The Chancellor repeated several times in his Budget today that austerity is coming to an end. He spoke of a strong economy and the UK's new future outside the EU, saying that a deal with the EU was a "when", not an "if". The Chancellor restated from previous Budgets that "Britain is open for business", covering a range of measures to back British businesses to "invest and grow" and ended with a patriotic flourish, praising the indomitable spirit of the British people, building a Britain we can all be proud of.
A pledge to deliver on promised £12,500 basic and £50,000 higher rate income tax thresholds a year early in April 2019 will be expensive for the Government, but no doubt popular. A new tax on digital platforms for "established tech giants" from April 2020 and cuts of a third to business rates on the high street reflect wider calls for fairness in global and retail taxation respectively.
Stricter qualifying conditions for Capital Gains Tax Entrepreneurs' Relief were introduced as expected and the widening of the IR35 rules to encompass the private sector was perhaps unsurprising. Despite the usual rumours, there were no changes to tax relief on pensions. The proposed extra SDLT charge for non-residents was widely publicised during the Conservative Party conference and yet we've had no further detail bar a reference to the rate now only being 1%. There were unexpected changes to Capital Gains Tax, with a consultation on CGT for non-residents and new restrictions on the main residence exemption.
However, many of the measures announced today will not come into effect until after Brexit. The Chancellor made it clear today that he might, if necessary, "upgrade" his Spring Statement to a full Budget next year. This could mean changes to the items announced today in only a few months' time.
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.
New Digital Services Tax
The Chancellor has announced that from April 2020 the UK will impose a digital services tax (DST) intended to raise £1.5 billion over four years. The details will be fleshed out following consultation but it is aimed at search engines, social media platforms and on-line marketplaces such as Airbnb . All of these activities derive significant value from user participation, for example searches, targeted advertising or transactions facilitated by the platforms.
DST at the rate of 2% will be charged on revenues linked to UK users where businesses have (presumed annual) global revenues of at least £500m and at least £25m revenues derived from the UK. Loss-making businesses will not pay DST and low-margin businesses can "elect to pay a lower rate of DST". The announcement confirms that DST will not apply to financial and payment services, the provision of on-line content, software and hardware sales, or broadcasting.
Note that DST may never become effective "if an appropriate global solution" is agreed before 2020.
Rather like a previous Chancellor who decided to impose the Diverted Profits Tax unilaterally, Philip Hammond has decided to announce a new tax, Digital Services Tax, both as a temporary tax-raising measure pending agreement but also to encourage agreement being reached internationally on the right way to tax global businesses paying minimal amounts of tax locally. It's interesting that the rate of tax (2%) is lower than suggested in earlier consultations, maybe as a nod to the UK being "open for business" post-Brexit.
Private Residence Relief: changes to ancillary reliefs
When a home owner sells their only or main residence, subject to certain conditions there is no charge to capital gains tax (CGT) as PPR applies. Currently, the last 18 months of ownership (36 months for disposals before 6 April 2014) are always treated as a period of deemed occupation, regardless of whether the taxpayer is living there or not. This relief exists to assist those who move to a new home at a time when they have been unable to sell their former home. From 5 April 2020, the 18 month final period exemption will be shortened to just 9 months. The Chancellor argues that this is still twice the length of an average property transaction and market conditions have improved somewhat from the early 1990s when the 36 month period was introduced.
The Chancellor also announced that CGT lettings relief is to be reformed. Lettings relief increases the amount of a gain that is sheltered from CGT when a taxpayer sells a property in respect of which some PPR is due. From 6 April 2020 lettings relief will only apply in circumstances where the owner of the property is in shared occupancy with the tenant(s).
This is an unexpected change and seems to be aligning the availability of lettings relief with rent a room relief. As a consequence, paying lodgers may become more common, which may well be the Government's intention. Where homeowners take in more than one lodger, there was always a risk that this could prejudice the availability of PPR. These changes seem to be a back door way of dealing with this problem by allowing lettings relief instead. This may encourage home-owners to increase the availability of low-cost accommodation as a way to help solve the housing crisis by renting out spare rooms.
Changes to Entrepreneurs' Relief
Following on from the announcement in the Autumn Budget 2017 that 2018 would see major changes to Entrepreneurs' Relief, the Government has today announced that in order to benefit from Entrepreneurs’ Relief, individuals will need to meet stricter qualifying conditions:
- From 29 October 2018 shareholders must be entitled to at least 5% of the distributable profits of a company and 5% of the net assets on a winding up to claim the relief. Previously it was only necessary to hold 5% of the ordinary share capital in a qualifying company and hold at least 5% of the voting rights, without the corresponding economic interest in the shares that these additional new conditions now require.
- From 6 April 2019, the minimum holding period will be increased to 24 months from 12 months.
- As previously announced at Autumn Budget 2017, from 6 April 2019, if an individual’s shareholding is diluted to below 5% as a result of an external investment, they will be able to claim Entrepreneurs' Relief on gains made up to that point.
The Government intends that these changes will support longer-term business investments, benefit genuine entrepreneurs and address the misuse of current Entrepreneurs' Relief rules. The increased holding period will also apply to options granted under Government-sponsored Enterprise Management Incentive ('EMI') plans. The changes that are immediately effective will impact many private equity structures with management incentive plans where these previously allowed a sub-set of managers to access Entrepreneurs' Relief by using more than one share class. The risk is that the rights attaching to those classes may not now pass the new 5% economic rights test effective as of today.
IR35: off-payroll working in the private sector
The Chancellor announced that from April 2020 medium and large businesses will become responsible for assessing the employment status of individuals in order to increase compliance with the off-payroll working rules (known as IR35). These rules affect people working like employees through a company and are designed to ensure that two individuals working in the same way will pay the same income tax and National Insurance Contributions (NICs) even if one provides services through a company. The Government confirmed that this change was being introduced to bring the private sector in line with the public sector, where HMRC estimates the reform has raised £550m in income tax and NICs in its first year. The Government listened to representations made by excluding small companies from this measure and allowing greater time for medium and large companies to adjust to the change.
Following the recent introduction of changes in this area for the public sector, it is perhaps no surprise that a similar change has been announced for the private sector – the distinction would have been difficult for the Government to justify. It goes without saying that once these changes come into force, private companies will have to apply resources in determining the status of individuals providing services through companies to ensure the correct level of income tax and NICs is withheld and accounted to HMRC. To assist with that, HMRC provides a Check Employment Status for Tax (CEST) service on its website to help businesses determine if the off-payroll rules apply and will also provide guidance before the reforms come into effect.
Business Rates changes
The Government has announced that it plans to make changes to business rates, including a targeted measure aimed at supporting small high street businesses that are struggling due to the rise of online retailers. The key announcements made include:
- Business rates are to be cut by a third for retail properties with a rateable value of up to £51,000 for two years from April 2019. According to the Chancellor, this cut to business rates will result in an annual saving of "up to £8,000 for up to 90% of all independent shops, pubs, restaurants and cafes";
- There will be an extension to the business rate discount scheme for local newspapers until 1 April 2020. The scheme was originally introduced in the 2016 Budget to provide a £1,500 discount for office space occupied by local newspapers in England, up to a maximum of one discount per office for two years from 1 April 2017;
- The introduction of a business rates public lavatories relief with a rate of 100% for all public toilets made available for public use, whether publicly or privately owned; and
- The Government will consult on whether to make self-catering and holiday let accommodation chargeable to business rates as opposed to council tax. The Government is concerned that property owners are seeking to reduce their council tax liability by falsely declaring that their second property is available as a holiday letting for at least 140 days a year.
The plan to cut business rates for small businesses appears to be part of a wider Government agenda to help the retail sector adapt to the digitalisation of the economy and revive the UK's high street. The changes should certainly aid small businesses in the short term but many of those businesses will surely welcome permanent incentives to provide them with certainty given the current economic climate. The new public lavatories relief undoubtedly gave the Chancellor ample opportunity for punning, which he used to the greatest extent during his speech.
Following the Prime Minister's announcement at the Conservative Party conference of a proposed "1-3%" SDLT surcharge for non-UK resident investors in UK property, we were braced for detailed changes in the Budget. The Government has however simply announced that a consultation will be launched in January 2019 regarding an "SDLT surcharge of 1% for non-residents buying residential property in England and Wales and Northern Ireland".
The Government has also made some technical amendments to the operation of the existing 3% SDLT surcharge rules for additional properties including allowing a longer period to reclaim the 3% already paid when someone sells their old home after buying a new one. The ambit of the first time buyer's relief rules for SDLT purposes has also been widened to include all qualifying shared ownership property.
Whilst not quite kicked into the long grass, the Government has clearly rowed back from the headline grabbing announcement of a new "1-3%" SDLT surcharge for non-residents. First, it has been confirmed that the charge will only apply to those investing in residential property. Second, the Government now seems to be talking about a 1% surcharge only – and the fact it will be subject to consultation is welcome. This turn of events is not entirely surprising, especially given the dubious legality of subjecting non-residents to a higher rate of SDLT compared to their UK counterparts, and the inevitable difficulty in defining "non-resident" for these purposes.
Avoidance and disputes
This year's Budget follows the recent trend of legislating on controversial issues in the hope that this reduces the scope for uncertainty. HMRC estimate that as part of the infamous 'tax gap' they lose £5.3bn due to 'legal interpretation', and so it comes as no surprise that HMRC have again sought to nail down as many identifiable issues as they can by way of primary legislation. The irony of enacting more legislation in order to avoid the risks of legal interpretation is apparently lost on HMRC.
In limited instances this approach may work. For example, there are to be some specific tweaks to how vouchers are to be treated from 1 January 2019, with the aim to prevent non-taxation/double taxation of goods or services which are purchased with vouchers. This will reverse the current position in the UK where the customer is deemed to be receiving two supplies: (1) a voucher; and (2) an underlying supply of goods or services. There will no longer be a separate supply of the voucher for VAT purposes and this will be of interest to retailers. Similarly, it has been indicated that "stricter rules" are to be introduced for how and when VAT adjustments should be made following a price reduction (for example, where a customer qualifies for a contingent discount). There is to be secondary legislation which will aim to narrow the scope of Regulation 38 and ensure a credit note is issued to customers.
In other cases though, the effectiveness of the proposed legislation may be questionable. For example, legislation is to be introduced which prevents the artificial fragmentation of permanent establishments from having a beneficial tax effect. What 'defragging' a corporate group will look like remains to be seen; clearly a functional analysis will not be sufficient. The hope is that HMRC will look sensibly at the huge volume of evidence and documentation which will be necessary to discharge the burden of proof. It is unlikely to be enough to look at an individual subsidiary; it will probably be necessary to look at large parts, if not the entirety, of the entire international group.
The tax gap also comprises £3.4 billion of unpaid taxes, so in these cash-strapped pre-Brexit times HMRC will move to preferred creditor status in relation to taxes collected and held by businesses on behalf of other taxpayers (for example, VAT, PAYE income tax, employee National Insurance contributions and Construction Industry Scheme deductions). HMRC will continue to be seen as an unsecured creditor in respect of a business's own taxes.
Increase in Remote Gaming Duty
The Chancellor has announced that for accounting periods beginning on or after 1 October 2019 the rate of RGD in relation to profits from remote gaming will increase by a staggering 40% from 15% to 21%. The Budget continued the theme of focusing on the gaming and betting sector by also confirming that the maximum stakes on Fixed Odds Betting Terminals (FOBT) will be slashed from the current limit of £100 to £2 in October 2019. This measure was originally set for implementation in April 2019 but has now been delayed.
We will have to wait and see whether such a large increase in RGD rates proves too much for some operators.
Whilst this is clearly, and to some not unexpectedly, a change aimed at raising finance, it is an unwelcome development particularly for those larger operators who may be affected by the introduction of the Digital Services Tax – also announced today as part of the Budget. The changes to RGD will impact a wider audience as the Digital Services Tax is principally aimed at profitable companies with more than £500m in "global in-scope revenues" and will not be introduced until April 2020 following a period of consultation. However it will be very interesting to monitor the extent to which the two regimes overlap, if at all. Overall, given the complexities of designing and operating systems to deal with these changes, many will welcome the extra time being allowed before implementation in October 2019.
New Structures and Buildings Allowance
The Chancellor announced that the Government will introduce a new Structures and Buildings Allowance for new non-residential structures and buildings. Relief will be provided on eligible construction costs incurred on or after 29 October 2018, at an annual rate of 2% on a straight-line basis over a 50 year period. This new relief will not be available for structures or buildings where a contract for the physical construction works was entered into before 29 October 2018. For structures or buildings constructed ‘in house’, relief will not be available where the construction activity began before 29 October 2018.
Details of this change have been published in a technical note, with draft legislation expected to be included in Finance Bill 2018-19. A fair amount of detail has been provided but some key points to note are that:
- for new commercial buildings and structures, the relief should apply to costs for new conversions and renovations;
- UK and overseas structures and buildings will qualify if the business is within the charge to UK tax (whether income tax or corporation tax); and
- only the costs of physically constructing the structure or building (including costs of demolition or alterations required for construction) and direct costs required to bring the asset into existence will be covered by the relief.
This is a welcome additional relief for the commercial property development sector. It reverses in effect the removal of Industrial Buildings Allowances in 2011 but by giving a straight line allowance at 2% (not 4%) and avoiding the balancing allowances/balancing charges concept reduces the scope for manipulation. However, it is accompanied by a reduction in the rate of writing down allowances on the special rate pool for integral features from 8% to 6%, which may offset the benefit to some extent. The Exchequer forecasts that this rate reduction will raise revenues of £75m this tax year, increasing to up to £360m in 2020/21.
Extension of Capital Gains Tax to non-UK residents
The Government has published its policy paper regarding the extension of CGT and corporation tax to post-5 April 2019 disposals by non-UK residents of: (1) UK land or (2) 'indirect disposals' of UK land (i.e. a disposal of an interest in an entity that derives 75% or more of its gross asset value from UK land). Eagerly awaited further detail is provided as to how the Government will calculate gains made on 'indirect disposals', how taxpayers should calculate whether an entity derives 75% or more of its gross asset value from UK land, and when the exemption for investors holding less than 25% of the entity will apply. There is a welcome exemption for disposals of interests in property-rich entities that are trading both before and after disposal, and the ability to use either the original acquisition cost of the asset (albeit with restrictions for calculating losses) or its April 2019 value when calculating the chargeable gain due. However, specific anti-avoidance rules will target those trying to avoid the indirect disposals rules. Provision will also be made to charge UK resident companies in the same group as non-resident companies who fail to pay the tax due.
New legislation will outline how the rules will apply to Collective Investment Schemes and Alternative Investment Funds. Whilst the detail is yet to be analysed, these funds (other than partnerships) will be chargeable to corporation tax, and investments in such a fund will be treated as if the interests of the investors were shares in a company. Therefore, where the fund is UK property-rich, the disposal of an interest in the fund by a non-UK resident will be caught by the new rules. More detail on how these complex rules will apply to funds will be published on 7 November 2018. The policy paper also confirms UK property-rich UK Real Estate Investment Trusts (REITs) will be exempt from being taxed on gains made on the disposal of UK property-rich entities.
Whilst we welcome the additional detail and confirmation of an April 2019 rebasing, there are still a lot of questions left unanswered as to how these rules will apply, particularly in relation to funds. We await more detail in the Technical Note to be published on 7 November 2018.
Inheritance tax residential Nil Rate Band
The Government has confirmed some minor amendments to the legislation governing the availability of the inheritance tax residential nil rate band (the RNRB) which has been effective since 6 April 2017. The RNRB is an additional nil rate band available to the estates of those who, broadly, pass their residential property to lineal descendants either by a Will or under the intestacy provisions. The amendments that have been announced relate specifically to the application of the RNRB where an individual has given away property during his or her lifetime but continues to live there.
Where an individual gives away a property during their lifetime but continues to use it, even to a limited degree, that property will remain part of their estate for inheritance tax purposes under the "gift with reservation of benefit" ("GROB") principle. The Government has confirmed that the RNRB legislation will be amended to clarify that if the GROB principle applies such that the gifted residence still forms part of the deceased's estate for inheritance tax purposes, the residence will be treated as the deceased's residence for the purpose of the RNRB rules, provided the recipient of the gift was a lineal descendant. This seems fair and consistent.
The amendments are minor and intended only to clarify and ensure that the legislation has its intended effect. That said, any clarification on the application of the RNRB legislation is welcome given its opacity and the historic anomalies in its drafting.