This year the budget speech came early. The budget was presented at the beginning of June rather than, as usual, at the end. However, the fiscal changes announced were limited. There were no give-aways, what was given with one hand was taken with the other. Many small businesses will find themselves worse off in 2008/9 than previously.

The main fiscal change affecting business is the reduction in the standard rate of Corporation Tax from 33% to 27%. A reduction to 30% for this coming year and to 27% for the following year had already been announced in the previous budget. The government decided to accelerate the process of Corporation Tax reduction by one year and thereby move directly to the 27% rate. This compares with a standard rate in the United Kingdom of 28%. Larger and more profitable businesses will benefit from this reduction, in some cases substantially. Small and less profitable businesses will see little or no change because the small companies’ Corporation Tax rate remains unchanged. Small companies with profits below £35,000 will continue to pay tax at 20%. Those with profits between £35,000 and £95,000 (approximately) will obtain a slight reduction in their tax bill because of marginal relief. In any case most  companies in Gibraltar will still be facing higher levels of Corporation Tax than in the United Kingdom where the small companies rate (currently 21%) applies to companies with taxable profits of up to £300,000.

Local businesses will find their costs will increase in other ways. Social insurance contributions will go up by 10% for both employers and employees. Electricity and water tariffs will go up by 15% and this will obviously impact on businesses as well as private individuals. So will the increase in import duty on petrol (3p per litre) and diesel (2p per litre).  The increase in the minimum wage by 10% to £5 per hour as from 1 January 2009, though socially desirable, will also raise the cost base of local businesses.

Inflation is now running at over 3% and is expected to rise further. The increase in duty and in electricity and water tariffs will push this figure even higher. These increases and the rise in social insurance mean that many employees will find their spending power reduced. The fact that personal tax allowances have not been increased in line with inflation will exacerbate this. Therefore we can expect demands for pay increases, probably of 4% or more by the end of the year.

The rumours that had been circulating amongst some retailers before the budget that import duty was going to be reduced or abolished proved unfounded. Given that import duties account for some £35 million of government revenue, this is perhaps not surprising.

There’s little doubt that Gibraltar plc has been doing well over recent years. However, the global economy is now entering a difficult phase. How long or how deep this slowdown will be is anybody’s guess. The views of experts range from ‘ a small blip’ to ‘catastrophic’. If the large economies experience a downturn then we should expect a knock-on effect in Gibraltar. The local economy is well-diversified given its size so should be sheltered to some extent. However some sectors will be more exposed than others. Already some retailers are noticing a reduction in sales and are planning to tighten their belts over the next couple of years.

It is clear from the budget speech that the government will be encouraging private employers to set up pension schemes for their employees if they haven’t already done so. The proposal to allow proprietary directors and shareholders to participate in company pension schemes is welcome and may prove to be particularly attractive for smaller businesses. From a social point of view the widening of pension provision by the private sector is obviously a positive move.   However, the devil will be in the detail and the cost to business could be substantial and difficult to bear at this stage in the economic cycle.

Changes to personal tax will also have an impact on different business sectors. The limiting of mortgage interest relief to new mortgage loans of up to £300,000 (and the phased reduction in relief on existing mortgages above that figure) will have an impact on residential property prices. Together with other measures announced last year (abolition of Category 3 and Category 4 status and introduction of Gross income based system of personal taxation) this reduces the fiscal attractiveness of buying residential property in Gibraltar. Similarly, the reduction in life assurance relief (premiums not to exceed 1/7th of assessable income instead of 1/6th and relief on new policies limited to basic rate tax) will reduce demand for life insurance linked savings products.

 The government appears to be signalling a gradual reduction in fiscal subsidies on residential property and on life insurance and generally to be pushing  individuals into the gross income based system. We are clearly moving from a personal tax regime with high headline rates and some generous allowances to one where headline rates are lower, but allowances are small or non-existent.

Last year we predicted, following the introduction of the earnings based system of social insurance, that contributions would rise. This year’s increase of 10% (which is effective from 1 July 2008 instead of 1 January 2009) is likely to be followed by further above-inflation increases in subsequent tax years. The problem is that contributions do not cover the costs that they are supposed to. In particular, contributions include amounts payable to the Group Practice Medical Scheme. Amounts paid into the scheme in 2007/8 came to around £27 million whereas the cost of the Gibraltar Health Authority was over £56 million. Therefore if Government intends to finance the Authority entirely out of social insurance contributions these are going to have to rise very steeply in future.

Conclusion

The budget is something of a mixed bag for the business community. On the positive side we have a reduction in the standard rate of Corporation Tax to a level just below that of the United Kingdom. However, in practice most businesses will continue to pay higher taxes than in that country because the local small companies rate is capped at a much lower level. Higher duties and other charges, rising inflation and the uncertain prospects for the world economy, indicate that many businesses will face a profits squeeze this year.