How Brown could batter business in a tax-raising Budget

As economic activity slows and the British Army becomes more deeply embroiled in the Iraq war, Gordon Brown is coming under more intense pressure to find additional ways of raising tax in next week's Budget to fill an estimated ?20bn hole in Treasury revenues. That could be covered by borrowings, but the Chancellor will be loath to endanger the present low level of interest rates by such a large issue of government stock.

Aidan O'Carroll, national head of tax at the accountancy firm Ernst & Young, said: "The Chancellor talks a lot about steady courses. If he wobbles now, there could be a crash. The tax take is down and economists are arguing that the shortfall is structural, not cyclical. Even on the Treasury's own assumptions, receipts will not recover as quickly as the economy as a whole."

That has put Mr Brown on a knife edge, needing more revenue but also needing to avoid bringing the economy to a halt under the burden of extra tax.

From the start of the new fiscal year on Sunday, the Treasury was looking forward to collecting an extra ?9.9bn from national insurance contributions (NIC). But this week the British Chambers of Commerce warned that one in five businesses was planning to lay off workers, at a possible cost to NIC of ?4bn.

Nevertheless, despite the simultaneous introduction of the new child tax credit and pension credit, Mr Brown may be reluctant to squeeze consumers much more and instead turn to taxes which impact mainly on business. These are less visible, even though many are ultimately passed on to consumers.

We know from last November's pre-Budget report and other statements Mr Brown has made that he is expected to announce measures to close loopholes which have collectively been leaking hundreds of millions of pounds in lost tax.

Top of the list may be stamp duty, where there are increasing signs that a new ?1m-plus rate of 5 per cent may be introduced in next Wednesday's Budget.

The government also intends to introduce a new regime for stamp duty on UK land and buildings late next year, because it believes that the existing stamp duty regime allows many large commercial land transactions to take place without incurring a charge.

In last year's Budget Mr Brown announced a review of the residence and domicile rules as they affect the tax liabilities of individuals, because residents who are not officially domiciled in the UK pay little income or capital gains tax. There are about 60,000 wealthy resident "non-doms" in Britain, embarrassingly including some prominent Labour Party supporters such as the Indian steel magnate Lakshmi Mittal, the Caparo chief Lord Paul and the art lover Christopher Ondaatje. Critics say if such people have to pay tax they will take their businesses away from Britain.

In November Mr Brown said the Government was looking at the interaction between increasing labour and capital mobility among these people and the Government's commitment to creating a fair tax system. The Treasury and Inland Revenue are due to publish a background paper on non-doms. One idea is for non-domiciled residents to be allowed to avoid UK tax on offshore investments for a maximum of five years.

The wealthy may face another attack on their finances through predicted plans by Mr Brown to root out those who illegally hide earnings and assets in offshore bank accounts. This may be achieved through an amnesty for those who hold secret funds offshore, on the lines of similar previous exercises in Italy, Germany and South Africa. An estimated ?269bn is believed to be held offshore by British residents, though most of this is legitimate and declared to the Inland Revenue.

However, in the pre-Budget report Mr Brown asked the Inland Revenue to bring into line the tax rules for offshore and onshore funds. But in return these funds, which include so-called hedge funds, will have to provide UK residents with details of how much income they have received at the end of each year. These investors would then be taxed on that income.

This could provide a huge deterrent for such investors, and would therefore threaten the hedge funds that cater for them.

Mr Brown is expected to prevent charities claiming tax relief on income from stocks and shares, raising a possible ?350m a year, on the lines of the similar controversial measure affecting pension funds at a cost of ?5bn a year.

In November Mr Brown said he was going to increase two environmentally friendly taxes, landfill tax and climate change levy, but these would raise only an extra ?5m a year.

Last week the Paymaster General, Dawn Primarolo, said legislation will be included in this year's Finance Bill to counter avoidance by individuals attempting to exploit the 100 per cent rate of capital allowances for expenditure on information and communications technology. The change will not affect small businesses claiming 100 per cent allowances where they have invested in information and communications technology for bona fide use in their own business.

Film producers, financial companies and North Sea oil companies are also believed to be on Mr Brown's target list. But tax experts agree that in the short term at least these measures will have little more than a marginal impact on filling the ?20bn hole in Treasury coffers.

The four big revenue raisers are income tax, which is currently due to produce ?118bn in the new tax year, NIC (?75bn), value-added tax or VAT (?67bn) and corporation tax (?31bn).

John Whiting, tax partner at PricewaterhouseCoopers, says: "Of the Chancellor's four big earners, arguably there is no scope to increase corporation tax – in fact the yield is going to come down and external pressures suggest it might have to come down further. NICs have already been 'done', though that's not to say they couldn't be done a bit more, and he can't raise income tax rates because of manifesto promises not to. So if he does want to raise serious money he could be left with VAT."

Mr Brown is known to regard VAT as fundamentally regressive, in that for any given item carrying the tax rich and poor people pay the same. However, wealthier people pay more VAT per year simply because they spend more.

If Mr Brown were to grasp the nettle, it could solve a large chunk of his problems at a stroke. An increase from the present 17.5 per cent to 20 per cent, which would be no more than moderate by European standards, would raise ?10bn.

As it is, Mr Brown has pledged to crack down on VAT avoidance through the use of artificial delaying schemes. However, any increase would cut across his commitment to helping small businesses, as it would have to be paid by any operation with annual sales of less than ?55,000. That would hit a swathe of firms and self-employed people from corner shop owners to taxi drivers.

Ernst & Young believes that while Mr Brown might be pushing his luck to add any more to employees' NIC, he could have a go at the employers' contribution with effect from 6 April next year, when the economy might be in better shape. Ernst & Young say this could be worth ?4.2bn.

Says Mr O'Carroll: "The Chancellor can be expected to take the opportunity to introduce new consultations, and is also likely to focus on anti-avoidance measures. In light of the current economic downturn he may also decide to provide incentives for businesses. However, all this is just as likely to cost money as it is to save it."

Either way, Mr Brown will have to wrestle with some uncomfortable choices as he completes his Budget proposals this weekend.