Stephen Herring, BDO Stoy Hayward

The Chancellor has been caught between the devil of his plans to increase public expenditure by £30bn between 2005/06 and 2006/07 and the deep blue sea of anaemic tax receipts influenced by flat consumer retail spending and corporate profits outside the energy sector.

The measures included in the pre-Budget report only increase tax receipts by £2.1bn in a full tax year in comparison to Budget 2005 receipts. The sums raised by his further assaults on tax avoidance raise only £730m as the bulk of the extra receipts come from his increase in North Sea oil taxation. Unfortunately, these measures may have found a few hundred million for him but it is a few billion that he really needs. I consider that tax hikes in the 2007 Budget remain very much on the agenda.

The concern is, of course, that tax rises in 2006 or 2007 could damage the UK economy's competitiveness at a time when the pressures on business costs, such as the trebling of oil prices over three years, have had a significant drag on the economic growth which the Chancellor had hoped would assist in raising tax revenues, particularly corporate taxation. Indeed the Chancellor has reduced his forecasts of growth from 3.5 per cent to 1.75 per cent and this has had an inevitable knock-on effect for tax collection. Figures released yesterday indicate that the Treasury is expecting to collect £41.8bn of corporate tax in 2005/06 against a forecast, just a year ago, of £44bn. The Chancellor is projecting corporation tax receipts to rise to £50.1bn in 2006/07 which, again, looks optimistic when set against slower growth and more pressure on corporate profits arising from higher energy prices.

Looked at from the perspectives of the Chancellor's need for tax revenues, the absence of a VAT increase may be considered fortunate and surprising as our main VAT rate, at 17.5 per cent, is, arguably, out of line with major competitors. For example, the VAT rate is 19.6 per cent in France, 20 per cent in Italy and 21 per cent in Ireland. In contrast, a significant number of our European competitors either already have lower rates of corporation tax such as Ireland, 12.5 per cent; the Czech Republic 26 per cent; Sweden and Norway 28 per cent, or are looking to lower their effective rates, for example, in Germany. I consider that the Chancellor needs to make room for a cut in the corporation tax rate to around 25 per cent to maintain competitiveness and he will need to find alternative tax revenues to fund this.

The abolition of the corporation tax zero rate band for the first £10,000 of profits earned in a year was predictable following the increasing use of small companies to mitigate the incidence of taxation on businesses which would otherwise be undertaken on a sole trader or partnership basis. Nevertheless, I imagine that many small businesses and, indeed, many Revenue tax inspectors will regret the need to process small corporation tax returns where the tax liability amounts to a few pounds.

Similarly, the prohibitions introduced for self-invested personal pensions (Sipps) being invested in residential property where this is not through prescribed investment funds was, at least, partially predictable although the extent of the prohibition will have come as a shock to most. Essentially, the Government has made a full U-turn. A more permissive approach, which would have achieved most of the Chancellor's objectives, but allowed investors to choose to invest their pension funds in individual properties, would have been to prohibit the inclusion within a Sipp of properties which have been or will be occupied by the beneficiary of the Sipp. From an economic standpoint, why is it acceptable for a Sipp to invest in commercial property but not residential?

The Chancellor has again decided to resist the calls for tax simplification in the arena of personal taxation. The inheritance-tax measures are limited to a miserly increase in the zero rate band threshold from £275,000 to £285,000 and certain anti-avoidance measures have been introduced. This tax is only forecast to collect £3.6bn in 2006/07 and the Chancellor could have introduced a more generous zero rate band threshold of, say, £400,000 which would have removed most more modest estates from the impact of this increasingly unpopular tax.

One of the major changes in the 2005 pre-Budget report is the promised introduction in the Finance Bill 2006 of UK-Reits (Real Estate Investment Trusts), a tax-efficient vehicle for property investors that is intended significantly to boost investment in the residential and commercial property markets. In the US, Reits have, over the past decade, been a very successful property investment, generating significant new investment in residential property. It is to be hoped that they will be a similarly successful vehicle in the UK.

In very broad terms, a Reit is tax transparent so that the investors solely pay tax on its income and gains, and not the Reit itself. I expect nearly all existing UK-listed property companies to convert to UK-Reits within a short space of time. It is regrettable that Mr Brown has felt it necessary to restrict UK-Reits to listed entities as this does not recognise the crucial role by privately owned property companies and smaller funds.

One wonders why he has favoured the more restrictive French model over the more successful US and Australian approaches. A key issue not yet addressed for existing listed companies is the conversion charge from a Plc to a UK-Reit. This will need to be set at a modest level and allow payment to be made over a number of years to achieve the desired take-up rate.

In summary, the 2005 report will be welcomed for the lack of the feared tax rises in VAT or National Insurance and the launch of UK-Reits, but the Chancellor can be criticised for failing to reduce the UK corporation tax rate to keep our fiscal competitiveness and his about-face on the inclusion of residential properties in Sipps and the abolition of the zero rate corporation tax band which he himself introduced in an earlier Budget. He has had to "own up" to the corporation tax revenues not meeting his targets and any further tax shortfalls which emerge from a weaker economy could well lead to VAT and/or National Insurance increases next year. This unpleasant option may, of course, be an issue for his successor.

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