The Emergency Budget 2010 and the Impact on PI/FA Claims

Article, PIBU Law JournalJuly 2010

Insurance / Legal / Liability / Casualty

Amanda Fyffe, of RGL’s London office, examines how the 2010 emergency budget will impact individuals’ earnings and what are the repercussions for Personal injury (PI) and Fatal Accident claims.

Following the formation of the Lib-Con Coalition Government we were braced for George Osborne's emergency budget in June 2010, expecting, as we surely received, a plethora of spending cuts and tax rises to be implemented over the next live years.

With an undertone of the Pareto Principle, the 80/20 split between spending reductions and tax increases intimated that it would be inefficient Government departments and Quangos bearing the brunt of the budget spending cuts. However, not overlooking the numerous public sector employees now entering into a two year salary freeze, or worse still possible unemployment, how will the 2010 emergency budget impact individuals' earnings and what are the repercussions for Personal injury {PI) and Fatal Accident claims?

Summary of changes

Whilst the 2010 emergency budget covers a host of cuts and rises, this article considers those changes affecting an individual's income and the implications for claims made with a loss of earnings element, either derived from employment or from their own owner managed businesses. As such, there is a focus on the changes in tax legislation, rather than commentary on revised Governmental budgets and the changes to the welfare system.

As an overview, the principle changes that PI/FA lawyers should be aware of for the preparation of loss of earnings claims include:

For the individual:
i. Income tax (IT) – the retention of the March 2010 budget 50% IT rate on earnings over £150,000 and from April 2011 a £1,003 increase in the personal allowance with a corresponding reduction in the higher earnings threshold;
ii. National Insurance (NI) – the retention of the March 2010 budget 1% increase on self-employed, employee and employer NI payments from April 2011 and a realignment of the Upper Earnings threshold in line with the income tax threshold;
iii. Capital Gains tax (CGT) – various amendments but notably a freeze to the £10,100 annual CGT exemption and from 23 June 2010 an increase in the 18% CGT rate to 28% for higher rate tax payers;
iv. Pensions – more details are to be made available later in the year, but from April 2011 individuals earning £150,000+ will start to lose higher rate tax relief on pension contributions.

For the individual with an owner managed business:
i. Corporation tax (CT) – from April 2011 a reduction in the small companies rate to 20% and a 1% reduction per annum in the main CT rate until April 2014 when it will be set at 24%;
ii. Capital Allowances (CA) – various changes but notably a 2% reduction in the CA rates to balance the reduction in CT rates;
iii. National Insurance (NI) – from April 2011 a increase in the Secondary Earnings threshold, the point at which employers start paying NI and a regional employers NI holiday for new businesses:
iv. Capital Gains tax (CGT) – from 23 June 2010 an increase in the lifetime allowance for Entrepreneurs Relief (ER) from £2m to £5m.

Impact of changes

It is not surprising that the impact of these revisions will have a greater or lesser effect on an individual depending on the level of their earnings and the operation/performance of their owner managed businesses. However, to demonstrate the materiality of these budgetary changes, it is easiest to present some case study illustrations, where the effects will be felt in any future loss claims made.

Case study 1: income tax on earned income
The March 2010 budget introduced a 50% rate for earnings over £150,000 from April 2010 and also a 1% increase in Nl scheduled for April 2011. The emergency 2010 budget has retained these measures and has also proposed a £1,000 increase in the personal allowance with a corresponding reduction in the Higher Earnings threshold so higher earners do not benefit from the increased personal allowance.

Following implementation of the March and June 2010 budgetary changes it will be higher earners who will experience the greatest increase in tax and Nl liabilities. For example, an individual with earnings of £200,000pa could see their annual tax bill increase by around £9,000pa or more, whereas an individual earning £30,000pa would experience little impact with a nominal increase of around £25pa.

The obvious impact this brings to loss of earnings claims is where claimants are high earners and/or where there is a lengthy future loss period. If the new tax regime is not accounted for in calculating expected earnings material overstatements could occur. This could then be exacerbated further by the abatement of tax relief on pension contributions for higher earners.

Case study 2: corporation tax on business profits
The emergency budget has introduced various incentives for businesses with a key measure being a reduction in Corporation Tax rates over the next few years. Although this benefit is off-set in part by the 2% reduction in Capital Allowances.

As an example, assuming a business generated taxable profit of £500,000pa the CT reduction would result in an annual saving to the business of £5,000pa. In the context of a PI/FA claim, if a claimant owned 100% of this business they would reap a personal benefit from greater level of distributable profits. Therefore, assuming this profit was extracted as dividends the benefit would manifest itself as a £5,000pa increase in dividend income for a basic rate tax payer, or a £3:750pa increase in income for a higher rate tax payer.

Consequently, in claims where there is a long future loss period, such savings in CT need to be accounted for to avoid understatements in a claimant's claim. Although, notwithstanding this, the reduction in CA would erode this benefit depending on the assets contained within the claimant's business.

Case study 3: employers National Insurance
During a three year qualifying period new businesses setting up in certain areas of the UK will be entitled to an employer’s NI ‘holiday’ for the first £5,000 of employer's NI due in the first 12 months of employment for each of the first 10 employees hired in the first year of business. The benefit of this incentive will of course vary depending on the number of employees and their respective remuneration levels, but a potential maximum cost saving of £50,000 could be realised in the first year of trading.

Many new businesses do not survive their first year, however, a saving of up to £50,000 during this fledgling period could benefit not only the bottom line profit figure but also the cashflow management of the business. In our current economic climate such a benefit could play a role in the success or failure of a business.

In PI/FA claims, new business ventures with an intended launch either immediately prior to or following an incident are often tricky situations where uncertainty and speculation dominate. And whilst an employees NI holiday would not alone secure the success of any new business, it is certainly a factor that should be considered along with any benefits to the expected profitability of that new business.

Case study 4: the sale of an owner managed business
ER was introduced in April 2008 with an original lifetime limit of £1 m. This limit was increased to £2m in the March 2010 budget and has been increased again to £5m in the June 2010 emergency budget. This substantial increase will result in a greater level of relief available to individuals with qualifying gains. Given this increase, ER is possibly the budgetary change that could have the most significant impact in PI/FA claims.

The clearest way to demonstrate this impact is by way of a calculated example. Assuming in the 'but for scenario an individual owns their own business and intended to sell this business on their retirement realising a gain of £5.5m. However, as a result of an incident their business has now lost all value. The table below summarises the pre- and post- emergency budget gains realised:

 

 

Pre-June 2010

Post-June 2010

 

£

£

Gain {A}

5.500,000

5,5D0,00Q

Annual exemption

(10,100)

(10,100)

Chargeable gain

5,469,900

5.439,900

Entrepreneurial relief available

2,000,000 x 10%

5,000,000 x 10%

(B)

= 200,000

= 500,000

Gain chargeable at lull CGT rate

3,469,900 x 18%

439,900 x 28%

(C)

= 628,182

= 137,172

Total CGT payable (B+C)

= 828,182

= 637,172

Net gain realised (A-B-C)

4,671,818

4,862,828

Difference

191,010

 



As illustrated, following the increase in the ER lifetime limit the claimant’s claim for loss in value of their business increases by over £190,000. As such, if the new ER rules are not taken into account the claimant’s claim could be materially understated.

Summary

The case studies above can only provide a sample of the range of potential issues arising in loss of earnings claims. Other factors could include:
i. the increase in VAT to 20% from 4 January 2011 – how will this impact the calculation of expected revenue of a business? How will demand be impacted? Will business need to adjust pricing strategies?
ii. public sector salary freezes – if public sector employees do not receive any increase in their annual salary then 'what are the implications for the application of a future loss multiplier, which already factors in inflationary increases in earnings?

Given the uniqueness of each Pl/FA claim it is impossible to present a complete summary of the issues that must be considered in Pl/FA claims in the wake of the emergency budget. The circumstances must always be assessed and any review and calculation tailored to meet the retirements of each individual claim.

 

As appeared in the PIBU Law Journal, July 2010.    

 

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