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In the Spring Budget  Jeremy Hunt, the Chancellor Exchequer has been hinting that there could be tax cuts coming up.

 

What is income tax?

Income tax is the tax you have to pay on your annual earnings or, if you’re self-employed, any profit you make. Depending on how much you earn determines how much income tax you pay. So, the more you earn, the more money you are paying in tax.

Income Tax is used to pay for public services and is the main source of income for the Government. The NHS, railway systems, education and more is paid for using income tax.

You are placed in band based off of what you earn, decided by HMRC, who collects the tax and the higher you earn, the higher your band, the more you pay and so the amount is as fair as possible.

The band you are in decides your tax code and therefore how much you can earn tax-free before you begin paying taxes on your earnings so, you could earn up to £12,570 before being taxed if your tax code is 1257L.

 

Why would the government cut it?

The government wants to cut taxes to relieve financial burdens across the UK however it has been suggested that there may not be enough money to do this.

With the elections coming up this year, the government is eager to make decision which will increase their poll numbers. As the UK entered a recession, the conservatives are under pressure to alleviate the financial pressures on the public.

 

What this means for your money?

If Hunt decides to cut income taxes then there will be the question of, what will pay for the public sector such as, the NHS? This could be spending cuts or using alternative funds.

If income tax is cut this will mean you will keep more of what you earn and be better off financially.

A tax cut will mean a decrease of how much you pay and will not altogether abolish income tax, they have been hinting at a 1p cut which could be beneficial to many.

 

On March 6th the Spring budget will be announced and we will find out what plans the government have made.

 

In the last Quarter of 2023, it was confirmed that the UK had fallen into recession. The picture of the UK over the last decade has been one of stagnation or decline. Productivity has grown by just 0.9% per year since 2008, and as per the Centre for Macroeconomics May 2022 Survey, it is believed that the UK will continue to suffer from low growth in the upcoming decade. This was considered to be a result of UK-specific structural issues, one of which being the UK's tax system, which has been described as “complicated, inefficient and beset with perverse incentives that do little to raise revenue” (Tetlow and Marshall 2019).

For some time now, there has been discussion about tax reform in the UK, whether they truly maximise the revenue the Government could bring in, and whether they are still fit for purpose, with some taxes not seeing true reform in decades. With an election looming, both parties looking to win will require additional revenue in order to enact their policies. With growth in the UK stagnant, it's likely that either party would currently have to rely on either borrowing money or cutting spending. Herein lies the argument for reforming the taxes we currently have in order to increase the revenues the government can earn whilst simultaneously making them less complicated.

Taxing Capital vs Taxing Labour

One of the key battlefields is where the balance of taxation falls in the UK. It can be argued that in the UK, labour is taxed far more aggressively than wealth. This can be best seen by the current Prime Minister Rishi Sunak. Mr Sunak recently published his tax returns in which we learned that he paid £508,308 in the financial year 2022-23 on overall earnings and gains of £2.23m. This is an effective rate of tax of 23%, which is far lower than the top rate of income tax, which is 45%. This is largely due to his earnings in the US being taxed at source, and capital gains tax is much lower at 20%.

Capital Gains Tax

This raises a good question, why is a millionaire able to pay less in tax than for example, a Doctor? The answer is that capital gains tax is very favourable to those with wealth. The capital gains tax is targeted at realised capital gains. Realised capital gains are the amount of profit made after selling an asset, usually real estate or stock investments. The ‘gain’ is the amount earned by the sale minus the original amount. A capital gains tax will then tax the seller on the profit made from the sale. 

For some time now, capital gains tax has been lower than income tax. This has resulted in those who earn in excess of the highest tax bands to re-characterise their income. As capital gains are taxed lower than income tax, a lot of business owners now take small salaries or in some cases no salaries and instead take money out of their company in the form of capital gains.

So, how can we reform this tax to make it more suitable? In 2023 the Economy 2030 Inquiry by the Resolution Foundation released a report suggesting the following reforms:

"The report proposes aligning the tax treatment of these different income sources by increasing tax rates on self-employment and rental income, enabling the rate of employer NICs to be cut by one per cent. Moving towards equal treatment would also mean increases in the rates of Capital Gains Tax, such as from 28 per cent to a top rate of 53 per cent for second homes, and a top rate of 37 per cent for shares. Crucially though, the report argues that this would be combined with a major tax cut, with no tax paid on gains that are merely in line with inflation. The result would be a net Capital Gains Tax cut for many, with anyone seeing an annual capital gain for shares of 8 per cent or less facing a lower net tax rate than the 28 per cent rate that George Osborne oversaw between 2010 and 2016."

National Insurance & Income Taxes

Another area for reform is income taxes. Both National Insurance contributions (NIC) & Income taxes are overly complicated. Both have a series of rules and exemptions that make it difficult to calculate. For example, Resolution Foundation's 2023 report provides the following example:

"A common example of this complexity is the ‘hidden’ 60% effective marginal tax rate that people must pay if their annual income falls between £100,000 and £125,140 due to the loss of personal allowance, despite a statutory income tax of 40%. Similarly, employees face different effective marginal tax rates depending on how their income is structured. For instance, the effective marginal tax rates for employees in the top income bracket (earning more than £125,140) can vary significantly, peaking at 53.4% when employer NICs are included or 54.5% paid on income from dividends, falling to 47% paid on self-employment income, 45% on rental income, 28% on gains from property, and as little as 0% if an employee keeps their income in a company and then emigrates".

In order to uncomplicate this tax, one solution is provided by Broome et al. (2023), who suggest equalising tax rates on different kinds of income and removing very high marginal rates, through higher dividend and capital gains taxes and higher top National Insurance rates for the self-employed, offset by indexing capital gains to inflation, a cut in employer National Insurance, reinstating the personal allowance above £100,000, and abolishing the High Income Child Benefit Charge.

Property Taxes

When we examine property taxes, we see further examples of poorly designed taxes that need updating or reform. Council tax, stamp duty, and business rates which bring in near 9% (£90 Billion) of the UK's tax revenues are all flawed in their own ways.

Council tax is a levy on properties, but it is based on house prices in 1991. In an article in the New Statesman entitled "Britain's Great Tax Con" Harry Lambert wrote:

"If you live in Burnley, where homes are cheaper than many other parts of the UK, you will on average pay 1.1 per cent of the value of your home in council tax every year. If you live in a typical property in Kensington and Chelsea, where council tax has scarcely risen but homes have rocketed in value since QE – leaping from 24 times earnings in 2010 to 38 times earnings in 2022 – you will pay 0.1 per cent. The burden of council tax is ten times as great in Britain’s poorest areas."

A fairer way to tax property would be to replace the tax with an annual proportional property value tax based on up-to-date house valuations. Harry Lambert noted that by setting a flat 0.5% tax on house valuations you would raise the same revenue whilst cutting taxes for 3 out of 4 people and eradicating the need for Stamp Duty Tax. So, whilst it would not increase tax revenue, it would simplify the property tax as well as reduce the increasing economic equality in the UK as well.

In Summary

In Summary, we've outlined several reasons why the UK needs tax reform. Currently, the inequality in wealth is part of the reason that growth and GDP are struggling. By using these tax reforms, the government could free up finances to invest in public services as well as reduce the load on those who rely on those services the most. 

 

 

The introduction of such a measure would see millions of households paying a fifth less in income tax, with those on the average UK salary of £32,000 saving approximately £777 per year. Sunak said this would be the “largest cut to income tax in 30 years” and called the move “responsible.”

The former chancellor said the commitment would be delivered by the end of the next parliament if he wins the Conservative leadership race.

Speaking to BBC Radio 4’s Today programme, Sunak said, Now the last week or so of this contest we’ve been focused on the here and now about how best to fight inflation and I think everyone knows where we stand on that and we have different points of view.”

“But, as chancellor, I was very keen to make sure that I started cutting taxes and what I’ve announced today builds on that and that’s because I believe in rewarding work and the best way for the government to signal that is to cut people’s income tax.”

"And in this parliament as chancellor, I already said we’re going to cut income tax for the first time in almost 15 years and, as prime minister, I want to go further than that and cut income tax at the basic rate by a fifth to 16p, but I want to do that in a way that’s responsible.”

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Taxes have always been a bit of a confusing matter for many people – now more than ever, due to the impact of COVID-19 on tax. There are so many things that can be overwhelming when it comes to taxes, such as which bracket you fall into, whether you need a UTR number, and many more.

One of the main things that confuses people is the fact that there are so many different types of tax. It can be hard to know whether you need to pay tax, and even once you know that, you may be unclear on what type of tax you need to pay.

There are various lesser-known types of tax, such as tax when you travel, or tax for gambling winnings, but in this post, we’ll be focusing on three of the most common types of tax: income tax, consumption tax, and property tax.

Income tax

This is the type of tax that tends to cost people the most. As the name suggests, income tax refers to compulsory money you need to pay to the government for any income earned. Keep in mind that this doesn’t just refer to money you earn form your business or job, but other forms of income as well.

There is usually a minimum income required in order for you to have to pay taxes, so if your income falls below this threshold, you might be exempt from paying. There are also various income brackets, which means the more you earn, the more taxes you’ll need to pay.

Consumption tax (VAT)

Consumption tax, also known as VAT, is the tax we pay on most of the products or services we buy. This varies from place to place. In the UK, the standard rate for consumption tax is 20%. This is the type of tax we encounter most often, since most people will pay VAT on nearly a daily basis.

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While the majority of goods and services will require you to pay consumption tax, there are a few that are exempt. These differ depending on where in the world you live. Some places don’t charge VAT on what is viewed as basic necessities, and instead only charge for items viewed as luxuries. In the UK, for instance, insurance is exempt from VAT.

Property tax

Property tax refers to money that is levied on real estate. The way that property tax works is dependent on where you live. In some areas of the world, you only need to pay property tax on a property when you buy it and it is over a certain value. Generally, property tax is taxed annually.

Property tax is the responsibility of the owner of the property, which means that renters are not liable to pay property tax, although a portion of their rent will probably be used towards it. If you don’t pay your property tax, your house could get taken away from you, so it’s important that you pay the amount that you should, and that you pay it on time.

The theme of the Budget, as articulated by the Finance Minister, is to transform and energise the country and the economy - as well as a much cleaner economy. How the year ahead will play out will depend on the growth in the major economies, fresh investment by Indian companies, and spending by consumers and the government.

The Budget laid emphasis on digitization of tax administration, use of IT systems to reduce human intervention and e-assessment ensuring transparency and timeliness.

Ultimately, the Budget turned out to be in line with the government's vision and policies so far. It had several announcements impacting startups directly and indirectly. Analysis of such provisions as made by Neeraj Bhagat, Chartered Accountant and Founder of Neeraj Bhagat & Co. are as under:

Amendments having direct impact:

  1. Reduced corporate income tax

Reduction in corporate tax for MSME to 25%: The government has decided to reduce the corporate income tax from FY 2017-18 onward to 25% from the current rate of 30% for all companies that had a turnover or gross receipts up to Rs. 50 crore in FY 2015-16. This would mean that small and medium scale companies having a turnover of up to Rs. 50 crore till FY 2015-16 and also the new companies can claim the benefit of this section. However, this benefit is available only to domestic companies. Foreign companies and other forms of businesses like LLP and partnership firms are not eligible for this reduced rate. Even individuals and HUFs are required to pay income tax @ 30% for income above Rs. 10 lakh. The idea is to promote private limited companies, which is a more structured form of business organization. This is a very welcome step for all startups and small and medium enterprises functioning under the company form. This matches our Budget expectations penned earlier.

  1. Relief for small traders and businesses opting for presumptive taxation and having non-cash receipts

As announced during the demonetization period, the government has reduced the requirement u/s 44AD for declaring a minimum presumptive tax profit margin to 6% from the existing 8% in cases of non-cash receipts and turnover. This was already announced by way of a press circular and was much anticipated. Also, the threshold limit for maintenance of books of accounts for individuals and professionals has been increased to Rs. 2.5 lakh from Rs. 1.2 lakh and the limit for tax audit u/s 44AB has also been increased to Rs. 2 crore from the current limit of Rs. 1 crore for the individual/HUFs opting for presumptive taxation u/s 44AD.

  1. Extension of time period for availing income tax benefits under Startup India Initiative

The startups recognized under the Startup India policy can now claim tax benefits in three out of the first seven years under Section 80-IAC of the Income-tax Act, 1961. Earlier, it was three out of the first five years. The government had received several representations that startups rarely earn profits in the first few years of their operations. This is again a welcome step and shall encourage more startups to register themselves under the government's Startup India initiative. This also matches our budget expectations penned earlier.

  1. Carry forward of losses for companies whose shareholding has changed considerably

Section 79 of the Income-tax Act, 1961 allows carry forward of losses of a company for seven years and then set-off against profit of future years. However, there was a restriction wherein the carry forward and set-off were not allowed in case 51% shareholding didn't remain intact in the year of loss and in the year of set-off. With the startup ecosystem's changing environment and more investments and buyouts happening, the government has allowed carry forward and setting-off of losses even if majority shareholding has changed hands. However, this benefit is available only for startups recognized under the Startup India policy and eligible to claim benefits of Section 80-IAC (NIL income tax in three out of the first seven years).

  1. No capital gains on conversion of preference shares to equity shares

Earlier, the conversion of preference shares into equity shares was considered a transfer and thus attracted capital gains tax. The government has exempted conversion of shares from preference to equity and otherwise from the definition of 'transfer' and given a big relief to startup investors who prefer buying convertible preference share. This is a very good step on the part of the government to boost the investments in startups.

  1. Extension of time limit for use of MAT credit

The existing tax laws have a provision of MAT (Minimum Alternate Tax) at approximately 19% on book profits of all the companies, who may otherwise be not be paying corporate income tax due to some deductions or exemptions available under the Income-tax Act. However, credit of MAT was available for 10 years to be set off against normal income tax liability, when the taxes under normal income tax provisions exceeded MAT. Startups exempt from income tax under Section 80-IAC discussed above are also liable to pay MAT. For simplification, in the long run, the government is targeting reduced corporate income tax rate, reduced exemptions, and abolishment of MAT. However, for the time being, the government announced its inability of abolish MAT and rather extend the time period for availing MAT credit to 15 years from the current limit of 10 years. This will benefit startups claiming tax exemptions u/s 80-IAC but paying MAT and shall also benefit the companies who have huge MAT credit lying unused.

  1. Penalty for late filing of income tax returns

After the end of each financial year, September 30 is the due date for income tax return filing for companies and assessees covered under tax audit. For others, the due date is July 31. Earlier, there was no or optional penalty for delay in return filing up to a certain date. However, now the government has prescribed a late filing fee of Rs. 5,000 for delay up to December 31 and Rs. 10,000 for further delay. However, the penalty has been limited to Rs. 1,000 in cases where the taxable income is up to Rs. 5 lakh. Many startups and startup founders do not take return filings within due date seriously. This is a wake-up call to all such startups and their founders. Also, this penalty is payable before filing of tax returns, along with other tax and interest liability.

Amendments towards 'ease of doing business':

  1. Tax on indirect transfer in case of certain foreign portfolio investors

Section 9 of the Act deals with cases of income which are deemed to accrue or arise in India. Sub-section (1) of the said section creates a legal fiction that certain incomes shall be deemed to accrue or arise in India. Clause (i) of said sub-section (1) provides a set of circumstances in which income accruing or arising, directly or indirectly, is taxable in India. The said clause provides that all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India, shall be deemed to accrue or arise in India.

The Finance Act, 2012 inserted certain clarificatory amendments in the provisions of Section 9. The amendments, inter-alia, included insertion of Explanation 5 in Section 9(1)(i) w.e.f. April 1, 1962. Explanation 5 clarified that an asset or capital asset, being any share or interest in a company or entity registered or incorporated outside India shall be deemed to be situated in India, if the share or interest derives, directly or indirectly, its value substantially from the assets located in India. In response to various queries raised by stakeholders seeking clarification on the scope of indirect transfer provisions, the CBDT issued Circular No 41 of 2016. However, concerns have been raised by stakeholders that the provisions result in multiple taxations. In order to address these concerns, it is proposed to amend the said section so as to clarify that Explanation 5 shall not apply to any asset or capital asset mentioned therein being investment held by non-resident, directly or indirectly, in a foreign institutional investor, as referred to in clause (a) of the Explanation to section 115AD, and registered as Category-I or Category II foreign portfolio investor under the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2014 made under the Securities and Exchange Board of India Act, 1992, as these entities are regulated and broad based. The proposed amendment is clarificatory in nature.

This amendment will take effect retrospectively from April 1, 2012, and will, accordingly, apply in relation to assessment year 2012-13 and subsequent years.

  1. Provisions relating to domestic transfer pricing have also been relaxed, so as to cover only those companies which who are claiming profit-linked deductions or exemptions.
  2. FIPB or the Foreign Investment Promotion Board has been done away with, leading to more emphasis on foreign direct investment (FDI) through the automatic route.

Amendments to boost digital economy and curb black money:

  1. Cash payment for expense or acquisition of asset of Rs. 10,000 or more not allowed

Earlier, cash payment in a day of Rs. 20,000 or more was not allowed as an expense in the books of the company. Now the limit u/s 40A has been reduced to Rs. 10,000. Over and above this, the provision now also covers capital expenditure. If payment against a capital expense of Rs. 10,000 or more is done in violation of Section 43, the cost of such an asset would not get added to the total asset value, which would mean that no depreciation can be claimed on such assets and also the cash value would not form part of the cost of such asset, which will also increase the capital gains amount in case of any future sale.

  1. Cash receipt of Rs. 3,00,000 or more would attract 100% penalty

A new Section 269ST has been proposed, to bar cash receipt or Rs. 3 lakh or more in a single day, or against a single bill or against a single occasion or event, attracting a penalty of the same amount.

(Source: Neeraj Bhagat & Co.)

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