Budget 2016: Corporate & Business Tax
The most eye-catching of the Chancellor’s announcements from a business tax perspective were the proposals on Business Rates, no doubt widely applauded by SMEs, and yet another reduction in the headline rate of Corporation Tax from 2020 to 17%. However, in the detail there were some welcome relaxations of the Entrepreneurs’ Relief rules and an increased rate of tax on shareholder loans.
Corporation Tax to reduce to 17% in 2020
Last year’s second Finance Act provided for the reduction of the headline rate of corporation tax from 20% to 19% for the financial years 2017, 2018 and 2019, and a further reduction to 18% from 2020.
The change will reduce the rate further from 2020 to 17%.
KS comment: The measure will benefit all companies within the charge to corporation tax and the hope is clearly that it will act as an inducement to multi-nationals to invest and shift profits to the UK. Quite how this fits with our commitment to the BEPS (Base Erosion and Profit Shifting) project is an interesting question, but it is estimated that the cuts announced since 2010 could increase GDP by between 0.6% and 1.1%.
The reduction will also increase the incentive on the part of small businesses to incorporate.
Loans to shareholders
Where a close company makes a loan to a participator (usually just shareholders), the company is required to pay corporation tax at the rate of 25% on the amount of the loan. The purpose of this is very simply to make the payment of loans a less attractive alternative to paying salaries or dividends. The rules permit this tax to be refunded as and when the loan is repaid.
With the rate of income tax on dividends being increased by 7.5% across the board from 6 April it was inevitable that someone at the Treasury will have spotted that this tax provision on loans should be adjusted accordingly. Therefore, for loans advanced on or after 6 April 2016 the rate of tax on loans increases to 32.5%.
KS comment: Whilst this change was expected, it is interesting that it does not come into effect immediately. Loans made before 6 April 2016 are taxed under the old rate. There is still a chance therefore for some planning with loans and dividends before the relevant tax rates change in April.
Corporation Tax: Limiting the deduction of interest expense
As part of its commitment under the BEPS project the Government will introduce, from 1 April 2017, measures designed to limit corporation tax deductions for net interest expense.
There will be a “Fixed Ratio Rule” which will ensure that interest in excess of 30% of EBITDA will not be deductible. The rule will be targeted at larger groups by setting a de minimis threshold of £2m net of UK interest expense, so the vast majority of companies by number will be unaffected.
Further consultation will take place on all aspects of the rules.
KS Comment: A widely trailed measure reflecting the UK’s commitment under Action 4 of BEPS to limit interest deductions for highly geared UK companies and groups, partially to level the playing field as between debt and equity, but also to prevent profit shifting via cross border debt structures.
Profits from Trading in and Developing UK Land
Under existing legislation it is possible for a non-resident company to deal in, or develop land in the UK without incurring a UK tax charge on the profits earned, by taking advantage of the interaction of the domestic and treaty definitions of “permanent establishment”.
New legislation is proposed to be inserted into the Finance Bill at the report stage, effective from the date of its introduction that will ensure that the entire profit arising on the dealing/development activity will be subject to UK tax, regardless of whether there is a permanent establishment.
Accompanying the new legislation is a protocol that has already been agreed amending the Double Tax Agreement between the UK and Guernsey (where many of these offshore development companies are resident), to close a perceived loophole in the operation of the treaty in these circumstances.
KS comment: The changes will put an end to a widely used, if controversial, structure for developing land in the UK.
A number of changes to Entrepreneurs’ Relief have been announced in the Budget.
Changes were made in the March 2015 Budget to deny or restrict Entrepreneurs’ Relief in the case of joint venture companies and companies that are partners in partnerships or LLPs. These changes were deemed to be harsh and caught out commercial structures.
The change announced today rolls back last year’s changes but only where the person making the disposal has an effective interest of 5% or more in the underlying trading entity. For example, a person who holds 20% of a company which does nothing but hold 40% of a trading company’s shares will be treated as holding 8% (20% x 40%) of the trading company and 40% of that company’s activities will be taken into account in deciding whether the person’s shares are shares in a trading company for Entrepreneurs’ Relief purposes. There is a similar change for partnerships and LLPs.
KS comment: We believe that this is a useful relaxation as last year’s changes were particularly harsh. Structures of this type need to be reviewed to ensure that, where possible, the revised ‘5% tests’ are met.
Entrepreneurs’ Relief is available where an individual owns an asset which is used for the trade of a partnership/LLP in which he has an interest or his personal company. The disposal of this asset had to occur along with a disposal of the owner’s interest in the business concerned. Changes were made in 2015 to only allow this relief where the individual also had a 5% reduction in their interest in the business that used the asset. It has now been decided that this would deny relief for associated disposals where the business and asset are passing within the family as part of normal family succession arrangements and the disposal of the interest in the business is less than 5%. This is being removed from 18 March 2015 to allow purchases by persons connected with the vendor.
In addition the 5% test is being relaxed where a person disposes of his entire interest in the underlying business and has previously held a larger stake.
KS comment: These may seem like minor technical changes but are welcomed as the 2015 changes were poorly targeted and applied in commercial or family situations on an unfair basis.
Extension capital gains tax entrepreneurs’ relief to long-term investors
Long-term investors in unlisted trading companies, who don’t own 5% of the shares or are not officers or employees of the company concerned, do not qualify for Entrepreneurs’ Relief. The good news is that the relief is now to be extended so such long term investors so as to give them a 10% rate of CGT up to a lifetime limit of £10 million. However, there are conditions:
- The shares must be newly issued, having been acquired by the person making the disposal on subscription for new consideration
- They must be in an unlisted trading company, or unlisted holding company of trading group
- The shares must have been issued by the company on or after 17 March 2016 and have been held for a period of three years from 6 April 2016
- They have to have been held continually for a period of three years before disposal
- There is no minimum holding of 5% as with existing Entrepreneurs’ Relief.
- The new relief is not available to officers and employees
- Like many generous reliefs, this provision will include an anti avoidance element which will ensure that shares must be subscribed for by individuals for genuine commercial purposes and not for tax avoidance purposes.
KS comment: This is a generous new relief and will help companies attract equity capital particularly in situations where SEIS, EIS or VCT investments are not permitted either because the company is too large or that does not conduct a qualifying trade. It puts Entrepreneurs’ Relief for companies on a par with partnerships and LLPs where passive investing partners could already claim that relief.
Entrepreneurs’ relief and goodwill
Budget 2015 prevented Entrepreneurs’ Relief from being available on goodwill where a business is transferred by a sole trader, partnership or LLP to a limited company. This curtailed a popular and tax effective way of incorporating a business.
This change is now being reversed in the limited circumstances set out below. The change is being backdated to the date the original change was effective from, that being 3 December 2014. Entrepreneurs’ Relief will be available on disposals of goodwill on transfers of a trade to a close company in the following circumstances:
- Where the claimant owns less than 5% of the shares and 5% of the voting power in the acquiring company.
- Where the claimant owns 5% or more of the shares and voting power but where the transfer is part of arrangements for the company to be sold to a new, independent owner.
KS comment: There were a number of changes to Entrepreneurs’ Relief announced in the Spring 2015 Budget to curtail perceived abuses and some of the have been rolled back in this year’s Budget. Again a welcome change but one that will only apply in a number of limited circumstances. It will not apply for instance where a partnership of five equal partners transfer their business to a company which they own equally as they will each own 5% or more of the shares and the company will not be controlled by a new, independent owner.
Income Tax: Royalty Withholding Tax
This measure targets arrangements entered into, invariably by multi-national companies, which facilitate the payment of royalties to non-residents in circumstances which do not require the deduction of income tax at source. This may be by virtue of the operation of a double tax agreement, because the royalty is of a type that does not attract withholding tax under the existing domestic law, or it does not have a source in the UK but is connected with a business carried on in the UK by a non-resident through a permanent establishment here.
Invariably the royalties are channelled into a low/no tax jurisdiction and so represent profits that are not subject to tax anywhere.
The changes will impose an obligation on the payer to deduct and account for income tax by extending the class of royalties subject to withholding tax, providing a clear rule to define where a royalty has a UK source, and denying treaty benefits where arrangements have been put in place with the main purpose of securing a benefit that is not in accordance with the object and purpose of the treaty (“treaty shopping”). With the exception of the “treaty shopping” provisions, which take effect for payments made on or after 17 March, the measures will take effect from the date of Royal Assent.
KS comment: This measure is part of a wider policy initiative focused on the BEPS project, and designed to prevent the exploitation by multi nationals of cross border tax arbitrage to reduce their global tax obligations, in this case by removal of otherwise taxable profits from the UK tax net. It may well lead to multi-national companies re-appraising their international structures, in particular the location and licensing of intellectual property rights.
Corporation Tax: Anti-hybrids rules
This measure targets a range of structures and arrangements entered into by multi-national groups exploiting mismatches of the tax treatment of transactions or entities in different jurisdictions. Mismatches can include deductions in more than one jurisdiction for the same expense or deductions for an expense with no corresponding taxable receipt.
The measure aims to neutralise the various forms of tax mismatch.
KS comment: The measure implements Action 2 of the G20/OECD BEPS project and is part of the UK’s continuing assault on “aggressive tax planning” by multi-nationals.
Income and Corporation Tax: Repeal of the renewals allowance
Current legislation permits a deduction for capital expenditure incurred on “…replacing or altering any tool used for the purposes of a trade. “Tool” is defined as “…any implement, utensil or article”.
Business have successfully applied the definition to, in some cases, large and expensive items of equipment, effectively obtaining a 100% deduction for capital equipment that would otherwise fall under the much less generous capital allowances regime. The existing rules will be repealed in respect of expenditure incurred on or after 1 April 2016 (companies) and 6 April 2016 (individuals and partnerships).
KS comment: The renewals allowance significantly pre-dates the capital allowances code and was intended to apply to small tools and equipment. Its demise is as a result of a number of very large claims resulting from a liberal interpretation of “article”.
Extension of enhanced capital allowances for Enterprise Zones
There has been a minor change extending relating to the availability of Enhanced Capital Allowances (ECAs) in Enterprise Zones. 100% ECAs are available for qualifying plant and machinery assets. Currently, the qualifying expenditure must be incurred in the period of eight years beginning with 1 April 2012, and the area in which the plant or machinery is to be used must be an Assisted Area at the time that the expenditure is incurred. The Budget change is that this eight year period will run from the date the Enterprise Zone was designated as such.
KS comment: This is a positive change for businesses established in Enterprise Zones.
Corporation Tax: Bank loss relief restriction
Current rules restrict the ability of banking companies to offset losses accumulated in earlier years. Current taxable profits can be sheltered by “old” losses to the extent of 50%, leaving the remaining 50% chargeable to corporation tax. The measure announced reduces the percentage of profits that can be sheltered in this way to 25%.
KS comment: This is a measure of interest only to banking groups. Other trading companies can utilise earlier years’ losses without restriction. It is perhaps not unreasonable to defer the tax benefit of bank losses in this way, given that in many cases those losses were effectively underwritten by the taxpayer.