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Focus on supply side - a welcome move

The latest Office for Budget Responsibility (OBR) forecasts will not provide much Christmas cheer to the chancellor…or anyone else! The economy is forecast to grow by just 0.6% this year and 0.7% in 2024 (forecasts not dissimilar to our own). And while inflation will fall, it will still be almost 3% by the end of next year. 

The weakness in GDP growth comes despite the chancellor trying to jumpstart the economy by increasing net spending by about 0.5% of GDP next year. However, this generosity won’t last. The budget deficit is due to fall sharply next year and in 2025 as spending growth slows and tax revenues rise. This will be a sustained drag on the economy over the next two years. 

Aside from the dismal OBR forecasts, the focus of the Autumn Statement was on measures to boost business investment, productivity and labour participation – all areas the UK has struggled with over the last decade. 

Indeed, the combination of a gradually rising tax burden, thanks mainly to frozen tax thresholds, a real terms freeze in government spending, and a small boost to the supply side of the economy, means the outlook for interest rates has not significantly changed. We still expect interest rates to remain at 5.25% until the second half of 2024, before gradually falling to around 4.5% by the end of the year.

How did Mr Hunt make the numbers add up?

It was only two months ago that the chancellor said tax cuts were ‘virtually impossible.’ So, how did he manage to afford two major tax cuts costing some £18bn, especially when economic growth is expected to all but flatline? 

Even though its forecasts for real GDP were revised down sharply, it’s nominal GDP that matters for the budget and the OBR expects that to be 5.5% bigger in five years’ time than it did previously. After accounting for increases in welfare, pensions and interest costs, this gave the chancellor almost £31bn of headroom against his fiscal mandate (for the debt to GDP ratio to fall in five years’ time, ie 2028/29). 

However, much of this extra headroom is because Mr Hunt has banked the increase in revenues from higher inflation without accounting for all the costs. Departmental spending hasn’t changed in response to the rise in inflation meaning that, in real terms, government departments will have less to spend over the next five years. 

What’s more, the budget deficit is set to shrink over the next two years. Cyclically adjusted net borrowing, which is the budget deficit adjusted for the economic cycle, is set to shrink by 2.1% next year and a further 0.6% in 2024/25. That leaves a lot of the fiscal pain to be dealt out by the next government. 

All in, the chancellor has about £13bn of headroom against his fiscal target, that’s double his previous amount but a lot lower than the £27bn average of previous budgets. Given the pressures on public spending and the economics risks – that’s a pretty small margin for error. 

Spending on the right areas 

Taking a step back, there were a lot of positives to take from this Autumn Statement. The focus on the supply side of the economy is a welcome step forward in solving the UK’s long-running economic problems. Making it easier to build critical infrastructure, encouraging business investment and taking action to address the huge increase in inactivity due to sickness should all have a positive effect on long-term economic growth. Indeed, the OBR estimates that the changes to business investment taxes will boost long term economic growth by 0.2% and the changes to national insurance and work benefits will boost labour supply by more than 100,000 full time equivalent workers. That won’t make up for the 500,000 increase in inactivity due to sickness since the pandemic, but it’s a step in the right direction. 

Conclusion 

Overall, the chancellor took a step in the right direction by focusing on some of the key supply side problems that have plagued the economy. But while the Autumn Statement provides a small boost to demand in the near-term, we doubt it will be inflationary enough to cause a change in course for interest rates.
The economy is still teetering on the edge of a recession, and the tiny sliver of headroom now left to the chancellor means that, should one arise he would be unable to respond to it, without breaking his fiscal mandate. What’s more, much of the pain of fiscal consolidation has simply been kicked into the next parliament. This provides a big challenge for whoever wins the next election. 

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Full expensing

The chancellor proudly announced full expensing as the biggest business tax cut in modern British history.

The announcement to make the full expensing regime permanent is likely to be welcomed by companies looking for greater certainty making long term investment decisions. The full expensing regime was introduced as a temporary measure in the 2023 Spring Budget, giving 100% tax relief for expenditure on qualifying general pool plant and machinery and a 50% first year allowance for special rate assets.

Under the regime, companies receive 25p of tax relief for every £1 of qualifying capital expenditure on new and unused plant and machinery in the period in which it is incurred. Importantly the relief is uncapped.

This is an acceleration of the timing of the relief that companies receive under the general capital allowances regime, providing a cash tax benefit to those companies able to take advantage. 

Although welcome, unincorporated businesses do not qualify, and the majority of companies with capital spend of less than £1m per annum will likely not see any benefit, as the existing annual investment allowance already provides for full relief in the year of expenditure. 

This announcement will be good news for many UK companies, giving them certainty on tax treatment to enable them to make decisions on long term investment plans. The measure mainly benefits capital intensive industries such as manufacturing and may be less help to the c80% of UK companies in service industries.

A consultation on extending full expensing relief to leased assets was also announced.

R&D tax incentives

It was a mixed afternoon for UK research and development (R&D) tax incentives. Overall it appears that the government has listened to feedback from stakeholders and made some important changes to its proposals. The headlines are as follows below.

• The proposed merger of the current R&D Tax Relief Scheme for SMEs and the R&D Expenditure Credit (RDEC) Scheme will go ahead, but with effect for accounting periods beginning on or after 1 April 2024 - a delay on the expected timing.
• Uncertainty around the definition of the term 'subcontract' has been addressed and, on the face of it, HMRC appears to have reached a sensible definition (broadly, the definition allows ‘the company making the decision to undertake R&D’ to make the claim). Whilst clarifying the definition brings certainty, further guidance will be required to help businesses correctly assess their eligibility, especially in the light of current ongoing legal cases.
• In defining 'subcontract', HMRC has accepted that it doesn’t need to exclude subsidised or grant funded expenditure from relief. This is particularly good news for businesses in sectors such as life sciences, for whom grant funding and R&D tax credits have both long been important sources of funding for future investment.
• There will still be a separate scheme for 'R&D intensive' SMEs, but the previously challenging threshold requiring 40% of a company’s cost base to be eligible for R&D tax relief has been reduced to 30% from 1 April 2024. This is expected to bring another 5,000 companies within the scope of this more generous relief. There will also be a 'year of grace', to stop companies falling in and out of this regime based on single year financial results.
• The amount 'withheld' from the cash payments received by loss-making companies under the RDEC Scheme will be reduced from 25% to 19%, meaning businesses will benefit from a greater proportion of the relief upfront.

Overall, there were some positive announcements, but with two regimes remaining (R&D and ‘R&D intensive’), was this a missed opportunity to further simplify the reliefs by having a single regime?

International tax

The government confirmed its commitment to the new global minimum tax, known as Pillar Two, which will apply to multinational enterprises with global annual revenues of at least €750m.

The majority of the Pillar Two legislation has already been implemented during 2023, although the government has confirmed that further legislation will follow to refine what has already been enacted. This is to align with guidance issued more recently by the Organisation for Economic Cooperation and Development (OECD) and G20 Inclusive Framework group of countries, and to bring in the undertaxed profits rule (UTPR), a supporting component of Pillar Two which had been expected to follow at a later date. 

The Pillar Two rules will apply for qualifying businesses for accounting periods starting on or after 31 December 2023, with the UTPR intended to come into force for accounting periods starting on or after 31 December 2024.

The UTPR will effectively act as a backstop where top-up tax cannot be collected under the main income inclusion rule (which was legislated for this year).  

The introduction of the UTPR will  allow the government to repeal complex existing legislation which taxes offshore receipts in respect of intellectual property that supports UK sales.

In the wider transfer pricing world, there was no mention of the outcome of the recent consultation on transfer pricing, permanent establishment and diverted profits tax. Apart from a hoped-for relaxation of UK to UK transfer pricing rules, this is, in any case, very much one for the purists.

Creative sector tax reliefs 

The Autumn Statement brought positive news for the creative sectors with the introduction of an audio-visual expenditure credit and changes to video games tax relief.

Enterprise Investment Scheme/Venture Capital Trusts

In another measure designed to increase investment in the small, high growth businesses so loved by the chancellor, Mr Hunt today announced a 10-year extension, to 2035, of the Venture Capital Trust and Enterprise Investment Scheme tax reliefs.

Reduction in Class 1 National Insurance contributions

The most significant announcement from today's Autumn Statement, from an employment tax perspective, was the reduction of the main rate of employee's National Insurance contributions (NICs), payable on earnings between £12,570 and £50,270, from 12% to 10%. This reduction will take effect from 6 January 2024. The government expects this to benefit 27 million workers, with the average worker on £35,400 receiving an effective reduction in 2024-25 of over £450.

The employer rate of NICs and the rate of employer NICs on employee benefits will remain unchanged at 13.8%. With the significant increase next year in the hourly National Living Wage to £11.44, and extending this to employees aged 21 and over, businesses will feel wage cost pressure from April 2024.

Whilst NICs rate changes generally take effect from the start of a tax year, the government is keen to bring forward the savings generated by the NICs reduction for employees, hence the change from 6 January 2024. With Christmas around the corner, these changes are welcome. However, they could present a challenge for payroll teams and it remains to be seen how prepared HMRC and payroll software providers are for this change. As statutory directors’ NICs are calculated on an annual income basis it is assumed that an average director NICs rate will be applied for the current tax year, but this is yet to be confirmed. 

With NICs being generally considered a tax on employment, this reduction in employees’ costs is clearly aligned to the government’s stated intent of encouraging and rewarding work. This can be seen in the wider context of measures to support people back into the workforce, simplifying and reducing the NICs burden on the self-employed, and extending the NIC relief for employers hiring qualifying veterans.

National Minimum Wage / National Living Wage 

The National Living Wage (NLW) will increase to £11.44 for those aged 21 and over from April 2024. This is an increase of £1.02, the largest ever single increase. The rate of National Minimum Wage (NMW) for 18–20-year-olds will increase to £8.60 (an increase of £1.11) and the 16-17 year-old and apprentice rate will increase to £6.40 (up by £1.12). Whilst welcome for low earners, the significant increase in the NLW/NMW rates will be a challenge for small businesses particularly as there was no announced reduction in employer NICs rates. 

Enterprise Management Incentives (EMI) – time limit for notification of grants

Legislation will be introduced to extend the time period in which EMI option grants should be notified to HMRC from 92 days after the date of grant to 6 July following the end of the tax year. This change will apply to EMI share options granted on or after 6 April 2024.

Construction Industry Scheme (CIS) and the gross payment status test

It has been announced that from 6 April 2024 changes will be introduced to strengthen the CIS gross payment status tests for subcontractors by adding VAT compliance to the tests to qualify, with allowances for minor non-compliance and where there is a reasonable excuse.

The measures will also expand the grounds for immediate cancellation of gross payment status by adding VAT, corporate tax self-assessment, income tax self-assessment and PAYE to the list of taxes where a gross payment status holder has fraudulently provided information.

It was also announced that a process for digital applications for CIS registrations will apply from April 2024. 

Off payroll working (IR35) – offset for tax and NICs paid

As expected, legislation will be introduced from 6 April 2024 to enable HMRC to offset tax and NICs already paid by an individual and/or their intermediary where an error has been made by an engaging entity when determining employment status. This measure will be of interest to deemed employers and will broadly align with existing legislation which applies where a self-employed individual is re-categorised as an employee. 

Other announcements 

It was announced that company car and company van benefit charges will remain unchanged for the 2024/25 tax year.

Disappointingly, the government announced that, at this stage, it will merely continue to explore the case for providing additional occupational healthcare support for employers through the tax system and will issue a further consultation in due course.

VAT treatment of private hire vehicles 

The government has announced a forthcoming consultation on the VAT treatment of private hire vehicles (PHV), which has been called into question after recent litigation involving aspects of Uber’s business. This follows concerns that a recent court ruling means that all taxi firms will be required to account for VAT on the full value of their fares, and not just on the agency fees they charge to their drivers. 

HMRC accepts that taxi firms using self-employed drivers act as an agent. Under this business model, fares received from customers are the income of the driver, so the taxi firm is only required to account for VAT on the agency services it provides to its drivers (eg booking services, hire of radios etc). In July 2023, the High Court examined the law covering the licensing of PHVs and held that this is not in fact an agency relationship. Instead, the PHV licensing law specifies that taxi firms act as principal, providing the service to customers in their own right. This applies to all PHV licensed taxi firms, not just to those using Uber style app-based bookings, regardless of the drivers’ employment status.

The consultation document will not be published until early next year but can be expected to ask for the views of PHV firms around the country on the impact of applying VAT to the full value of their fares before the government decides how to implement the court’s decision. Many firms are concerned that this may increase prices and/or the running costs of their businesses. Meanwhile, separate litigation is expected soon to consider whether taxi firms are eligible to account for VAT under the Tour Operators Margin Scheme, which allows some travel service providers to account for VAT on their profit margin.

VAT Retail Export Scheme 

There was disappointment for retailers in the Autumn Statement, with no announcement on the reintroduction of tax-free shopping for overseas visitors to Great Britain (this relief is still available for overseas visitors to Northern Ireland). The abolition of tax-free shopping went ahead in January 2021 despite strong opposition from many stakeholders who relied on tax-free shopping to generate strong sales in airside outlets and boost trade in tourist heavy areas such as London’s West End. The government has offered a glimmer of hope for affected retailers, stating that it was grateful for the many industry representations it has received, which it will continue to consider carefully alongside other broader data. 

Extension of reforms to energy-saving materials VAT 

The temporary zero-rate of VAT for energy saving materials, which currently applies to installations in residential buildings, will soon be expanded to cover more materials. The zero-rate, which was introduced in April 2022 and will run until 31 March 2027, currently applies to a limited range of energy saving materials including solar panels, insulation, and heat pumps. Following a consultation, the government has announced that it will, from February 2024, be extended to cover other items, including water source heat pumps.  

The government will also reinstate the VAT relief for installation of those materials in buildings used for a relevant charitable purpose. A previous reduced VAT rate of 5% was withdrawn in 2013 on the basis that it was incompatible with European Union law. The scope of the zero-rate will soon be widened to include those buildings. More details have been promised soon. 

Other VAT related changes

Perhaps the most well publicised change in the media before the Autumn Statement was delivered was the government’s proposal to remove VAT from the sale of ‘period pants’, ie washable and reusable underwear which contains a highly absorbent lining and can be used in place of sanitary pads or tampons. It was confirmed that from 1 January 2024, these will be added to the VAT zero-rate, which has applied to other women’s sanitary products since 2021. Following criticism that previous VAT cuts in this area were not fully passed on to customers, several large retailers have already committed to cutting prices in response. However, while the extension of this VAT relief delivers a positive social and environmental message from the government, the savings may be quickly swallowed up by inflationary pressures. The government may therefore wish instead to consider the recommendations of a 2022 study that proposed funding through the tax and benefits system or providing free or subsidised products as a better way of making such essential products more affordable for consumers in the long term.

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The focus of the Autumn Statement on making work pay extended to the proposals for personal tax. 

In addition to the cut to National Insurance (NICs) for employees, the self-employed will benefit from a 1% reduction in the headline rate of Class 4 NICs on profits from 9% to 8%, as well as the abolition of Class 2. The impact of these changes will mean that the self-employed will see an increase in their after-tax profits, but the effect of the freeze in allowances since 2021 may outweigh these new benefits.

There was speculation before the announcement of potential tax changes, but very few of those measures made it into the chancellor’s speech. Of note was the lack of any mention of inheritance tax. Whilst this did not feature at all in any of today’s announcements, tactically the chancellor could revisit this in the Spring Budget in the run up to a general election.

Those who rely on investment income may be feeling ignored. Not surprisingly, following the reduction in the annual exemption which was announced last year, there has been no change to the capital gains tax (CGT) rate. The reality is that the reduction in the annual allowance does not affect the majority of people who can still make small gains and pay no tax. It seems likely that the 20% rate is here to stay, at least into the next tax year. For those with large investment portfolios, there is unlikely to be any requirement to consider pre year-end sales to lock in the current rate of CGT.

Some welcome announcements in the small print will lead to a simplification for high earners, who will no longer need to file a tax return where their income is fully taxed under PAYE. This won’t help those at the other end of the scale who receive the state pension and investment income, and whose income is likely to increase above the frozen personal allowance. They have no mechanism to pay tax at source and will therefore need to submit an annual tax return or rely on HMRC to calculate their tax.

It was a shame that the chancellor didn’t take the opportunity to address the extreme cliff edge faced by working families who can lose the benefit of 30 hours of free childcare when income moves from £100,000 to £100,001. The cost for parents of the extra £1 of income is thousands of pounds to pay for childcare that would otherwise have been provided free.

A headline grabbing reduction in the rate of income tax was also missing from the announcements. The focus on the statement was on making work pay and as a cut in income tax rate benefits all individual taxpayers, perhaps it is not a surprise that this has been kept as the potential rabbit in the hat for the Spring Budget.