The first Conservative Budget in 18 years unsurprisingly made much of delivering on manifesto promises. George Osborne fleshed out the detail behind his party's election pledge to tackle "abuses" of the non-dom status, announcing sweeping changes from April 2017 so that "British people pay British taxes in Britain". The changes are the latest in a long line of non-dom tax reforms, and they repeal laws only recently introduced. Such inconsistency and uncertainty is surely unhelpful to taxpayers and HMRC staff alike, as well as the international reputation of the UK tax system.
Without the Lib Dems in tow, the Chancellor was free to introduce his much-trailed million pound inheritance tax nil rate band for the family home. However, there was also a surprise attack on buy to let landlords with a reduction in income tax relief on mortgage interest for higher rate taxpayers. Companies will have to pay a national living wage, but in return will benefit from a new lower 18% rate of corporation tax by 2020. Increases to the tax free personal allowance and higher rate income tax band were also announced, as promised in the manifesto.
Commentators may remain unconvinced that "those with the broadest shoulders" really are "bearing the largest burden" in light of the widespread welfare cuts announced today, but the Chancellor was certainly correct in saying that he delivered a Budget with "lower welfare and lower taxes". Despite capital gains tax not being included in David Cameron's "tax lock", there were no changes to the CGT rate or the Entrepreneurs Relief rules..
In this Briefing we highlight some of the main points we think will be of interest. Please contact any member of our tax team if you have any queries.
Reform of dividend taxation
Step forward, those of you understood how dividends were taxed for income tax purposes? No takers? We're not entirely surprised. The current regime will disappear from April 2016 to be replaced by a Dividend Tax Allowance. This will exempt the first £5,000 of dividends received and thereafter tax them at 7.5%, 32.5% and 38.1% for basic, higher and additional rate taxpayers respectively. This allowance will be in addition to the tax-free status of dividends received in an ISA.
This means that for the owner managed company, the benefit of taking dividends over salary is reduced once the £5,000 threshold has been exceeded. That said, when employer's NICs are taken in to account, dividends remain beneficial, particularly for basic rate taxpayers. For portfolio investors this represents a slight increase in the marginal tax rate once the threshold is exceeded.
The taxation of income from one’s own labour, whether as an employee, self-employed or through a personal service company, is moving gradually closer to parity. However, there is still a long way to go – especially as retained profits in a company suffer tax at just 20%, going down to 18% by 2020.
Deemed domicile for long-term UK residents
From April 2017, non-domiciled individuals who have been resident in the UK for more than 15 of the previous 20 tax years will be treated as UK domiciled for all tax purposes. This means they will no longer then be able to use the remittance basis. They will also be deemed domiciled for inheritance tax purposes earlier than under the current rules. After 15 years, inheritance tax will apply to their worldwide personally-owned assets.
From their 16th continuous tax year of UK residence, non-domiciles will be subject to tax on an arising basis on their worldwide personal income and gains. There are no concessions for non-doms who were here before the new rules take effect. The government will consult on whether split years of UK residence count towards the 15 years. If a long-term resident leaves the UK, he will need to spend more than five tax years outside the UK in order to lose his deemed domicile. The recently introduced £90,000 remittance basis charge payable by those who have been resident for 17 out of 20 years will be redundant, as they will be taxable on an arising basis after 15 years. The £30,000 and £60,000 remittance basis charges remain unchanged. Following the consultation announced at Autumn Statement 2014, the government will not now introduce a minimum claim period for the remittance basis charge.
This is a political move to appease those who view the tax benefits open to long-term UK resident non-doms as unfair. By extending the three-year "domicile tail" to five years for long term UK residents, this brings it in line with the five-year rule for income tax and CGT for "temporary non-residents". Individuals at or approaching the 15 year mark will need to take careful advice as to their position going forward.
IHT changes for UK residential property owned by non-doms
From April 2017 all UK residential property held directly or indirectly by foreign domiciled individuals or excluded property trusts will be within the scope of UK inheritance tax (IHT). The extension of IHT in these cases will broadly be in line with the Annual Tax on Enveloped Dwellings (ATED) but, unlike the ATED regime, there will be no £500,000 minimum threshold and ATED reliefs for let property will not apply. However, it is intended that the same reliefs and charges will apply as if the residential property was held directly by the owner of the company (e.g. spouse exemption) and there will be no IHT charge for diversely held vehicles that hold UK residential property. The government has accepted that there will be complications when implementing these changes and intends to consult on the proposal after the summer recess.
The announcement is a further restriction on the tax advantages open to non-doms. If followed through it will significantly reduce the benefits of owning UK residential property via offshore companies (or other opaque entities), whether personally or through a trust. Many non-resident and non-domiciled individuals and trustees will have already considered de-enveloping existing structures when ATED and ATED-related CGT were introduced – and extended – but decided to maintain the structure due to the IHT advantages and confidentiality offered. Those individuals and trustees will now need to reconsider their position and the potential costs of de-enveloping following the extension of CGT to non-UK residents. For new property purchases, this change does look like the nail in the coffin for corporate ownership of UK residential property by non-doms.
Income tax changes for residential letting
The government has moved to restrict the amount of interest which can be deducted by individual landlords of residential property when calculating their income tax liability. Under current rules, if the landlord is a higher or additional rate income taxpayer, then any interest on a loan taken out to acquire the let property will be deductible in full when calculating the individual's income tax liability. So if an individual pays income tax at the top rate of 45%, this effectively saves the individual a sum equal to 45% of the interest paid. The new rules will restrict the amount of tax relief to the basic rate (currently 20%), even if the landlord is a higher or additional rate taxpayer. The restriction will be in full force from the 2020/21 tax year, but will be phased in with effect from the 2017/18 tax year.
It is also proposed that the so-called "Wear and Tear Allowance" for furnished residential lets will be replaced by a new relief which will allow a percentage of the actual expenditure on furnishings to be deducted when computing taxable profits. The benefit of the current regime is relative simplicity: the Wear and Tear Allowance is broadly calculated as 10% of rents less certain expenses incurred by the landlord such as Council Tax. With effect from April 2016 this will be replaced by the new relief, which will be based on actual expenditure and will certainly be more complex. The government has promised to issue a Technical paper on this in the summer.
The restriction on the amount of interest which can be deducted for tax purposes is only relevant for individuals owning buy to let properties. It does not apply to commercial property. It is also not relevant for companies, including offshore landlords who own their property through non-UK resident companies: these will always be liable to income tax on rental profits at the basic rate anyway. We await the detail of the proposed replacement to the Wear and Tear Allowance; clearly it is hoped that any changes do not place a significant compliance burden on residential landlords.
Crackdown on non-domiciled individuals and trusts
The Chancellor mentioned tackling non- compliance by wealthy individuals and offshore trusts right at the start of his speech. In detail, this means extending the remit of the HMRC High Net Worth Unit to people with a net estate of £10m or more and pursuing more criminal investigations against wealthy tax evaders. In addition, £36m will be invested over the next five years to tackle perceived non-compliance by trusts, pensions schemes and non-domiciled individuals.
The government clearly believes it will obtain a handsome return on its investment. Given the Byzantine complexity of our tax regime and regular tinkering – such as the changes to the remittance basis charge, the ATED regime and the rules on the use of offshore collateralised debt – non-domiciled individuals and offshore trustees will have to work extraordinarily hard to ensure that they are 100% accurate in their compliance.
The returning UK domiciled individual
The government wants to make it impossible for individuals who have a UK domicile at the date of their birth (i.e. a UK "domicile of origin") to claim non-dom status if they later leave the UK, acquire a domicile of choice in another country, but subsequently return to the UK. Where an individual with a UK domicile of origin leaves the UK, acquires a domicile of choice elsewhere, and then returns to the UK, he will be taxed as UK domiciled for all tax purposes once he becomes UK resident (irrespective of whether he has maintained a non-UK domicile status for general law purposes). In addition, while the individual is resident they will not benefit from any favourable tax treatment for trusts set up when they were non-UK domiciled. The measure will affect all returning individuals with a UK domicile of origin from 6 April 2017, including those who returned prior to April 2017. It will also affect all trusts set up when such individuals were non-UK domiciled if they are UK resident on or after 6 April 2017. The government intends to consult further on the introduction and interaction of these tax proposals after the summer recess.
The announcement is a big deterrent for individuals with a UK domicile of origin who believe they have since acquired a non-UK domicile of choice from returning to the UK, in particular those who have set up offshore structures. Individuals with a UK domicile of origin should seek advice to ensure they do not inadvertently become UK resident again and get caught by these rules. If they do intend to become UK resident again, they should seek advice on the potential tax consequences of doing so. The big surprise is that the new rules do not seem to prevent individuals who were born and brought up in the UK from claiming non-dom status where their parents had a foreign domicile at the time of their birth – the so-called "inherited foreign domicile".
Further pension changes for individuals
The first key change announced is that the government will reduce the lifetime allowance for pension contributions from £1.25 million to £1 million from 6 April 2016. Transitional protection for pension rights already over £1 million but below £1.25 million will be introduced alongside this reduction to ensure the change is not retrospective. The lifetime allowance will be indexed annually in line with the consumer price index from 6 April 2018.
The second key change is that the government will restrict pension tax relief by introducing a tapered reduction in the amount of the annual allowance for individuals with annual income (including the value of any pension contributions) of over £150,000 and who have an income (excluding pension contributions) of over £110,000. Currently the annual limit on tax relieved pension savings is £40,000 and the recovery of excess relief is through the annual allowance charge and the carry forward of unused annual allowance. The government has proposed that the rate of reduction in the annual allowance will be £1 for every £2 by which the adjusted income exceeds £150,000 (or £110,000), up to a maximum reduction of £30,000. In practice this means tapering the annual allowance down to a minimum level of £10,000. This policy will come into effect from April 2016.
Both of these measures are designed to decrease the cost to the Exchequer of pensions tax relief for high earners and are in line with recent restrictions to the benefit of pensions for high earners over the last few years.
Main residence inheritance tax nil rate band
Each individual has an Inheritance Tax (IHT) nil rate band. It was confirmed in today's Budget that the amount of the IHT nil rate band will remain at £325,000 until the end of the 2020/2021 tax year. The IHT nil rate band is the amount which can pass tax-free on an individual's death (in addition to any available IHT exemptions or reliefs). If the IHT nil rate band of a spouse or civil partner is not used on his or her death (for instance, because all of the spouse's or civil partner's assets pass to the surviving spouse or civil partner), it can be transferred for use on the later death of the surviving spouse or civil partner.
It was announced in the Budget that, from 6 April 2017, individuals who die owning a main residence will have the benefit of an additional IHT nil rate band. This will be known as the Main Residence (MR) nil rate band and it will be set at £100,000 for the 2017/2018 tax year. It will rise in each subsequent tax year reaching £175,000 in the 2020/2021 tax year, after which it will rise in line with the Consumer Prices Index. The MR nil rate band will be available when an individual passes their main residence to their descendants on death. If the main residence is, instead, passed to a surviving spouse or civil partner, the MR nil rate band can be transferred for use on the later death of the surviving spouse or civil partner.
Individuals who die without owning a main residence will still have the benefit of the MR nil rate band if they had owned a main residence up until 8 July 2015 but had ceased to do so from that date. The benefit of the MR nil rate band will also extend to individuals who have downsized and do not own as valuable a main residence at their death as they had previously owned. In both cases, the MR nil rate band will be available to reduce the IHT payable on other assets in the estate of equivalent value to the MR nil rate band. The benefit of the MR nil rate band will be restricted for estates with a net value of more than £2m.
The MR nil rate band is a welcome announcement for many home owners although it does seem to be a rather complicated way of achieving a long-held Conservative objective of ensuring that married couples or civil partners could pass on assets up to £1m to their families on death without any IHT charge. It will involve a degree of additional record-keeping by individuals and their executors. Nonetheless, the announcement is in line with the government's ambition to increase levels of home ownership. With restrictions above £2m, it is aimed squarely at the aspirational homeowner rather than the ultra-rich. The application of the relief for downsizers and those who may be forced to sell to move into a nursing home is also sensible.
Changes to venture capital schemes
Assuming state aid approval is granted, the Summer Finance Bill 2015 will change the rules on venture capital schemes (Enterprise Investment Schemes (EIS), Seed Enterprise Investment Schemes (SEIS) and Venture Capital Trusts (VCTs)). Investments will have to be made with the intention of growing and developing the business. Investors will have to be independent from the company from the time of the first share issue. Generally, companies will only qualify for relief where their first commercial sale was made within the previous seven years. A company's total investments through EIS and VCTs will be capped at £12m, or £20m for knowledge-intensive companies (which are now allowed up to 500 employees). There will be further restrictions on EIS and VCT funds acquiring existing businesses. Finally, the requirement that 70% of SEIS money must be spent before EIS or VCT funding can be raised will be removed.
The government continues to refine the rules on venture capital schemes to ensure they serve the purpose for which they were intended: providing high tax reliefs to high risk enterprises. Although expected, the changes adjust and, generally, shrink the scope of the schemes, requiring those wanting to benefit from them to think carefully about their eligibility. Indeed, the government's continued monitoring of the schemes' investments in subsidised energy organisations sends out a signal that it will not tolerate abuse despite its general willingness to support venture capital schemes.
Corporation tax restrictions for cost of goodwill
The government has announced that it will restrict the corporation tax relief a company may obtain for the cost of positive ‘goodwill’ acquired after March 2002 (the reputation and customer relationships associated with a business). At present, goodwill is not depreciated over time, but rather is subject to 'impairment reviews'. Where a loss is recognised in a company's accounts as a result of an impairment review, a broadly corresponding deduction is available for tax purposes.
The proposed change will affect all acquisitions of goodwill on or after today (8 July 2015), although we are yet to see draft legislation setting out the details of the change, or explaining how the new rules will work. It is not clear how this change will interact with a seller's current ability to claim roll-over relief where an intangible asset is sold and the proceeds are reinvested in other qualifying intangible assets.
This is a further change to the tax treatment of goodwill, following the 1 January 2015 change recognising 'negative' goodwill in the balance sheet. This further change highlights the fact that businesses intending to make acquisitions and disposals should carefully consider their tax position before doing so to ensure that they avoid being 'tripped' up by rule changes.
Restrictions on the capital gains tax treatment of carried interest
For many years the investment fund industry, particularly in relation to private equity, has used fund structures involving partnerships to enable fund executives or investment managers to share in a percentage of the profits of the fund. The profit share could be structured in a number of ways, but probably the most common was the use of a carried interest limited partnership (typically a Scottish LP) that was a limited partner in a fund formed as a limited partnership. The profit share was usually subject to an agreed performance target and on the target being reached the fund was "in the carry", which usually gave the executives a right to as much as 20% of the gains over and above the hurdle IRR that had to be achieved by investors.
This use of tax transparent partnerships meant that executives or managers could participate in profits returned to them in the form of a share in the underlying capital gain realised when the investee company was sold or listed. Unlike co-investment plans used by such funds, the executives effectively paid nothing for their carry. However, by an application of the rules set out in Statement of Practice D12 (SPD12), when the executive came to calculate their taxable gain, they were also attributed 20% of the investors' base cost (which was often several million pounds), even though they had paid nothing. This is known within the industry as the "base-cost shift". The base cost was deductible from the gain, thereby reducing the amount that was subject to tax. Investors would, in effect, lose part of their base cost but many seemed not to care, particularly as a large proportion of investors are tax-exempt pension or sovereign funds or non-UK resident.
Measures announced in the Budget will immediately bring to an end the benefit of the base-cost-shift for investment managers. They will now pay tax on the full amount they receive i.e. the true economic profit. Executives or managers will now only get a deduction for the actual investment they made and not for the base cost attributed to them under SPD12. This change should only apply to carry and will not otherwise affect the application of SPD12. It seems that the base-cost-shift will still take place but the executive or manager will not be able to claim an allowable deduction for it. This also means that the base cost "lost" by investors will not be returned to them. However, for the reasons stated above, many of them may not mind. It remains to be seen whether taxable UK resident investors might now focus a little more on their loss.
Investment managers may be feeling a little bruised by all this as it comes hot on the heels of the "disguised fee" rules that came into force on 6 April 2015. Under these rules, sums received by investment managers for their services would be charged to income tax as part of their trading income. Arrangements (general partner share streaming or diversion and fee waivers) had been devised to structure what would otherwise be management fees as an investment return. The latest changes and the announcement in the Budget of further consultation (on performance rewards to investment managers) prove that HMRC are keeping to their promise of actively reviewing the situation.