The general thrust of this year's Budget was to help the economy continue to grow despite the much reduced productivity forecasts. George Osborne continued on the familiar themes: continued reform of business taxation by clamping down on avoidance by large international corporations whilst making the UK more competitive by reducing tax rates and helping small and micro businesses to grow. The headlines will likely be dominated by the changes to Entrepreneurs' Relief rules, cuts to corporation tax, and the changes affecting UK real estate. With regard to real estate in particular, whilst the changes to business rate relief are welcome, the proposal to cap the amount of relief for interest to 30% of earnings, the new top rate of 5% SDLT for commercial/mixed use property and the absence of any relief from the new additional 3% SDLT rate for institutional investment in residential property can be classified as shock developments.
The theme was very targeted on the next generation with the introduction of a Lifetime ISA, schools being forced into academy status, a sugar tax on soft drink manufacturers and increased sport in schools. The Budget, surprisingly and somewhat unhelpfully, contained not much more detail on the changes for non-doms which are due to start in 2017 leaving many unable to plan properly.
In this briefing, we highlight some of the main points of interest. Please contact any member of our tax team if you have any queries.
Changes in tax rates
The Chancellor announced reductions to the various tax rates. From April 2016, the higher rate of capital gains tax (CGT) will be cut from 28% to 20% and the basic rate will fall from 18% to 10%. However, the rates for gains made on investments in residential property and carried interest will remain unchanged.
The Government will continue to increase the income tax personal allowance, which currently stands as £10,600. With plans already in place to rise to £11,000, it is now set to go up to £11,500 in April 2017. The Government has also increased the threshold at which the 40% higher income tax rate is paid. Currently it is applied to income over £42,385, which will rise to £43,000 in 2016, and now £45,000 in April 2017.
Following significant cuts to corporation tax to the current rate of 20%, the Government has proposed to reduce corporation tax further to 17% in 2020.
As usual VAT rises in line with inflation. The Registration limit rises from £82,000 p.a. to £83,000 and the deregistration limit goes up by the same amount, from £80,000 to £81,000.
Whilst the VAT rise in line with inflation is not surprising, generally the overall reduction in rates is good news for all. The restriction that the new lower CGT rates will not apply to gains on investments in residential property and carried interest is consistent with the recent Government's approach to capital gains made by individuals on such returns.
Trio of changes to Entrepreneurs' Relief
The Government announced three changes to the rules regarding entrepreneurs' relief. The first of these will allow the taxpayer to claim the capital gains tax relief where they make certain disposals of privately-held assets when there is an accompanying disposal of business assets to a family member. It should enable the relief to be claimed where the disposal of business assets do not meet the present 5% minimum size condition. The second change, termed 'investors' relief', will allow Entrepreneurs' Relief to be claimed on the disposal of certain qualifying shares in an unlisted trading company, even where the shareholder is not an employee or officer of the company. The shares will need to have been newly issued on or after 17 March 2016 and must have been held for at least three years starting from 6 April 2016. The third and final change relates to joint ventures and partnerships and will enable companies to claim entrepreneurs' relief where they invest in a trading business that is not part of the same group. Further, the activities of a corporate partner in a firm will be treated as having their true nature (i.e. trading or non-trading) when determining if the company is a trading company.
The announcements represent successive Governments' continued support of Entrepreneurs' Relief. The changes are welcomed, but the devil is always in the detail and care should always be taken to ensure that you are within the strict conditions of the relief to reduce your capital gains tax liability.
SDLT on non-residential and mixed used property
The Government has decide to abandon the "slab" system for non-residential and commercial property, bringing it into line with residential property. With effect from midnight tonight, the following 'slice' system of SDLT will therefore apply to non-residential and mixed use property:
Transaction Value Band Rate
£0 - £150,000 0%
£150,001 - £250,000 2%
Similarly, from midnight tonight, a new 2% rate for rent paid under a non-residential/mixed use lease will be introduced where the Net Present Value of the rent is above £5 million.
The new rates bands and thresholds for rent paid under a lease are:
Net present value of rent Rate
£0 - £150,000 0%
£150,001 - £5,000,000 1%
This surprising change is likely to keep many property practitioners (at least those not at MIPIM…) busy until midnight tonight. This is because contracts exchanged by then will still be taxed under the old rules (with a top rate of 4% under the old 'slab' system) – even if completion occurs after today – provided the contract is simply completed in accordance with its terms.
Additional SDLT rate for residential property
As announced in the Autumn Statement in November 2015, new higher rates will generally apply to purchases of "additional residential properties" on and after 1 April 2016. The following changes to the original policy have been proposed:
- the higher rate will apply equally to all purchasers without an exemption for significant investors.
- purchasers will now have 36 months rather than 18 months to claim a refund of the higher rates if they buy a new main residence before disposing of their previous main residence. The refund can be claimed once the previous main residence has been disposed of.
- purchasers will also have 36 months between selling a main residence and replacing it with another without having to pay the higher rates.
- the 36 month period will commence from 25 November 2015 for purchasers who disposed of their previous main residence prior to Autumn Statement in November.
The standout change in policy is the removal of the proposed relief for the purchase of "15 or more" dwellings. This is clearly bad news for those buying portfolios of residential stock. Whilst multiple dwellings relief (MDR) will still remain to ensure SDLT will only arise on the average unit price, the rate of SDLT on each "slice" will now be caught by the 3% increase. This is clearly bad news for investors into PRS and an odd policy move given the general desire to promote investment into this sector. The Government seems to have decided that being seen to favour larger institutional landlords buying multiple properties over smaller scale landlords could not be justified. The only real relief from the additional rate is therefore where an individual is replacing their main home. Finally, it should be noted that the purchase of 6 or more dwellings as part of a single transaction can be treated as non-residential if this gives a better result than MDR – but, as noted above, the top rate of SDLT for non-residential and mixed use property is increasing from 4% to 5% on the slice of the price over £250,000. All in all, unwelcome news for the sector.
Corporation Tax: Hybrid mismatches
The Government is seeking to implement Action 2 of the OECD's Base Erosion and Profit Shifting Project (BEPS) by introducing rules to counter tax arbitrages arising from mismatches (or incoherence) between the tax laws of different territories.
Mismatches can be achieved through hybrid instruments, hybrid entities, hybrid transfers or permanent establishments (p.e.). Typically the mismatch would result in either a double tax deduction or the deduction for an expenses without any recognition of a taxable receipt (a deduction/non-inclusion outcome).
The rules propose to counter double deduction arrangements by either denying a deduction to a parent company or denying a deduction to the hybrid entity or p.e.
The rules further proposed to counter deduction/non-inclusion outcomes by either denying a deduction to the payer or by bringing into charge the receipt.
These rules will target multinational groups with either a UK parent company or UK subsidiaries with international financing or treasury functions. Interestingly, and as with the diverted profits tax, the Government has taken a unilateral step rather than wait for a unified standard to be created by the EU. Whilst this may not be pleasing to some in Brussels it will put pressure on a huge array of instruments or constructs used to effect borrowing and secure deductions for interest expenses. The use of preferred equity certificates (PECs) or convertible preferred equity certificates (CPECs) under which the payer deducted an amount of interest expenses but where the receipt was characterised as a tax free dividend, is likely to be caught. In addition, to apply the rules companies and advisors will be required to have an understanding of the tax rules in countries other than the UK and along with other OECD proposals in relation to tax reporting there is likely to be a significant increase in the tax compliance costs of implementing and monitoring the new regimes.
Following the OECD's BEPS recommendations, the Government is proposing to cap the amount of relief for interest expense to 30% of UK taxable earnings (or based on net interest to earnings ratio for the worldwide group). There will be a threshold limit of £2m net UK interest expense to ensure that smaller businesses are not adversely affected by this. Currently tax deductions for interest expenses are covered by a raft of rules under various headings such as transfer pricing, thin capitalisation and the worldwide debt cap. This most recent development is closely modelled on the existing rules in German tax law which seek to limit interest deductions to 30% of EBITDA.
This particular measure confirms the Government's intention to be one of the first movers when it comes to implementing the BEPS project. The stated intention is that the Government will work with the OECD to ensure that the UK rules implement the purpose and detail of the OECD's own recommendations. If the EU separately moves to adopt a tax avoidance directive then – within a very short period of time – businesses and advisors will have to deal with an almost bewildering array of different regimes all targeted at the same arrangements.
Income Tax: royalty witholding tax
As part of the Government's take-up of the OECD BEPS project and having gained particular insight into the structures adopted by large multinational corporates (such as Amazon, Google and Starbucks) the Finance Bill 2017 will contain an extension of the UK's royalty withholding tax rules on payments to non-UK resident group or connected entities where there is a tax avoidance arrangement.
Typically this will be targeted at payers of royalties in structures which separate IP ownership (offshore) from software development or R&D activities (onshore). Arguably those structures should already have been reviewed in light of the Diverted Profits Tax (DPT). However even if the DPT was relevant to those structures the new rules go further to: a) widen the definition of a royalty to include trademarks and brand names; and b) prevent the use of the UK's extensive double tax treaty network to avoid or reduce any such withholding tax (treaty shopping).
This is likely to impact on any business involving significant offshore IP ownership. Those arrangements, particularly those used in the digital economies, are now the subject of increasing pressures as they seek to navigate the UK's existing DPT, transfer pricing rules and satisfy substance requirements in preferential IP regimes. Notably, IP based or cloud-enabled technologies that will generate revenues in a number of countries will need to consider very carefully the tension between finding a sensible IP holding jurisdiction and the need to have workforces based in countries with access to the appropriate skills base. Whereas previous IP owners may have had low functionality or small personnel functions those arrangements should now be revisited together with the existing transfer pricing policies applied to them.
Increase in the 'loans to participators' tax rate
The 'loans to participators' tax rate will be increased to 32.5% from 25% on loans, advances and arrangements made on or after 6 April 2016.
The 'loans to participators' rules prevent owners of ‘close’ companies (companies controlled by a small group of shareholders) from avoiding income tax or national insurance contributions by taking out a tax-free loan from their company (that they may not repay) instead of dividends or salary. The tax is payable by the company to HMRC as extra corporation tax, and is refunded to the company from HMRC once the loan has been repaid.
The Government's stated intention in increasing the tax rate is to bring these rules in line with the higher rate of dividend tax. Whilst this change was not expected, it does make sense in the context of the Government's aim of reducing tax avoidance. Clients who are considering how best to structure remuneration packages for senior managers and shareholders should take tax advice to ensure that the arrangements put in place do not have adverse tax consequences.
Restriction of loss relief
In today's Budget, the Government stated that it wants to "modernise" the corporation tax rules on losses, "making the system more flexible for businesses while ensuring that companies making large profits pay tax on these". To achieve this, from 1 April 2017, companies will be able to use carried forward losses against profits from other income streams or from other group companies. The trade-off for this further flexibility is that, also from 1 April 2017, the Government will restrict the proportion of taxable profit that can be offset by carried forward losses to 50%. This restriction will only apply to profits in excess of £5m. From 1 April 2016, the existing rules restricting the proportion of banks’ taxable profit that can be offset by carried forward losses will be tightened to 25% (down from a current level of 50%).
The 50% restriction general trading companies brings the UK in line with many of the G7 countries and so is not altogether a surprise.
Since 9 December 2010, specific rules have been in place to prevent the avoidance of tax through schemes that involve payments made to employees by third parties. Typically this involves a loan being made by an employee benefit trust on terms that the loan would be interest free and would never be repaid. Alongside those rules HMRC gave users of disguised remuneration schemes an opportunity to disclose and settle such arrangements, avoiding the penalties imposed. That settlement opportunity closed in 2015.
Whilst the 2010 rules have been largely successful, new schemes have since been promoted that exploit perceived loopholes and which HMRC consider even more contrived and aggressive. As a result new anti-avoidance measures are to be introduced. This will be done in stages. The first stage will introduce two measures (effective immediately) as follows:
- HMRC will withdraw a relief that applies in cases where the settlement opportunity has been taken up. This means that unless tax on the disguised remuneration is paid to HMRC by 30 November 2016, any "investment return" on that disguised remuneration will be subject to the 2010 rules (and therefore subject to the related penalties); and
- there will be a new charge on all outstanding disguised remuneration loans. Broadly, this will apply if the loan remains outstanding on 5 April 2019. Any charge will fall on the employer in the first instance.
Further changes will be introduced in future Finance Bills that will address other types of avoidance schemes that do not necessarily involve a third party. In the meantime, HMRC intend to consult on the immediate changes over the summer and we will let you know of any significant updates.
It is clear that HMRC continues to be proactive in closing down any remuneration schemes that seek to avoid employment tax. Whilst having some recent success in court (most notably against the Murray Group) today's changes will allow HMRC to rely on legislation that gives them the ability to challenge new schemes and also pre-2010 schemes without having to debate the complexities of the viability of such arrangements.
Employee Shareholder Status
Employee Shareholder Status (ESS) was introduced in 2013 and enables employees to be issued with shares in their employer on a tax beneficial basis. In particular, where the shares are worth less than £50,000 at the time of issue, any capital growth of those shares are completely exempt from capital gains tax. A holder of ESS shares is required to give up certain statutory employment rights.
Today's Budget introduces an individual lifetime limit of £100,000 on gains eligible for the capital gains tax exemption. This limit will apply to arrangements entered into on or after 17 March 2016 and will not apply to arrangements already in place.
Today's change addresses the perceived unfairness that ESS has formed part of the remuneration arrangements of already highly paid executives or within a private equity transactions, rather than by start-ups or fast growing companies, as originally intended. The new £100,000 limit severely restricts the ESS advantages and will require executives to carefully consider whether it is appropriate for them to give up certain employment rights in this context.
HMRC currently allows employers to pay the first £30,000 of certain termination payments free of tax. Any amount over the £30,000 would be subject to income tax, but not national insurance contributions (NICs).
Some time ago, the Government consulted about possible changes to this system in order to simplify it. Many of the responses to the consultation condemned the proposals as overly complex and retrograde. Instead, the Government has today announced that, from April 2018, termination payments over £30,000 will be subject to employer NICs, as well as income tax. Employees will not be liable to pay national insurance contributions on the payment.
This will make the cost of settling disputes with employees more expensive for employers. While it would not be lawful to require employees to pay employer NICs, we imagine that the cost to the employer will be factored into any calculation as to the 'pot' of money available to the employee. While this could curb unnecessarily large payouts, it may lead to more litigation from employees who are unhappy about the amount of compensation offered to them.
Offshore trading in UK land
Historically it has been possible for a non-UK resident businesses to avoid UK tax to the extent they were not trading through a "permanent establishment" in the UK. The spotlight has been on the Googles of this world, but such structures have also been used by non-UK resident developers of UK land. Some offshore developers have been relying on certain double tax treaties (typically in the Channel Islands) to argue that the profits of their UK property business cannot be taxed in the UK at all, on the basis that the offshore developer does not have a PE in the UK. Whilst HMRC has always scrutinised such structures carefully (and the new Diverted Profits Tax has affected many structures) the Government has now taken fairly drastic action to stop the perceived tax benefits of a non-resident structuring their affairs in this way. In short, the intention is to introduce legislation in Finance Bill 2016 which subject the profits of an offshore developer/trader in UK land to UK corporation tax. This will require changes to certain treaties and the Government states that it has already agreed protocols with each of the Channel Islands and Isle of Man which come into effect today. The Government has invited feedback on the detail of its proposals. Interestingly, the changes have effect "on or after the date the legislation is introduced to Parliament at Report Stage, expected to be June 2016". In addition, a targeted anti-avoidance rule (effective from today) is designed to stop any restructuring designed to get around the rules before this Report Stage.
Whilst we will need to review the detail of the legislation, the ability of offshore property developers to minimise their UK tax exposure by utilising certain jurisdictions/double tax treaties seems at an end. There have always been practical difficulties with such planning and the Diverted Profits Tax reduced the scope of such structure significantly in any event.
Small Business Rate Relief has been permanently doubled from 50% to 100% and the thresholds have been increased. Businesses with a property with a rateable value of £12,000 and below will receive 100% relief. For values between £12,000 and £15,000 there will be a tapered relief. There are certain other technical changes, including increasing the threshold for the standard business rates multiplier to a rateable value of £51,000; from April 2020, the annual indexation will be changed from CPI to RPI. Finally, a discussion paper is expected outlining how more frequent valuations (a minimum of every 3 years) may be introduced.
The changes will be welcomed by business and the discussion paper about more frequent valuations will be eagerly awaited.
Remote Gaming Duty
Remote gaming operators currently benefit from a more generous tax treatment when they offer discounted or free gambling (freeplays) to customers in Remote Gaming Duty than would be the case for operators offering free bets on things like football and horseracing in General Betting Duty. The Government therefore plans to amend the tax treatment of freeplays in Remote Gaming Duty to bring it into line with the tax treatment of free bets in General Betting Duty.
Value Added Tax: avoidance/evasion by online sellers
Overseas businesses making online sales of goods located in the UK are in some cases failing to register for and pay VAT in the UK as they should. This not only has a revenue cost but also prejudices compliant UK sellers. To tackle this HMRC is strengthening its enforcement and collection powers.
HMRC will now have discretion to deal with these overseas sellers by: compulsorily registering them; directing them to appoint a UK VAT representative (who will be jointly and severally liable for the VAT); and/or requiring deposit of a security (invariably in cash).
HMRC will also have the power to move against the operator of the marketplace providing the seller with online facilities to sell , regardless of where the operator or marketplace is itself located or controlled from. They will be able to issue a notice on them whereupon they too will become jointly and severally liable to pay the VAT . In effect, HMRC are seeking to enlist the enthusiastic support of the online marketplace operators to secure compliance by overseas sellers.
Slow news day for non-doms
Many non-doms will have been eagerly awaiting further news from the Government regarding the sweeping changes to the non-dom tax regime announced by the Chancellor in the 2015 Summer Budget. Whilst the Government has confirmed that it is continuing with their undertaking to reform the rules that will be introduced in April 2017, not much more detail was provided. As a reminder, the three main changes announced in the 2015 Summer Budget are: (1) non-doms will become UK domiciled for all tax purposes after they have been UK tax resident for more than 15 of the previous 20 tax years, (2) individuals born in the UK with a UK domicile of origin will revert to their UK domicile status whilst they are UK resident, and (3) all UK residential properties held through an offshore structure will be within the scope of inheritance tax. The Government have also said they will change the taxation of offshore trusts. However, the Government have confirmed three points in the Budget. The first is that non-doms who become deemed-domiciled in April 2017 can treat the cost base of their non-UK based assets as being the market value of that asset on 6 April 2017. The Budget also confirms that non-doms who set up non-resident trusts before becoming deemed domiciled in the UK will not be taxed on the income and gains retained in the trust. Finally, taxpayers who expect to become deemed UK domicile under the 15 out of 20 year rule will be subject to transitional provisions with regards to offshore funds to provide certainty on how amounts remitted to the UK will be taxed.
To an extent no news is good news after the recent attacks on the non-doms. The points that the Government have confirmed are welcome news but it is disappointing that more clarity has not been provided on some complex points that have arisen out of the consultations on the new rules being introduced in April 2017. The countdown to 2017 continues…