Introduction
Tax treatment of royalties
Corporate tax and digital economy
Environmental tax
Business rates
VAT
Introduction
On November 22 2017 Chancellor of the Exchequer Philip Hammond delivered the Autumn 2017 Budget, the first budget in the new annual tax policy-making cycle.
For observers interested in UK politics, this budget was hotly anticipated, partly because the chancellor's personal political reputation was at stake following the botched Spring Budget 2017, but also because the government's credibility was under the spotlight following a string of damaging events, economic headwinds and infighting over the handling of Brexit.
The gloomy economic growth forecast grabbed the headlines, but the consensus seems to be that the chancellor and the government managed to navigate a safe course through choppy waters. Although there were no radical policy changes, some changes, particularly concerning tax and business rates, will affect the UK franchise business sector.
New liability for income tax
Unsurprisingly, following the publication of the so-called 'Paradise Papers', the government reasserted its commitment to tackling tax evasion and avoidance, including offshore structures, by announcing a number of measures aimed at companies seeking to minimise their tax bill. One such measure was the publication on December 1 2017 of a consultation on expanding the circumstances in which a royalty payment to persons not resident in the United Kingdom has a liability to income tax.
Expansion of withholding tax to royalties
The government plans to extend withholding tax to royalty payments and payments for certain other rights made to low or no-tax jurisdictions in connection with sales to UK customers, regardless of where the payer is located. While the budget itself contains little detail of the government's proposals, it is likely that they will significantly widen the scope of the withholding obligation. Under the existing rules, the deduction of UK tax at source (at the basic rate of 20% at present) applies to royalty payments in respect of intellectual property where the person entitled to the payments usually resides outside the United Kingdom and the obligation on non-UK persons applies only where that person carries on business through a UK permanent establishment. The government intends to introduce draft legislation setting out the details of its proposals in the Finance Act 2018 and 2019 and for the changes to come into effect from April 2019.
Why is this relevant to franchising?
Franchisees often pay an ongoing percentage of their turnover to their franchisor. While these payments may be described in a variety of ways (eg, a management or service fee or a royalty), in reality at least some portion of that payment relates to the ongoing right to use intellectual property relating to the franchise business.
For UK franchisees paying royalties to foreign franchisors located in low or no-tax jurisdictions, these changes may affect their commercial model. The same applies at an intra-company level – a typical structure for a franchising business will separate the franchisor from the IP holding company and, consequently, a franchisor may pay part of the revenue that it receives from franchisees as a royalty back to its IP holding company. For large domestic franchise systems or multinational franchise systems, the IP holding company may be located in a low or no-tax jurisdiction.
Corporate tax and digital economy
In response to the increasingly widespread perception that multinationals do not pay a fair amount of tax, the government published a position paper alongside the budget, setting out its proposals for ensuring that UK corporation tax paid by the tech sector is proportionate to the value that it generates in the UK market, specifically from the participation of UK users. The government believes that changes should be made primarily at an international level and has put forward some broad proposals which it would like to be considered (along with some suggested unilateral actions) in the Organisation for Economic Cooperation and Development's interim report on the digital economy to be delivered in mid-2018.
Why is this relevant to franchising?
For UK franchise systems which are competing with tech or online multinationals (eg, in the retail and food and beverage sectors), this announcement is welcome news as it signals that the government understands that there may be an uneven playing field at present which disadvantages UK companies. If this translates into effective policy, a levelling of the playing field may also have the indirect effect of boosting the use of the franchising model within sections of the gig economy.
Reducing single-use plastic waste
The government has announced that it will seek views in 2018 on how the tax system or charges could reduce the amount of single-use plastic waste. This proposal aims to build on the success of the existing £0.05 plastic carrier bag charge, which has reduced the use of plastic bags by 80% in the past two years. It also follows the October 2017 launch of an enquiry into regulatory or voluntary measures to reduce littering and improve the recycling of drinks containers.
Why is this relevant to franchising?
This particular review is likely to have a significant effect on businesses in the retail and food and beverage sectors, many of which use the franchise model. The government will seek views on reducing single-use plastic waste through the tax system and charges. Disposable plastics like coffee cups and polystyrene takeaway boxes damage the environment and are an example of increasing regulatory costs to businesses which will need to be factored into business plans and consumer pricing.
A planned cut to business rate rises in England has been brought forward by two years and will take effect from April 2018. In addition, the government has announced that business rates in England will rise according to the Consumer Price Index (CPI). Business rates traditionally rise according to the Retail Price Index, which is a different way of measuring inflation that tends to be higher than the CPI. Further, business rate revaluations will take place every three years, rather than every five years, starting after the next revaluation due in 2022.
Why is this relevant to franchising?
This is good news for premises-based franchised businesses following the steep increases in business rates which took effect earlier in 2017. However, some commentators have complained that it is merely another short-term relief measure that will do little more than add complexity to an already complex system and is likely to lead to higher rates in the long term, as revaluations will happen every three years rather than five.
The government has announced that it will not change the value added tax (VAT) registration and deregistration thresholds for two years from April 1 2018 while it consults on the design of the VAT registration threshold. Since April 1 2017, the registration threshold has been set at a taxable turnover of £85,000 and the deregistration threshold has been set at £83,000.
Why is this relevant to franchising?
For low entry-level franchise systems, which typically generate franchisee revenue under the VAT threshold, this announcement will provide some short-term certainty. Nonetheless, franchisees which operate at or close to the VAT threshold and their franchisors will need to pay close attention to these developments, as a tip in the balance could easily be the difference between an economically viable and a loss-making franchisee.
For further information on this topic please contact Gordon Drakes at Fieldfisher by telephone (+44 20 7861 4000) or email ([email protected]). The Fieldfisher website can be accessed at www.fieldfisher.com.