The new tax announcements are designed to improve productivity and correct imbalances in the tax system.
On 8 July, UK Chancellor of the Exchequer George Osborne made a number of announcements relating to the tax system in the UK, including a number of changes that were not previously announced or expected.
Reduction in UK Corporation Tax Rate
The government has announced a reduction in the main rate of corporation tax of up to 2% by 1 April 2020. In keeping with this aim, the main rate for the current year will remain unchanged at 20%, with the rate dropping to 19% starting 1 April 2017 and to 18% starting 1 April 2020. This is designed to support a competitive UK tax system and to encourage growth and investment. It will result in the UK having the lowest rate of corporate income tax of the G-20 (the group of finance ministers and central bank governors from 20 major economies).
Tax Treatment of Carried Interest and Asset Management/Performance Fees
It is no surprise to many that the government continues to focus on the investment funds industry. The news with respect to carried interest is mixed. On one hand, some may be comforted that true carried interest should continue to benefit from capital gains tax treatment, which results in considerably lower tax rates (up to 28%) than income tax treatment would (up to 45%, plus national insurance contributions in some cases). On the other hand, there is clearly some focus on precisely which fees should be treated as carried interest.
One technical change is described as closing a “loophole”, although the tax treatment in question directly follows HM Revenue & Customs’ (HMRC’s) own published practice in this regard. This relates to what is known as “base cost shift”, which effectively enables carried interest holders to pay capital gains tax on an amount of gain that is actually lower than their economic gain because they have part of the base cost of other investors attributed to them despite not contributing to such amounts. The changes, to take effect for carried interest starting 8 July, will ensure that carried interest holders do not benefit from base cost shift but instead pay capital gains tax on their actual gain, taking account only of consideration actually provided by that individual for acquiring the carried interest. The draft legislation does have an unsatisfactory result, in that it does not seem to override the base cost shift entirely as it applies to carried interest, so other investors will still suffer a reduction in their base cost; in all likelihood, most investors in private investment funds will not be subject to UK tax, so this may have a limited effect in practice.
In addition, the government has announced a consultation on rewards paid to asset managers, which will focus on the types of rewards that will be able to continue to be treated as carried interest and benefit from capital gains tax treatment. This is part of the continued focus on perceived abuse and artificial structuring by asset managers. The consultation has a number of focuses, including both the way rewards are paid and the nature of a fund (and its underlying assets) in respect of which carried interest is earned. It appears that one outcome may be some sort of safe harbour of fee structures and fund/asset types that benefit from capital gains treatment, with any other returns being taxed as income. This could potentially lead to adverse tax consequences for asset managers of innovative or hybrid funds for whom performance fee arrangements may fall outside a narrowly defined safe harbour (although the investors in such funds should be unaffected), and asset managers will be interested to follow (and perhaps contribute to) this consultation. This work is a continuation of the rules relating to disguised management fees (see our LawFlash Tax Measures in the 2014 UK Autumn Statement), which were introduced in April this year and aim to ensure that fees that are not properly treated as carried interest are taxable as income.
The government announced that it will also publish a consultation on technical changes to limited partnership legislation, which is aimed to enable private equity and venture capital investment funds to use partnership structures more effectively. Part of the background to this is that there are few specific legislative provisions in the UK tax code that address limited partnerships and their members, which can make their use uncertain and complicated. Again, the progress of this consultation will be interesting to follow.
Introduction of Bank Surcharge
As a reaction to the recoverability and return to profitability of UK banks, starting 1 January 2016, banks will face a new surcharge of 8% on their profits in addition to their usual corporation tax liability. The profits for these purposes will be calculated in the same way as for corporation tax but will deny the banking companies access to certain reliefs, including group relief (which is, broadly speaking, the way that the UK allows consolidation for corporate groups). An annual allowance of £25 million will be available to banking groups and single-company banks for offset against surcharge profits. This surcharge will operate alongside the existing bank levy (a balance sheet–based tax), which is gradually being reduced to 0.09% over the next six calendar years. It is expected that the surcharge will offset the reductions in the bank levy.
Other Changes to the Corporate Tax Regime
Changes to corporation tax instalment payments regime: Currently, large companies in the UK pay tax in instalments, but they do not start paying tax until the seventh month of their accounting period. This means that large UK companies pay tax later than in most other G7 countries (Canada, France, Germany, Italy, Japan, and the United States) and later than most individuals. This time lag creates a cost to the exchequer. To rectify this, the government will bring forward payment dates for the largest UK companies (those with profits in excess of £20 million) so that payments are made closer to the point when a company earns a profit. Starting April 2017, these companies will be required to make corporation tax payments in the third, sixth, ninth, and twelfth months of their accounting period.
Reform of loan relationship rules: The government has been reviewing the rules relating to the tax treatment of corporate debt (known as loan relationships) and derivative contracts to take account of developments in accounting and in business practice since their original introduction in 1996. It intends to introduce additional changes to these rules, to apply from the introduction of the 2015 Finance Bill, a draft of which should be released next week. These changes include tax relief for credits arising to financially distressed companies as a result of debts being released as part of a debt restructuring and a new general antiavoidance rule to counter arrangements entered into with a main purpose of obtaining a tax advantage under the loan relationships or derivative contracts rules (which could potentially apply to a wide range of arrangements). These measures are part of a wider package of reforms to the tax treatment of corporate debt and derivatives that were originally proposed in 2013. The guidance that HMRC will produce in due course in applying those rules is likely to be important in determining the precise scope of the changes. The other reforms will take effect for accounting periods beginning on or after 1 January 2016.
Removal of amortisation on purchased goodwill: Currently, UK companies are given tax relief for amortisation on the cost of purchased goodwill and intangibles, either on an accounts basis or, if a company so elects, on a 4% reduced balance basis. This relief applies where a company acquires an existing business directly, but not where it acquires shares in a company that carries on a business. For accounting periods beginning on or after 8 July 2015, this relief will no longer be available, as it was considered to distort commercial practices and lead to manipulation and avoidance.
UK Continental Shelf (UKCS) Investment and Cluster Area Allowances
The government will broaden the application of the basin-wide investment and cluster area allowances to support investment on the UKCS. These recently introduced allowances permit companies that operate within the UKCS to reduce the level of profit that is subject to the supplementary charge applicable to oil and gas ring fence profits. The definition of investment expenditure will be extended to include certain discretionary noncapital expenditure and long-term leasing of production units.
Withholding Tax on Peer-to-Peer (P2P) Loans
As it previously announced, the government will consult on how withholding tax applies to P2P loans, which any resulting changes will take effect starting April 2017. This reflects the growing P2P loan market in the UK and internationally. It remains to be seen what changes, if any, will be introduced to the withholding tax rules.
Personal and Employment Taxes
The budget contains a number of measures that affect personal taxation. In particular, the following are of interest:
- The government confirmed its announcement earlier this year that it will introduce legislation for the duration of the current Parliament to fix the rates of income tax, Class 1 national insurance contributions (NICs), and value-added tax (VAT), known as the “tax lock”, for the remainder of the current Parliament (which should be until May 2020). This would mean that the income tax rates will be fixed at 20%, 40%, and 45% for basic, higher, and additional rate taxpayers, respectively. In addition, the standard and reduced rates of VAT will not be increased from the current 20% and 5%, respectively. There will also be no increases in the rates of employers’ and employees’ Class 1 NICs.
- It has also been announced that the long-standing dividend tax credit mechanism that currently applies to individuals’ dividend income will be replaced with a dividend tax allowance and new dividend tax rates will be introduced. Under current rules, individuals who receive dividends are generally taxed at the rates of 10%, 32%, and 37.5% (for basic rate, higher rate, and additional rate taxpayers, respectively, depending on their total income). However, the effective rate is reduced to 0%, 25%, and 30.56% as a result of a deemed credit allowable to individuals on the receipt of dividends. The tax-free annual allowance will be set at £5,000, effective starting April 2016. Dividend income received by the individuals from April 2016 exceeding this new allowance will be taxed at new rates of 7.5%, 32.55%, and 38.1% for basic rate, higher rate, and additional rate taxpayers, respectively, but will no longer carry a credit. It is expected that the new rules will be easier to apply in practice. Although investors with smaller portfolios should not be significantly affected by such rules, individuals who are subject to the additional rate of income tax (i.e., those who already have more than £150,000 of income) and receive substantial amounts of dividend income (approximately £25,000 or more) are expected to have a higher dividend tax burden, despite the introduction of a tax-free allowance. The changes are designed in part to discourage use of dividends to incentivise employees in lieu of salary to minimise their tax liabilities.
- The government also announced an overhaul of the non-UK domicile rules that have to date been benefiting long-term UK resident individuals who are not domiciled in the UK by permitting such individuals to ring-fence their non-UK income and gains with the view to minimise UK taxation. The purpose of this reform is to ensure that long-term UK residents who are not domiciled in the UK make as similar tax contributions to the UK as possible compared to the UK domiciled individuals who are taxed on a worldwide basis. A major change to the rules will be to deny the availability of this relief to non-UK domiciled individuals who have been resident in the UK for at least 15 out of the last 20 years. This rule is expected to be effective starting 6 April 2017. Specific provisions will be made for individuals returning to the UK after a temporary period of nonresidence. The government will also consult on wider reforms in this area, including on how these new changes should interact with the other tax regimes.