to be tapered for individuals earning between £150,000 and £180,000 per annum, from the 50% top rate of income tax down to the 20% basic rate. Individuals earning in excess of £180,000 would, from 6 April 2011, only enjoy tax relief on pension contributions at the basic rate of 20%.

Since this reduction in tax relief on contributions to pension plans was not due to come into effect until 6 April 2011, the previous Government proposed a complex raft of "anti-forestalling" measures designed to prevent individuals from front-loading contributions into pension plans prior to that date. In broad outline, these measures were based upon the imposition of a tax charge upon any contributions in excess of a "special annual allowance" (£20,000 per annum) where individuals changed their normal pattern of contributions after 22 April 2009 (the date on which the pensions tax changes were announced).

It was evident that these proposals represented an additional layer of complexity upon an already complex pensions taxation regime. Ironically, the stated aim of the Finance Act 2004 (the legislation which governs pensions taxation) was one of "simplification".

The Chancellor has today suggested that, whilst a reduction in pension contribution tax relief for higher earners must remain in order to generate much needed revenue for the Treasury, the Coalition Government intends to "work with industry to find [less complex] ways to raise the same revenue". He suggested that this might be by way of a simple reduction in the annual allowance, and we anticipate that this solution will be adopted. The Budget Report states that provisional analysis has indicated that an annual allowance in the range of £30,000 to £45,000 would raise the same tax revenues. On this basis, the Government intends to repeal the legislative provisions limiting/tapering tax relief to the basic rate of 20% for high earners, and the complex anti-forestalling provisions.

Compulsory annuity purchase at age 75 to be abolished, with transitional measures
The Government intends to end the requirement that members of registered money purchase pension plans must purchase annuities by age 75. Under present law, annuity purchase by age 75 is effectively compulsory, with any lump sum death benefits being chargeable to tax at 70% in the event that the member dies after reaching age 75 (insofar as those funds are not used to pay pensions to dependants or to make charitable donations).

As transitional measures:

money purchase plan members who reach age 75 on or after today's date will only be subject to these restrictions with effect from their 77th birthday; and
a reduced tax charge of 35% will apply to lump sum death benefits paid by a plan (insofar as they are not used to pay pensions to dependants or make charitable donations) where a member who has reached age 75 dies on or after today's date.

It is anticipated that the detail of compulsory annuity purchase abolition will be announced next year.

Public sector pay and pensions: watch this space
The Chancellor has also made clear his view that the UK can no longer afford to bear rising public sector pay and pensions costs. A two year pay freeze for public sector employees earning in excess of £21,000 per annum was announced immediately, but detail on pension cost reduction will come only after completion of a review by John Hutton (a former Labour cabinet minister). His report is not expected for another year, but the Chancellor's message was clear: the public sector must either engage in discussions to save pay and pension costs, or jobs will otherwise be lost.

State pensions
The Chancellor announced the Coalition Government's intention to "accelerate" the increase in the state pension age to 66 years. He also announced that the link between the level of the basic state pension and earnings will be restored from April 2011. Thereafter, the basic state pension will be protected by a "triple lock" guarantee, rising in line with earnings, prices or 2.5% per annum, whichever is the greatest. This change is intended to be consistent with the Coalition Government's policy to protect the lowest earners from the full effect of the austerity measures which the UK faces over the coming years.

Comment
The new measures announced today in connection with Capital Gains Tax were somewhat contrary to expectations in that, although an increase in rates was widely forecast, related provisions concerning the possible re-introduction of taper relief and business assets did not materialise. The Chancellor explained that his rationale was to minimise the level of bureaucracy and administration - this approach has to be welcomed. However, it is also notable that the increase in rates will have an immediate effect for those individuals whose taxable income exceeds £37,400 during this tax year, although the rise in rates is not as great as many expected. There still remains a significant gap between the rates of CGT and income tax. This means equity based compensation plans that attract capital gains treatment rather than income treatment continue to be attractive, especially when one considers that income tax treatment also carries with it NICs for employers and employees at increased rates. Employers should therefore consider whether they are making full use of the available plans, including approved option plans, EMI plans, SIPs, SAYE, restricted share plans, and joint ownership plans. At this stage, there is nothing to indicate any changes that would affect the tax treatment of these plans or other popular vehicles, such as employee benefit trusts (EBTs).

The likely abolition of the overly complex measures surrounding pensions tax relief is welcome. These measures have caused a good deal of confusion and it was likely that many employees would have inadvertently fallen within the special annual allowance charge. However, it remains to be seen at what level the annual allowance for tax relieved pension contributions will be fixed and employees may well need to start to consider alternative vehicles for long-term saving, such as EBTs or employer financed retirement benefits schemes (EFRBs).

Please speak to your usual White & Case contact for more details on any of the issues raised in this document.

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