Following the draft clauses of December 2014, a final version of the UK Finance Bill 2015 was published on 24 March 2015. Since there is a general election in the UK this May, the Bill received Royal Assent on 26 March to become the Finance Act 2015. A further finance bill is likely after the election. This Alert provides more details on the most significant measures contained in the Finance Act. It is not intended to be exhaustive and provides a summary of the key areas and the issues surrounding them.
Diverted profits tax
As included in the draft clauses published in December, a new "diverted profits tax" was introduced in response to the publicity surrounding multinationals conducting extensive business within the UK but falling outside the charge to UK corporation tax. This would generally arise either by an overseas entity structuring itself so that its business activities in the UK did not amount to a permanent establishment or by an entity's being party to arrangements in which fees are payable to a parent in a low tax jurisdiction, thus reducing UK profits. The government introduced a 25-percent tax payable on amounts deemed to be diverted profits. The rate of tax appears to be designed to alter corporate behaviour since it is higher than the 20-percent corporation tax payable in the UK.
The diverted profits tax can apply in two sets of circumstances. The first is when an overseas entity with substantial UK activities deliberately avoids establishing a UK taxable presence. The avoidance of UK corporation tax has to be the "main purpose or one of the main purposes" of the structure.
The second test applies to UK companies or UK permanent establishments that reduce their corporation tax by making payments to related parties with an effective lower tax rate—for example, by paying royalties. This applies only if the payment would not have been made at all were it not for the tax benefit of doing it.
In terms of administration, companies are obliged to inform HM Revenue & Customs (HMRC) if they might be within the regime. Beyond that, HMRC is generally able to make an estimated assessment and serve a "charging notice" upon the company, which must then pay the tax within 30 days. A one-year review period follows to determine if the assessment was correct. The company can then appeal to the courts under normal procedures.
Certain exemptions apply, such as an exemption for small and medium-sized enterprises and an exemption for entities with limited UK sales.
Duane Morris comment
Although the principle behind this legislation is understood, it contains some controversial elements that have not been addressed in the updated legislation. Some parts of the tests remain subjective and this, combined with the process of payment on demand from HMRC and the opportunity to appeal only arising later, appears to place considerable power in the hands of HMRC. This measure being included in the pre-election Finance Act is likely to limit the opportunity for proper consideration of the new rules, and the timing has been the subject of criticism.
Disguised investment management fees
The Finance Act provides for the income taxation of "disguised fee income"—sums that investment managers receive for their investment management services via partnerships or other transparent vehicles. The measure is intended to stop investment managers from converting into capital receipts what the government considers to be trading income.
A new chapter of the Income Tax Act 2007 provides that if an individual provides investment management services for a collective investment scheme through an arrangement involving any number of partnerships, any sums received for those services will be treated as profits of a trade, unless already charged to income tax as employment or trading income. Sums will not be caught if they represent carried interest or constitute a return of capital that the individual invested or a commercial return on that capital.
The drafting has been updated since December to account for some concerns. For example, the trade in question is treated as carried on in the UK to the extent that the services are carried on in the UK, and outside the UK to the extent that the services are carried on outside the UK. In the draft legislation from December, the services were treated as performed wholly in the UK if they were to any extent performed in the UK and, otherwise, outside the UK.
Management fees now exclude the repayment of capital invested by the individual manager, an arm's length return on that capital and carried interest. The second item appears to be designed to exclude co-investment from the measure. "Carried interest" is also more widely defined as a "profit-related return," which accommodates a range of carried interest structures. The original definition (referring to a preferred return of not less than an amount calculated by reference to an interest rate of 6 percent) is retained. However, guaranteed sums are not carried interest and constitute management fees taxable under these rules.
The measure contains an anti-avoidance rule providing that no regard is to be had for any arrangements intended to circumvent the rules. It also contains rules preventing double taxation. The measure is to have effect for sums arising on or after 6 April 2015.
Duane Morris comment
Although the changes amount to an improvement, this area is still likely to present issues for the private equity industry. A more detailed Alert will follow on this new measure.
Overseas owners of UK residential property – capital gains tax
Legislation has been introduced to extend capital gains tax to disposals of UK residential property by non-UK resident persons. Companies that are widely held will be exempt from the charge, as will unit trust schemes and open-ended investment companies that meet a widely-marketed fund condition.
The legislation will have effect for disposals on or after 6 April 2015, subject to transitional provisions.
Duane Morris comment
This measure was announced in the 2013 Autumn Statement and was the subject of a consultation that closed on 20 June 2014. The government published a response to the consultation outlining the main features of the extended charge on 27 November 2014. Accordingly, this development is not unexpected. Those impacted should consider that only gains arising from the implementation date are affected, which could place significance on valuations.
Stamp Duty Land Tax (SDLT) reform
The UK's system of SDLT on residential property was reformed with immediate effect from December, but the legislation has now been finalised. SDLT for residential property is now charged at different rates depending upon the portion of the purchase price that falls within each rate band. The new rates are set out below.
Click here to view table.
There are no changes to certain other SDLT rules. The changes do not apply to SDLT on purchases of non-residential property or on the rent payable when a new lease is granted. Certain anti-avoidance provisions will also continue to apply, such as the rates for commercial property being used where six or more residential properties are acquired as part of a single transaction. Furthermore, the 15-percent SDLT rate payable by certain non-natural persons that purchase residential property for more than £500,000 will also remain in force.
Duane Morris comment
As noted in December, the application of SDLT rates to the amount of the purchase price within each band is likely to be a welcome reform. The government has been keen to emphasise that 98 percent of purchases will be subject to a reduced rate of SDLT. However, for purchases where the consideration is more than £937,000 (not uncommon in London) the rate will be higher and the rises quickly become steep. For example, a property costing £2.5 million would attract £175,000 in SDLT under the old regime. Under the new regime, £213,750 is due, a difference of nearly £50,000. Hence, those who pay more under the new regime pay significantly more.
As announced in December, those individuals who are resident but not domiciled in the UK are entitled to use the "remittance basis" of taxation, which means they are taxed on overseas source income and gains only to the extent the same are "remitted" to the UK. After a certain number of years, an annual charge applies for the use of this basis of tax. Changes have been made in this area.
The charge for those resident for seven of the past nine years, but fewer than 12 of the past 14 years, will remain at £30,000. The charge for those who have been resident for 12 of the past 14 years will increase from £50,000 to £60,000 from April 2015. Finally, also from April 2015, a new charge of £90,000 will be introduced for those who have been resident for 17 of the past 20 years.
Currently, individuals may make an annual choice as to whether they use the remittance basis and pay the charge or whether they are taxed on an arising basis in the same manner as those domiciled in the UK. Consultation closes next month on the issue of whether an election should apply for three years.
Duane Morris comment
The "17 of the past 20 years" test for the application of the new £90,000 charge matches the residence test used for the purposes of the deemed domicile rules for inheritance tax. However, it is slightly incongruous in light of the residence tests for the £30,000 and £60,000. A remittance basis user who has been resident for only six of the past nine years, or 11 of the past 14 years, may have been resident for 17 of the past 20 years. This means that an individual who is not subject to either the £30,000 or £50,000 charges under the current rules potentially could still be subject to the new £90,000 charge from April 2015.
The consultation on the application of the election for three years appears aimed at those who elect to use the remittance basis on a "one off" occasion in a year in which they anticipate substantial offshore gains or income. However, it seems that many will oppose the inflexibility that will likely ensue.
The above changes seem to be part of the erosion of benefits applicable to those not domiciled in the UK. Although there are no apparent plans to abolish the domicile system entirely, its use is becoming more limited.
Individuals can benefit from entrepreneurs' relief if they have a 5-percent or more interest in a trading company. This reduces the applicable rate of capital gains tax to 10 percent. In certain joint venture structures, the requisite interest can be achieved indirectly through an interest in a joint venture company that may not, in itself, carry on a trade. The government announced on 18 March 2015 that restrictions will be introduced so that entrepreneurs' relief cannot be claimed by those entering into "contrived structures" in which they do not hold a genuine interest in a trading company. Related proposals will ensure that individuals who make "associated disposals" that also qualify for entrepreneurs' relief make an eligible disposal in a trading company or partnership. Legislation on this has now been published, and it appears to be the case that it is targeted as originally stated.
Duane Morris comment
This may be a legitimate anti-avoidance measure, but it is possible that some legitimate joint venture structures will also be affected. Consideration should be taken in reviewing such structures. A further Alert will follow on this measure.
Venture capital and enterprise investment
Certain changes will be made to the venture capital and enterprise investment schemes. The main ones are a cap of £15 million (£20 million for certain "knowledge intensive" businesses) and the limitation of first investment to companies that are less than 12 years old, unless the investment involves a substantial change in the company's activity.
Duane Morris comment
What may be viewed as the most controversial change is that relating to the age of the investee company. Consideration is likely to be required regarding what involves a "substantial change" and legislation may need to account for it.
Withholding tax exemption on private placements
Measures will be introduced to exempt certain UK source interest from withholding tax.
UK income tax rules currently require deduction of income tax at the basic rate (20 percent) from payments of yearly interest arising in the UK to, among others, overseas residents. There will now be an exemption from the duty to withhold from interest on qualifying private placements. They will need to be unlisted loans issued by a trading company for a minimum three-year period. The minimum and maximum issuance size by a company is likely to be £10m and £30m, respectively.
The relief will require the holders of the loan notes to be qualifying investors unconnected to the issuer. They will be a UK-regulated financial institution, or an equivalent entity authorised outside the UK carrying on substantially similar business. A number of other requirements need to be met to qualify for exemption from the duty to deduct income tax on interest, including anti-avoidance rules.
Duane Morris comment
There are stiff requirements to qualify for this new exemption from the duty to deduct income tax on UK source interest. However, it may serve to provide a useful alternative from traditional bank sources of funding.
Annual Tax on Enveloped Dwellings (ATED) – As anticipated, new, higher rates of ATED, applicable to UK residential property owned by certain non-resident, non-natural persons have been announced. Measures are also underway for the reduction of the value of properties within the scope of ATED to £500,000.
National Insurance Contributions (NICs) – Class 2 NICs will be abolished in the course of the next parliament and Class 4 NICs will be reformed following consultation. These NICs are those applicable to the self-employed.
Employee benefits and exemptions – The government has published draft legislation to introduce a new tax exemption for non-taxable expenses paid or reimbursed to an employee and to abolish the current dispensation regime. The exemption will not apply if the expenses are paid or reimbursed as part of a salary sacrifice arrangement. These measures will take effect from 6 April 2016.
Employment – Following the report of the Office of Tax Simplification (OTS) earlier this month, the government has pledged to review the recommendations in the report, specifically those relating to a statutory definition of employment, and respond in the next parliament.
Oil and gas – In response to the challenges faced by the oil and gas industry, the government has announced that Petroleum Revenue Tax (PRT) will be cut from 50 percent to 35 percent to support continued production in older fields. The existing supplementary charge for oil companies will also be cut from 30 percent to 20 percent, backdated to January. Furthermore, an allowance will be introduced for investment in the oil and gas industry.
Personal allowance, savings and pensions – The individual personal income tax allowance will rise to £10,800 in the 2016–2017 tax year and to £11,000 in the 2017–2018 tax year. Furthermore, a new allowance of £1,000 on savings income will be introduced for basic rate taxpayers. However, the lifetime allowance for pension contributions will be reduced from £1.25 million to £1 million from 2016.
Anti-avoidance – As anticipated, various anti-avoidance measures were announced. They include a review of certain aspects of the Disclosure of Tax Avoidance Schemes (DOTAS) regime, the introduction of special penalties under the General Anti-Abuse Rule (GAAR) and certain measures against "serial avoiders."
Partnerships – The OTS report in January 2015 contained a number of recommendations related to partnerships, and the government has pledged to implement 70 percent of the proposals. In addition, legislation has been published clarifying the application of the business use of a partner's home.
Simplified filing – The government has announced a review of the self-assessment system to reduce the burden on small business and individuals by way of introducing digital tax accounts.