Budget '97: Pensions blow to Middle England

Wage-earners face a big increase in pension contributions as a result of the Chancellor's decision to abolish tax credits on dividends, pensions experts warned last night.

Pension schemes will have to find another pounds 50bn over the next 10 years to fund the same level of retirement income. In final salary schemes much of the shortfall is expected to be funded by the employer, but for personal pensions the burden will fall on the individual.

"What he's really done is to steal from every person and business who pays into a pension," said David Harrison of accountants Kidsons Impey.

According to RK Harrison, a leading firm of independent financial advisers, a male aged 35 expecting to retire at 65 faces a 15 per cent reduction in his annual pension. Alternatively, he would need to contribute an extra 2 per cent of his income a year to fund the same retirement benefits, according to some pensions experts.

The corporate sector has been badly hit by Labour's first budget, which slaps a pounds 5.2bn windfall tax on privatised utilities, as well as the abolition of tax credits on dividends - a move whose cost falls largely on business and the City. This has only partly been offset by lower Corporation Tax rates and improvements in capital allowances.

The Chancellor hopes the measures will create a climate for long-term growth and investment, but this was being viewed with scepticism in the City and industry last night.

The windfall tax will raise pounds 5.2bn as a one-off charge against water and electricity companies, along with BT, Railtrack, the old British Gas, BAA and British Energy.

The levy will be used to fund the Welfare to Work programme, aimed at finding jobs for the young and long-term unemployed. A further pounds 1.3bn will be set aside from the windfall tax to be invested in a capital renewal programme for schools.

The tax is an attempt to claw back for the taxpayer the undervaluation of privatised companies when they were sold to the private sector. The liability for each company will be based on a revised market capitalisation, which will be inflated to reflect its underlying value.

BT estimates its liability will be pounds 500m, BAA reckons its liability will be between pounds 70m and pounds 100m. Anglian Water anticipates a pounds 170m charge and Railtrack anticipates paying pounds 135m. BT is unhappy about the amount it will have to pay and is considering mounting a legal challenge against the windfall tax.

However, it is the changes to the system of tax credits on dividend payments which will provide a higher and more sustained yield for the Revenue.

Payments of tax credits to pension funds and UK companies other than charities were abolished yesterday. Other shareholders, including individual Personal Equity Plan investors, will not be affected until 6 April, 1999.

The change is a blow to big institutional investors, such as pension funds whose tax-exempt status has allowed them to reclaim the tax credits on dividends paid by UK companies. The Treasury estimates that an pounds 800 dividend paid by a company is worth pounds 1,000 to an exempt investor because it can reclaim the pounds 200 tax credit the dividend attracts. The Chancellor believes has been an incentive for companies to pay dividends rather than invest in the business.

The abolition of tax credits for exempt investors will yield pounds 2.3bn for the Exchequer in 1997-98, rising to pounds 5.4bn in the tax year 1999-2000.

Mr Brown also cancelled the Foreign Income Dividend Scheme, which allowed companies with international operations to reduce the amount of advance Corporation Tax they paid. This will raise an extra pounds 250m a year from 2000-1 onwards.

However, the corporate sector has also been given a boost with a cut in the basic rate of Corporation Tax from 33 per cent to 31 per cent. That reduction, which had not been anticipated, helped push share prices higher as dealers preferred to concentrate on the short-term boost this will provide rather than the impact the abolition of the tax credit will have on share prices.

Around 500,000 companies will benefit from the reduction in Corporation Tax. Britain can now boast a lower main rate business tax than the US, Japan, Canada and many European competitors. Cutting the rate of Corporation Tax raises the return on investment and makes the UK a more attractive place to invest for the long term.

Smaller and medium-sized firms have also been given a Budget boost, with a cut in the small companies Corporation Tax rate to 21 per cent from 23 per cent, which gives Britain the lowest rate in the EU for businesses with profits up to pounds 300,000.

Small business have also been encouraged by a temporary doubling of allowances for machinery and plant to 50 per cent, returning to 25 per cent for subsequent years. Around 3.5 million businesses are expected to benefit in the uplift.

VAT thresholds have also been increased in an effort to minimise the burden on smaller companies. From 1 December 1997 the VAT registration threshold will be raised to pounds 49,000 from pounds 48,000.

The deregistration threshold rises to pounds 47,000 from pounds 46,000. The increases are broadly in line with inflation and represent a nil cost on an indexed basis.