2024 was the year of elections and barring a few exceptions almost everywhere the elections were for change and it was thus that the Labour party came back to power in the UK after a long gap of 15 years. Incidentally, the Labour Party's manifesto was appropriately named - Change. The budget presented by the Chancellor of the Exchequer, Rachel Reeves on the 30th October, 2024 generated considerable interest both for historic and economic reasons.
In her own words:
"it is the first Budget in our country's history to be delivered by a woman. I am deeply proud to be Britain's first ever female Chancellor of the Exchequer. To girls and young women everywhere, I say: Let there be no ceiling on your ambition, your hopes and your dreams. And along with the pride that I feel standing here today…… there is also a responsibility… … to pass on a fairer society and a stronger economy to the next generation of women. (…)"
Reeves was an economist with the Bank of England and has authored a book in 2023 titled- The Women Who Made Modern Economics. Rachel Reeves has indeed made history by becoming the UK's first female chancellor of the exchequer, bringing with her a significant promise for change in economic and financial policy-making at the highest level.
The post of the Chancellor has existed for the past 800 years in the UK and, notably, has always been held by a man. Until now. In India, we have a female Finance Minister who has also made history by presenting seven consecutive budgets surpassing the record held by Morarji Desai.
Other key roles in economic policy-making that have yet to be filled by a woman include the Governor of the Bank of England and the first permanent secretary to the Treasury. In India too, we haven't had a woman RBI Governor as yet.
Ms Reeves has championed the gender equality issue for a long time and has pointed out that the burden of austerity measures pursued by the Conservative government over the years disproportionately affected the vulnerable sections and particularly the women. The fallout of the COVID was also severe on women - many of whom suffered job losses.
Naturally, therefore, Ms. Reeves was critical of the previous government to whom she attributed the mismanagement of the economy and lack of growth. She was particularly critical of the earlier government for the lack of investments and for leaving a massive black hole in public finances and promised to mend the same.
Sir Kier Starmer, the Prime Minister, had been preparing the public during the days preceding the presentation of the budget that it was going to be tough in the short-term finding the resources required to mend the economy in the long term. Raising resources however requires more tax revenue which is not very popular or resorting to borrowing which then increases inflation and reduces the purchasing power of the people, which is equally unpopular. Ironically, people everywhere require government to ensure better services like in the National Health, mass transport, education etc. It is always a delicate balance that needs to be struck particularly when taxes are raised or new imposts are put in place. Although the initial reaction from the market to her first budget was not too bad. In recent days, there are massive demonstrations by farmers against the change in the rules relating to the Inheritance tax on agricultural estates. But before discussing this issue, let us see what were the salient features of the UK budget in so far as income taxes are concerned.
In line with the Labour's shadow proposals while they were in the opposition, the Chancellor has increased the Employers' National Insurance Contributions 1.2 percentage points to 15% and the threshold at which employers start paying national insurance on the employee's salary was reduced from GBP 9100 per year to GBP 5000 per year. At the same time, for small businesses the employment allowance was increased from GBP 5000 to GBP 10,500. According to the Chancellor this will allow a small business to employ the equivalent of 4 full time workers on the National Living Wage without incurring any additional tax burden.
Incidentally, employer's contribution to provident fund is compulsory in India for the organised sector and one wonders why the same is not taken into consideration for the purpose of calculating our tax efforts. Doing so, will certainly increase India's tax GDP ratio.
The difference between the fruits and the tree is deeply ingrained in British tax history with the result that Capital Gains used to be completely exempt in the UK till the 1965 when James Callaghan also a Labour Chancellor introduced it for the first time. The tax has since evolved over time. What is important to note is that as in most other countries that tax capital gains, there is a difference between the general rate and the rate at which such capital gains are taxed. Labour has earlier questioned the logic of a large gap. Naturally, the Chancellor has proposed to tweak the regime such that the lower rate of Capital Gains Tax is proposed to increase from 10% to 18%, and the Higher Rate from 20% to 24% while maintaining the rates of capital gains tax on residential property at 18% and 24%. Even with such a change, the Chancellor asserted that the UK will still have the lowest Capital Gains Tax rate of any European G7 economy.
Carried interest "loophole" as it is called, has been under attack by the Labour party as also in the USA. Carried interest is a term used in the investment sector, private equity, venture capital etc. According to a paper put out by J.P. Morgan, the fund business borrowed the term from a practice when European colonisation through shipping was going on in the 16th century. Since such long voyage was a risky business and depended on the capabilities of the crews, a practice developed whereunder the crews were rewarded by a percentage of the profits that the goods and merchandise generated. Apparently, such compensation was typically fixed at 20%. Later, the investment business adopted this quaint practice and the general partners being the managers of the fund are compensated by 20% of the profits without making any additional personal investments. Of course, the carried interest is paid only when the fund achieves a minimum return which is known as the hurdle rate.
Ironically, it was under President Trump's first term that the taxation of carried interest underwent a change through the Tax Cuts and Jobs Act, 2017 when the period of holding for the purpose of being considered as long term capital gains was increased from one year to three years. Thus, in the USA, for holding periods of less than three years, the amount will be treated as ordinary income.
The critics of the special dispensation for carried interest argue that it represents, in effect, a compensation for the services rendered and should therefore be at par with the same. A Bill to this effect has been introduced by a Democratic Congressman but its fate will be uncertain considering the change in the composition of the House in the near future.
In the UK also the buyout fund managers aided by the historic low interest regime that was prevalent for a number of years particularly following COVID, made enormous profits in a very short time when they exited the private equity target. Naturally, this has been a matter of envy and also of concern for policy makers in the context of the growing inequality. According to a Financial Times article, Oxford professor Ludovic Phallippou has termed the carried interest phenomenon as the 'billionaire factory'.
But, the fund managers themselves see the situation differently. Apparently, there are certain differences in the structure of the UK system as compared to the American system. In the UK the carry managers also bring in a small amount of investment of their own and their argument is that but for their contribution, the fund will not exist at all.
As of now, from the taxation point of view, carried interest is taxed as capital gains and hence suffers preferential taxation as compared to labour or other ordinary income and despite the rhetoric, the UK government has, as of now, only opened consultations and the final contours of the ultimate proposal may be a compromise. This is evident from the Chancellor's speech wherein she acknowledges that "the fund management industry provides a vital contribution to our economy but as our manifesto set out, there needs to be a fairer approach to the way carried interest is taxed. So we will increase the Capital Gains Tax rates on carried interest to 32% from April 2025 and from April 2026 - we will deliver further reforms to ensure that the specific rules for carried interest are simpler, fairer and better targeted."
The Labour party had also been extremely vocal in their criticism of the non-domiciled persons, particularly when Rishi Sunak was heading the conservative government and his wife Akshata Murthy had claimed the preferential status in some years. As a result, the regime was already diluted by the Conservatist government and subsequently even the conservatives had promised to abolish the same and usher in a new regime.
HMRC guidance in this behalf mentions that the government will introduce legislation in Finance Bill 2024-25, abolishing the remittance basis of taxation for non-UK domiciled individuals and replacing it with a residence-based regime, which will take effect from 6 April 2025.
It has been stated that individuals who opt into the regime will not pay UK tax on foreign income and gains for the first 4 years of tax residence in the UK. From 6 April 2025, the government will introduce a new residence-based system for Inheritance Tax.
For Capital Gains tax purposes, current and past remittance basis users will be able to rebase personally held foreign assets to 5 April 2017 on a disposal where certain conditions are met.
Tax avoidance is obviously a favourite punching bag for the politicians and more so of those belonging to the labour party. This year's budget is no exception. The Chancellor's speech in this regard however lacks the specifics. In her speech, she formulated it slightly differently saying that even before a government could consider any change to a tax rate or threshold, it must ensure that people pay what they already owe. The problem with this formulation is that if the law allows certain loopholes to exist, it will be difficult to ask people not to exploit the same. And how exactly, the Chancellor proposes to ensure that there is no tax avoidance? She proposes that the government will invest more to modernise HMRC's systems using the very best technology and recruit additional HMRC compliance and debt staff.
Further, she promised to clamp down on those umbrella companies who exploit workers and increase the interest rate on unpaid taxes to ensure that people pay on time.
While increasing interest on unpaid taxes is easily understood and has been implemented in India since long, the misuse of umbrella companies and measures to prevent the same deserves more elaboration.
As explained in the Policy Paper- Tackling non-compliance in the Umbrella company market, umbrella companies are employment intermediaries that employ workers on behalf of agencies and end clients. It has been stated that while many umbrella companies operate diligently, supporting their employees and providing convenience and administrative benefits for agencies too, many are used to facilitate non-compliance including tax avoidance and tax fraud.
The tax fraud occurs mainly through non-compliance with the PAYE scheme of the UK (equivalent of TDS scheme) and National Insurance contribution. The fraudulent umbrella companies apparently, avoid the PAYE through camouflaging salary as credit, shares, loans etc and take home pay will be inflated. There are many markers which the HMRC has identified such as registration of these companies in suspect jurisdictions- Channel Islands, Philippines etc, unknown directors and the like. It has been pointed out that such non-compliant umbrella companies undercut compliant firms, threatening the viability of those businesses that do the right thing, as well as the functioning of the market itself. In fact, the Conservative government had in 2023 itself undertook consultations and various options were put on the table. Each of these options was intended to encourage the businesses that choose to use umbrella companies within their labour supply chains to undertake greater assurance activity in their labour supply chains to ensure the legitimacy of their suppliers.
The Labour government will introduce legislation to make agencies that use umbrella companies to employ workers responsible for ensuring that the correct income tax and National Insurance contributions (NICs) are deducted and paid to HMRC. This will mean that the agency that supplies the worker to the end client will be legally responsible for operating PAYE on the worker's pay and will be liable for any shortfall, whether they operated their payroll themselves or used the umbrella company to run payroll for them. If there is no agency involved in the supply of the umbrella company worker, this responsibility will be placed on the end client itself.
The Chancellor has also promised to go after promoters of tax avoidance schemes. The UK is one of the first countries to have the Disclosure of Tax Avoidance Schemes in advance (DOTAS) way back in 2004. It is not exactly clear what all other schemes the government is considering. The Chancellor however announced that these measures will reduce the tax gap by UK 6.5 billion GBP.
Inheritance tax is a touchy subject everywhere. In her speech, Ms Reeves said that only 6% of estates will pay inheritance tax this year meaning that the tax impacts a very small number of people. She also stated: "I understand the strongly held desire to pass down savings to children and grandchildren. So I am taking a balanced approach in my package today.
First, the previous government froze inheritance tax thresholds until 2028. I will extend that freeze for a further two years, until 2030. That means the first £325,000 of any estate can be inherited tax-free rising to £500,000 if the estate includes a residence passed to direct descendants and £1m when a tax free allowance is passed to a surviving spouse or civil partner."
However she promised to close the loophole created by the previous government made even bigger when the Lifetime Allowance was abolished. His will be done by bringing inherited pensions into inheritance tax from April 2027. She has also promised to reform Agricultural Property Relief and Business Property Relief.
The Chancellor pointed out that from April 2026, the first £1m of combined business and agricultural assets will continue to attract no inheritance tax at all but for assets over £1m, inheritance tax will apply with 50% relief, at an effective rate of 20%. According to a Guardian article, this tax can be paid in instalments of 10 years rather than immediately as in the case of other inheritance tax payments. However, the broad arguments of the farmers who demonstrated before the Parliament, is that the agricultural property relief was meant for food security and keeping farming alive such that family farms could be passed on tax free from generations to generations and the tinkering with the same will force the farmers to sell the farms merely for paying the tax since although the market value of their farms could be high on paper, they don't have the money to pay the tax. One has to see whether any compromise will finally be worked out. |