Budget Preview

Boxing clever?

20th March 2012

When George Os-borne stands up at the Dispatch Box tomorrow to deliver his Budget, he will

be wrestling with a series of com-peting pressures – not all of them financial. The Chancellor’s first task is to revive the economy, and while he is unlikely to deviate from the “austerity first” path first embarked on two years ago, he also knows he has wider political considerations to juggle, not least of which is saving the Union.

Mr Osborne effectively has two jobs: running the Treasury and set-ting up the UK Government’s strat-egy to see off the threat of Scottish independence. Tomorrow’s Budget will reveal how carefully he has managed to mesh the two roles.

While it will be primarily con-cerned with sweeping UK meas-ures designed to stimulate business growth, reduce the tax burden on the so-called “squeezed middle” and pay down more of the country’s debts, the Budget will also be about showing the importance of West-minster for the whole country, not just for England.

The recent announcement by the UK Government on the siting of the Green Investment Bank rep-resented a classic example of this new, Scottish-sensitive approach to policy. The headquarters of the new bank will be based in Edinburgh, but its transactional base will be created in London. The subliminal message was clear – the UK Government created these new jobs in Edinburgh and the UK Government will take them away again if Scotland votes for independence.

Financial and business experts expect similar themes to emerge from the Budget. For example, the

SNP administration at Holyrood has asked the Chancellor to allow them to bring forward some capital budgets so that Scottish firms can press on with building a series of middle-sized infrastructure projects. Scotland’s Finance Secretary John Swinney has asked for £300 mil-lion in advance capital funding for this year so that he can authorise 36 “shovel-ready” projects, including £4 million for a new pier at Ullapool and £38 million for a series of mo-torway upgrades across the Scottish central belt.

This will not cost Mr Osborne any- thing in cash terms and it will help stimulate at least part of the Scottish economy, so he might well accede to Mr Swinney’s request – but only if he is given the chance to champion the move as an example of West-minster Government largesse and it being of benefit to the Union.

There are other areas of the economy which affect Scotland more than the rest of the UK, and on these, too, Mr Osborne will be under pressure to act – and to send out a message that he is using the clout of the UK Treasury to help Scotland.

Colin Borland, head of external affairs at the Federation of Small Businesses in Scotland, identified one particular concern for small businesses where Mr Osborne may decide to intervene. “There will be calls across the UK for the Chancel-lor take action over how the banks treat their small business custom-ers,” Mr Borland said. “These calls will be particularly loud from north of the border, where three-quarters of the small business banking mar-ket is in the hands of the two big players, Lloyds Banking Group and RBS.

By Hamish Macdonell

continued on page 2

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Open doors to overseas markets

An important regional business event will take place in Glasgow to hear how the UK Government, Scottish Government, HSBC and PwC, as well as other intermediaries and agencies can help businesses to expand and encourage exporting and growth.

You will hear fi rst-hand from businesses who have successfully exported, and how they continue to grow and succeed in the current market conditions. Export help and advice will also be available to help your business break into new international markets.

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Closing date for registration is 24th March 2012

NATIONAL CHALLENGE: EXPORTING FOR GROWTH29th March, Radisson Blu, Glasgow (8.45 -1.00pm)

20th March 2012 | the times

Budget Preview2

“While getting this right is important, sorting out bank behaviour on its own won’t address the business finance issues which are holding back the growth plans of one in five small firms. The Chancellor must therefore look closely at encouraging the development of realistic alternatives to bank finance, such as peer-to-peer lend-ing and community development finance institutions.”

Mike McCusker, private business tax partner at PwC in Glasgow, said: “Stimu-lating job creation is vital. A targeted ap-proach such as a cut in National Insurance will be attractive to employers, enabling them to take on hires while limiting the costs borne by them in doing so.” These are areas the Chancellor may wish to ad-dress – but, if he does, expect the spin to stress the benefits to Scottish firms and Scottish enterprises.

The Institute of Directors in Scotland believes the Chancellor should go further and embrace policies which have a pro-portionately beneficial effect in Scotland – even if they do not offer the same ad-vantages south of the border. Fuel duty is of particular concern in Scotland, where driving distances are greater than in Eng-land and where the most remote rural residents have to pay more for fuel than anywhere else in the country.

There is also the issue of air passenger duty, which the SNP Government wants to control so that it can lower the tax and encourage more passengers through Scot-tish airports. There is a suspicion in gov-

ernment circles in Scotland that the cur-rent tax levels are set for the over-heating airports of the South East, not the relative-ly lightly used airports north of the border, and that some flexibility is required.

“We do feel there is an even greater emphasis needed on growth,” said David Watt, executive director of the Institute of Directors, “and hope that the Scottish government will use any consequential to do the same rather than shore up public spending.

“Issues like an ongoing commitment to spending on UK transport infrastruc-ture, getting a grip on fuel duty and en-ergy costs, and most particularly reduc-ing air passenger duty – not increasing it as planned – are of vital importance to Scotland. These measures have a dispro-portionate effect on Scotland and directly adversely impact on business costs, so re-ducing the likelihood of business expan-sion and job growth.”

The Budget will inevitably have some side-effects which will benefit the SNP administration, and there is little the Chancellor can do about this. For every pound of every spending that Mr Osborne announces for England, Scotland will get its Barnett consequential share – about 8p for every pound. So if Mr Osborne allo-cates an extra £100 million to smooth the path of the controversial NHS reforms in England – which is likely – the Scottish Government will be automatically given an extra £8 million to spend as it sees fit.

That money can be used for anything from the ministerial car pool to the new Forth Replacement Crossing, but the UK

Government will be keen to put pressure on SNP ministers to follow their lead. If money is allocated for the NHS in Eng-land, Mr Osborne is likely to call openly for a similar spend in Scotland.

Given the focus on an export-led eco-nomic recovery, PwC’s Mike McCusker believes businesses need more encour-agement to reach new markets. “You have to look at where you would get the best return on a sustainable basis for the Scottish economy,” he said. “There is a strong argument for using the money to stimulate exports. Almost 70 per cent of Scotland’s exports are to the UK, with half of the remainder going to Europe – both of which are low-growth econo-mies.

“We need to encourage exporters to increase their activity with high-growth economies rather than decrease it, and to reassure new entrants that BRIC [Bra-zil, Russia, India and China] economies, for example, still provide a significant opportunity to boost sales and increase profits.”

There are areas where the policy gap – which has been steadily developing be-tween the administrations in London and Edinburgh – is likely to have a marked effect. The Prime Minister, David Cam-eron, has already signalled his determi-nation to cut or halt subsidies for wind turbines – something to which the Scot-tish Government is opposed – and more money for the outsourcing of public sec-tor services to private sector providers or an expansion of road tolling will also be fiercely resisted north of the border.

The competing pressures Osborne faces

The Chancellor must avoid higher taxes on business

However, the business group CBI Scotland believes that, as usual, the test of this Budget will be in its tax meas-ures. “The Chancellor must avoid higher taxes on business,” said David Lonsdale, assistant regional director at CBI Scot-land, “whether on North Sea oil and gas, spirits, or business more generally, as this would be the wrong approach and could undermine economic growth. If previous form is any guide, then the devil is often in the detail with government financial statements and we will need to examine closely the small print in the Budget.”

Duty on spirits is always watched very closely from north of the border, and not just by whisky manufacturers.

Scotland also produces a huge amount of gin, brandy and vodka, so any tempta-tion Mr Osborne might have to squeeze the drinks industry for more in tax must be tempered by a recognition that any tax increases will raise the ire of many in Scotland – something the Chancellor does not want to do.

This conundrum over duty on spir-its encapsulates the dilemma that Mr Osborne faces. He might feel he can squeeze lucrative and successful Scottish-based industries such as whisky and oil to generate the cash he needs to cut taxes, stimulate the economy and pay down debt. But if he does so, he risks alienating more Scots and undermining his political function, which is to save the Union.

It will not be an easy balance to strike, and business, economic and political ob-servers across Scotland will be watching closely to see if he manages to achieve it.

Alison Fleming, head of....................pensions, PwC in Scotland.............

No-one can have failed to miss the mounting speculation about possible changes to the taxation of pensions in tomorrow’s budget. This is a difficult one for George Osborne to balance –

on the one hand, there is an argument that pen-sions have been tampered with many times in recent years and that further changes risk eroding trust in pensions. On the flip side, economic ne-cessity means the Government is exploring every means of clawing back revenue and tax relief on pensions costs the Treasury around £28bn every year.

So what are the likely scenarios? Below is some analysis on three options for reducing tax relief on pensions that have recently been mooted:

1) Cutting tax relief on all contributions to 20%

Reducing tax relief on all contributions to the basic rate of tax (20%) would mean higher rate (40%) tax payers would lose £20 for every £100 invested into pension. For someone investing £1500 a year into a pension this equates to £300. Top rate (50%) tax payers would lose £30 for eve-ry £100 invested.

Individuals also pay tax on pensions in retire-ment, which could be at the 40% or 50% rate. As

such, this approach could mean that higher and top rate tax payers may be better off taking cash, which would be taxed as income at the time, in-stead of saving for retirement.

It would also be very difficult to administer in practice and could mean that defined benefit scheme members are required to complete tax re-turns going forwards – potentially impacting on millions of public and private sector employees who pay tax at the higher and top rates. The com-plexity of administering such a scheme in practice was one of the reasons a similar plan from Labour (to reduce pensions tax relief for those earning over £150,000) was replaced by a reduction in the Annual Allowance by the Coalition government in their emergency budget in June 2010.

2) Reducing the annual allowance

The annual amount of pension savings which an individual can receive tax relief on, known as the annual allowance, is currently £50,000, having been reduced by the Coalition government from £255,000 from April 2011.

Reducing the annual allowance further would be simpler to implement and would still give eve-ryone a strong incentive to put some money into a pension; however, depending on the level that the annual allowance is reduced to, substantial numbers of ‘middle income’ earners could be affected - particularly those in defined benefit schemes who could have additional tax to pay if the increase in their pension entitlement exceeds

the allowance in any year. A further reduction in the annual allowance would also penalise those who deliberately planned to increase pension savings later in life, rather than save a little each year.

3) Cutting the tax free lump sum on retirement

In November last year there was speculation that cash lump sums paid at retirement could be taxed. HMRC estimates that the tax-relief on lump sum payments from pension schemes cost £2.5 billion a year, although it is difficult to accurately track this cost with certainty.

Lump sums at retirement are commonly used by savers to ease the transition into retirement, allowing many people to pay off mortgages or other large commitments in order to prepare for retirement. Those people who had already started to plan to receive a tax free cash lump sum at retire-ment would see a reduction of up to 50% in the lump sum received.

So, while economic necessity is likely to put pensions on the Chancellor’s target list, given his commitment to encouraging long-term sav-ing, we would hope that George Osborne tack-les this in a way that will incentivise rather than undermine pension saving. After all, if further changes impact confidence in the pension regime, it could result in longer term problems if ultimately people save less for retirement.

We may perhaps see an increase in ISA limits as a little sweetener to compensate for any potential pension changes but this is unlikely to compen-sate in the long term for the damage to confidence if pensions are cut back again.

Will the Chancellor be bold or retiring when it comes to pensions?

Commercial View

Alison Fleming

From page 1

Budget Previewthe times | 20th March 2012 3

There are several reasons why the Chancellor might give tax breaks to the oil and gasindustry in his Budget

By Peter Jones.................................

Oil companies, generally re-garded as big and rich, are demanding tax breaks just as the price of crude oil is hitting $120 per barrel, guaranteeing

them big profits. And yet the chances they will get something from the 2012 Budget look quite good. Why?

Since the demise of the banks, the North Sea oil and gas industry has be-come one of the UK’s biggest single sourc-es of corporation tax revenue, paying £8.8 billion in 2010-11, or 1.6 per cent of all tax revenues.

In 2011, the Chancellor made a last-minute decision to cancel fuel duty in-creases to ward off motorists’ discontent. As this created a £9.4 billion hole in pub-lic finances in the years 2011-16, Mr Os-borne whacked an extra tax on oil and gas producers, predicting it would raise £10.1 billion over the same period.

The public cheered the redistribution of wealth to them from oil company prof-its, fattened by high crude oil prices aver-aging nearly $80 per barrel in 2010, but the industry howled. Having promised no changes to the tax regime less than a year previously, Mr Osborne was now clobber-ing them.

Mr Osborne increased the sup-plementary corporation tax rate — charged on top of normal large com-pany offshore 30 per cent corporation tax — from 20 per cent to 32 per cent. He predicted this would raise an extra £10.1 billion in the years 2011-16, offset-

ting a reduced fuel duty tax yield of £9.4 billion over the same period.

It took the headline tax rate on fields given development approval since 1993 to 62 per cent, and to 81 per cent for pre-1993 fields on which petroleum revenue tax (PRT) is levied — above the 78 per cent tax rate charged by Norway.

Several companies promptly an-nounced they were deferring develop-ment decisions on the more costly North Sea projects, including Norway’s Statoil which halted work on its Mariner and Bressay fields, south-east of Shetland.

Alex Kemp, professor of petroleum economics at Aberdeen University, the leading authority on the workings of the North Sea, estimated that if crude oil prices averaged $90 per barrel, the tax hike could reduce investment in the North Sea by £29 billion and cut produc-tion by a tenth over the next 30 years.

The Government, in other words, risked losing more oil tax revenue in the long term than it expected to gain in the short term. Losing £1 billion of invest-ment every year is also estimated as like-ly to cost 15,000 jobs, so the overall tax impact on the economy could be much greater.

The Government, said Alan McCrae, head of energy tax at accountants PwC and who has been closely following the talks on mitigating measures between government and industry, needs to rec-ognise that the North Sea is very mature. “Most of the North Sea is now about the really challenging stuff and that is more risky and more high cost,” he said.

The industry is seeking tax changes in four main areas:�� Extension of oil field allowances. These have the effect of reducing the amount of profit from particular fields on which tax is charged. Quali-fying factors which allow companies to claim these allowances include distance from shore, depth of water where a field platform is sited, and the

additional costs of getting out certain types of heavy or sticky oil.

“I would expect the government to extend the field allowances,” said Mr McCrae. The industry wants new allow- ances for oil fields in the deep and stormy west of Shetland and for new invest- ment aimed at squeezing a bit more from older fields, particularly those on which PRT is levied.

“There is some evidence in favour of that in the past,” said Mr McCrae. “Back in 1993 when the PRT rate was 75 per cent, it was then reduced to 50 per cent. That reduction allowed BP and Shell to put further significant investment into the Forties and Brent fields.

“As a result, much more oil was got out of these fields and we got far more revenue as a country than we would ever have done if we had stuck with the previous high tax regime.”�� Removal of the cap on decommission-ing relief. At the end of a field’s life, when it is no longer producing oil or revenue, companies still have to spend large sums to remove platforms and sub-sea installations. The tax system recognises this and allows companies to, in effect, store up money to cover the costs.

But the 2011 Budget put a cap on this, an unprecedented move which raised worries that there might be further detrimental changes and future govern-ments might renege on the deal.

“I would expect there to be some an-nouncement about this in the Budget that would give the industry some com-fort about government intentions,” said Mr McCrae.�� Recognition that gas is not as lucrative as oil. Firms involved in gas production have been pointing out that the gas price equates to about $60 per barrel, half the current crude oil price, so gas fields generate much smaller profits and yet are subject to the same penal tax rate as oil fields.

Mr McCrae said he was “hopeful” that the Government might recognise this, although the extent to which it may do could depend on how much it values having a more secure domestic supply of gas rather than relying on Norwegian and Russian gas imports.�� An increase in the crude oil price which would trigger reductions in the supplementary corporation tax rate. Mr Osborne said that if the oil price dropped below $75 per barrel then the supplementary corporation tax rate would be cut back to the former 20 per cent rate. Mr McCrae thinks that rais-ing the trigger price for this cut would be nice, but is unlikely as it would in-volve the Treasury admitting that it miscalculated.

But can Mr Osborne assure the in-dustry that the North Sea regime will be stable from now on? Mr McCrae doubts that: “They will probably be reassured no more than the extent that the rest of us get any comfort from political statements,” he said.

Most of the North Sea is now about the really challenging stuff

Turning the tax tide for oil

How to stimulate business and export growth

These are nervous times and not just for the Chancellor ahead of his 2012 budg-et delivered tomorrow. British business has now weathered four years of the worst economic storm in many decades

and is hungry for better news. Few are naive enough to expect a Budget give-

away on March 21st. It certainly won’t be Christ-mas for fans of fiscal freebies. We do expect the Chancellor to confirm the outcome of a review into the amount of tax raised by the top 50% income tax rate so some announcements to con-firm at least a direction of travel for this top tax rate would come as a welcome tonic for business.

The Chancellor could steady the ship tomor-row by confirming the detail on the corporate tax reform proposals which have been the subject of hot debate for many months now. Reassurance that the corporation tax rate is still on course to reduce to 23% by 2014 would be good. Indeed, even better would be a further reduction in the medium term – perhaps to as low as 20% - to keep the UK competitive as other countries take similar action to boost their attractiveness as in-ternational trading centres.

Further detail is also expected on tax exemp-tions for UK companies who finance overseas operations via offshore subsidiaries and for profits from overseas branches. The new rules promise to make the UK an attractive place to do business.

The Government continues to promote ex-ports as the “big bet” for future growth, par-ticularly for small to m edium size enterprises (SMEs) who may have been put off in the past by a perception of regulatory or fiscal red tape. The UK and Scottish Governments will unite in their support of this issue at a Scottish Exporting for Growth forum to be held on 29 March. These types of forums are essential for SMEs to share their export experiences and growth aspirations, to hear from seasoned exporters, and to dispel the myth that export is a hard nut to crack. Any further announcements by the Chancellor on measures to promote exporting would be timely as Scottish businesses look to new economies to fulfil their aspirations for growth.

The Government also needs businesses and consumers to start spending before there is any chance of a truly sustainable recovery. Initia-tives such as research and development (R&D) tax allowances already do much to stimulate investment in new product development. And we can expect further progress on proposals for an “above the line” R&D allowance which could mean cash back incentives even for large compa-nies, cranking R&D spending up a gear.

In an ideal world, this type of support for in-novation which increases spend on skilled labour might be combined with a National Insurance Contributions holiday for young employees to address youth training and employment. In re-

ality, however, the Government’s coffers may not stretch this far without further tax raising meas-ures.

While taxing the better off might make good headlines, the Chancellor should not forget that corporate and business stimuli will prove tooth-less if the entrepreneurs, senior management and key talent behind the businesses leave the UK be-cause of an unfriendly personal tax system.

To this end, no-one would expect an immedi-ate lowering of the 50% tax rate. However, an end to the speculation regarding further changes to the pensions tax system would prove healthy. Everything from scrapping the tax free lump sum which pensioners receive on retirement to cap-ping tax relievable annual contributions or re-moving higher rate tax relief have been mooted as “up for grabs” in the press over the last few weeks.

Such intense continued speculation and un-certainty could damage the UK’s reputation as a stable location in which to live and work. Yet limiting tax relief on pensions for higher earn-ers could be a tempting target for the Chancellor as a source of funds to, for instance, increase the personal allowance taking lower earners out of tax altogether.

On balance, business does not need a budget bonanza but a steady, certain roadmap for the medium term to boost UK business and to keep UK plc firmly in the spotlight on the global stage.

�� Susannah Simpson, private business and tax director at PwC in Scotland

20th March 2012 | the times4

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