The Chancellor has today delivered his Budget through which he aims to set the course of the UK's recovery from the COVID-19 pandemic. The Government will renew, for what it hopes to be the last time, the various support packages offered to the economy in response to the pandemic. The Chancellor has set out his intention to fund that support through freezing various tax allowances, imposing tax rises in real terms, and increasing the rate of corporation tax to 25% from 1 April 2023. In the interim, the Chancellor hopes to fuel an investment boom by business with the introduction of a 130% "super-deduction" for capital investment, and a resurgence in the hospitality sector with reduced rates of VAT applying until 31 March 2022.
- Corporation tax increase: the corporation tax rate will increase to 25% from 1 April 2023; the rate of DPT will be increased to 31% in unison.
- Small profits rate and taper relief: a small profits rate will be re-introduced alongside taper relief. Companies with profits of less than GBP 50,000 will continue to be subject to corporation tax at a rate of 19% from 1 April 2023. Companies with profits between GBP 50,000 and GBP 250,000 will be subject to a rate between 19% and 25% under the similarly reintroduced taper relief mechanism.
- Banking company surcharge to be reviewed: the 8% surcharge on banking companies is to be reviewed in light of the increase in corporation tax. While this is welcome news, the outcome of that review may not be delivered in time to avoid deferred tax being recognised by banks at a rate of 33%, which could have a knock-on effect on CET1 positions.
- Potential GBP 4 million three-year loss carryback: losses of up to GBP 4 million incurred during the pandemic will be available for carryback for a three-year period, providing immediate relief to businesses profitable in the years prior to the pandemic. The relief will be available to individuals, partnerships, and companies, applying a GBP 2 million cap for each of 2020 to 2021 and 2021 to 2022 tax years.
- Enhanced reliefs for capital investment: a temporary "super deduction" regime will be available for expenditure qualifying for capital allowances incurred from 1 April 2021 to 31 March 2023. Expenditure qualifying for allowances at the main rate of 18% will be eligible for a deduction of 130%, effectively providing a subsidy of 5.7% that equalises relief now versus relief under the 25% rate of corporation tax in 2023. Assets qualifying for relief at the special rate of 6% will be eligible for a 50% first-year write-down. The Annual Investment Allowance will continue to be GBP 1 million until 31 December 2021.
- Repeal of the Interest & Royalties Directive: in a further indication of the UK's appetite to depart from previous EU constraints, its implementation of the EU interest and royalties directive is to be repealed from 1 June 2021. Payments from the UK to EU residents from this date will need to rely on the relevant treaty, or identify another relevant exemption under UK domestic law.
- Amendments to hybrid mismatch legislation: as announced in November 2020, changes will be made to the UK's hybrid mismatch legislation to ensure it continues to operate as intended. While there are a number of welcome changes proposed, as we discussed here, many do not go far enough to prevent taxpayers from suffering economic double taxation. Sadly, the literature released today does not suggest these issues will be rectified.
- HMRC information powers - Financial Institution Notices: despite criticism received from the House of Lords on the proposals in 2020, the Government looks set to legislate for a new "Financial Institution Notice" that will allow HMRC to request access to certain information on taxpayers directly from third party financial institutions without first requiring authorisation from the Tribunal, as they are currently required to do.
- Freezing of thresholds: as suggested pre-budget, the Chancellor has opted to freeze thresholds in a number of areas to capture a broader base of taxpayers and deliver a tax rise in real terms. Frozen thresholds include boundaries for income tax, VAT registration, the nil rate band thresholds for Inheritance tax, the Pensions Lifetime allowance, and the annual exempt amount for capital gains.
- Continued VAT boost for hospitality and tourism sectors: the temporarily reduced rate of 5% VAT applied to certain supplies relating to hospitality and tourism will be extended for a further six months, until 30 September 2021. To ease the re-introduction of the standard rate of VAT on such supplies, an interim reduced rate of 12.5% VAT will apply until 31 March 2022, with the standard rate of VAT applying from 1 April 2022.
- SDLT cut to be extended: the increase in the Stamp Duty Land Tax nil rate band threshold to GBP 500,000 will be extended for a further three months until 30 June. To ease the transition back to normal rates of SDLT, the nil rate band will be lowered to GBP 250,000 from 1 July until 30 September, before returning to GBP 125,000 from 1 October.
- What has not changed? The run-up to today's Budget saw a flurry of speculation, briefing, and counter briefing on potential changes to the tax system. A number of proposals (some relatively radical) have not made it into today's Budget: changes to CGT rates, changes to pension tax relief, an online sales tax, an excess profits tax, a wealth tax, etc. However, the Government has moved to ensure that policies that will be legislated for the future are announced outside of the Budget - this year that will be on 23 March. Therefore, there may yet be more radical reforms on the way, so watch this space.
In more detail
Corporation tax rate rises to 25% from 1 April 2023
As indicated in pre-Budget briefings, the rate of corporation tax will rise to 25%, taking effect from 1 April 2023. Despite initial indications of a staggered approach throughout the course of this Parliament, a cliff edge increase of 6% will be applied from 1 April 2023.
The rationale for the timing is that the economy should resemble something closer to normality by 1 April 2023, and so for profitable businesses, paying an additional rate of tax will come after the recovery has taken hold. What this ignores is that due to the UK's corporate loss relief restriction, businesses will be forced to pay tax immediately once they return to profit during 2021 to 2022, and this will be regardless of whether the losses they incurred during 2020 are outsized to those profits (as we discussed here).
Reintroduction of the small companies rate and taper relief
The Chancellor has delivered a boost to small businesses (and tax exam setters) with the reintroduction of a lower rate of corporation tax for small businesses alongside taper relief to avoid a cliff-edge for small businesses with profits in excess of the small profits rate.
From 1 April 2023, companies with profits of GBP 50,000 or less will avoid the increase in the general corporation tax rate, continuing to be taxed at 19%. Companies with profits between GBP 50,000 and GBP 250,000 will be subject to tapering relief that delivers a tax rate somewhere between 19% and 25%. Companies with profits in excess of GBP 250,000 will be subject to the general rate of corporation tax of 25%.
Increase in DPT rate to 31%
To ensure Diverted Profits Tax (DPT) remains a punitive tax, the rate of DPT will be increased from 25% to 31% from 1 April 2023.
Review of the surcharge on banking companies and potential amendments to "banking company" definition
Conversely, the Chancellor has indicated that he intends to review the surcharge on banking companies to ensure the UK banking sector remains competitive. The 8% surcharge introduced with effect from 1 January 2016 would lead to a tax rate of 33% on the profits of banking companies from 1 April 2023 when the general rate of corporation tax rises to 25%.
The DPT rate of 33% applied to banking companies will also presumably be reviewed as part of that process.
The timing of any outcome of that review will be of interest to banks in measuring deferred tax assets, particularly those that have headroom within the 10% of CET1 capital allowed for deferred tax assets arising in respect of temporary differences. Assuming the increase in the corporation tax rate to 25% is included within Finance Bill 2021, that should be substantively enacted by Q2, or Q3 at the latest. In the likely event that legislative action on the 8% surcharge is not delivered before then, banks may therefore need to recognise deferred tax on balances expecting to unwind post 1 April 2023 at a rate of 33%.
Alongside this review is an intention to give the Treasury power to legislate to amend the definition of a "banking company" for the purposes of the surcharge, the bank loss restriction, and the bank levy rules.
Current definitions of a banking company draw heavily on definitions provided for under the Investment Firms Prudential Regime, which is currently under consultation by the FCA. Corresponding updates to tax legislation will therefore be necessary to account for any changes to definitional terms applied by the new regime.
Potential carryback of GBP 4 million of losses over a three-year period
A further boost to small business will be the ability to carry back up to GBP 2 million of losses incurred during the 2020 to 2021 and 2021 to 2022 tax years up to a three-year period. The GBP 2 million cap applies to each tax year therefore a potential GBP 4 million could be carried back under the measure.
Current rules allow the carryback of losses for a period of 12 months. The extension of carryback mechanism for a further 24 month period allows businesses that were profitable at some point during the 36 months prior to the pandemic taking hold, to receive immediate relief for up to GBP 4 million of losses incurred during the pandemic.
The relief will be available to companies, partnerships, and individuals alike. There appears to be no limitation on large companies making carryback claims, but the benefit will likely be immaterial relative to the multi-million-pound losses incurred as a result of the pandemic (which as we have noted will be subject to the 50% restriction under the UK's loss limitation rules when they return to profit).
Capital allowances super deduction of 130% for two years, plus AIA continues at GBP 1 million until 31 December 2021
In a surprise announcement designed to encourage businesses to invest now rather than later, the Chancellor has revealed a "super deduction" scheme.
The temporary measure will operate like the annual investment allowance but "on steroids" by allowing businesses to deduct 130% of the expenditure incurred that qualifies for capital allowances at the main rate of 18% (with no apparent limit on the quantum of qualifying expenditure). Effectively, this provides a government subsidy of 5.7% (being an additional 30% deduction at a corporation tax rate of 19%). This is presumably designed to counter any reticence there may be to invest in capital assets for fear of missing enhanced relief when the rate of corporation tax increases to 25% from 1 April 2023 onwards. The draft legislation released today does not appear to limit relief for the purposes of the surcharge on banking companies, so banks may be able to obtain a subsidy of 7.8%, assuming the surcharge is not retroactively repealed later this year or next.
For assets that qualify for the special rate allowances at 6%, there will be a first-year allowance providing 50% relief (i.e., half the value of the asset written off immediately, with the remainder subject to the 6% rate).
For expenditure incurred on plant and machinery used in a ring-fence trade in the oil and gas sector, assets ordinarily qualifying for allowances at 18% will be subject to a first-year allowance of 100% (i.e., immediate expensing, but no enhanced deduction), while qualifying special rate expenditure will also be subject to a 50% first-year allowance.
The temporary regime will have effect for expenditure incurred from 1 April 2021 to 31 March 2023, and will exclude contracts entered into prior to 3 March 2021 (even where the expenditure is incurred on or after 1 April 2021). As usual, relief will be subject to various anti-avoidance provisions to ensure it is provided in line with the original intention of the regime.
Somewhat overshadowed by the super deduction announcement, the annual investment allowance, which allows immediate expensing of qualifying expenditure, will continue to be maintained at GBP 1 million until 31 December 2021. This will be of use to taxpayers that had committed contractually to capital expenditure prior to today's announcement, or have significant special rate expenditure.
Repeal of the UK's implementation of the Interest & Royalties directive
The Chancellor omitted to mention in his speech a bold but not unexpected development in the UK's tax strategy following Brexit taking full effect - the UK's implementation of the Interest & Royalties Directive is to be repealed with effect from 1 June 2021. Relief from withholding tax on payments of interest and royalties from the UK to EU resident companies continued to be available from 1 January this year as the UK's implementation of the directive formed part of the body of retained EU law 'snapshotted' into UK law following exit from the EU. The Government is now exercising Parliament's sovereign right to depart from EU law following the end of the Transition Period by putting payments of interest and royalties to EU-based recipients on the same terms as payments to recipients in the rest of the world.
No change is necessary in respect of the Parent-Subsidiary Directive as the UK does not impose a withholding tax on dividends.
Amendments to hybrid mismatch legislation
During 2020 the Government consulted on certain aspects of how the UK's hybrid mismatch rules are operating in practice following their introduction from 1 January 2017. That consultation ended up drawing comments on a broader range of issues that taxpayers are facing due to the complex mechanistic nature of the legislation, with a number of taxpayers facing economic double taxation as a result.
A response to that consultation was released in November 2020, alongside draft legislation for certain aspects of the proposed changes. A number of those changes are to be applied retroactively from 1 January 2017, correcting the way rules operated from their inception. As we commented at the time (see here), while those changes are welcome, in a number of instances they do not go far enough to correct the economic double taxation that many taxpayers, particularly US in-bound groups, continue to face.
The literature released by the Government on Budget day does not suggest their position has radically altered since November. Curiously, there is an omission of a previous intention to ensure LLCs that are treated as transparent by their members are treated as akin to partnerships under the rules, thereby ensuring no counteraction where income is taxed at the level of its members. The Finance Bill is expected to be published on 11 March; that will provide a clearer picture on how the rules will operate going forward.
HMRC information powers - Financial Institution Notices
The rules governing HMRC's information powers are to be extended to allow HMRC to compel financial institutions to either produce certain information and documents or face financial penalties for non-compliance. With approval from one of its authorised officers, HMRC may issue a Financial Institution Notice (FIN) seeking information or documents reasonably required for the purposes of checking the tax position of a known taxpayer and for the purpose of collecting a tax debt. Further, a FIN may be issued to enable HMRC to gather requisite information to comply with international exchange of information requests, where the foreign tax authority making the request has exhausted all reasonable domestic methods of obtaining the information and can demonstrate that the information is relevant to the administration and collection of tax. HMRC can, with the approval of the Tribunal, withhold explanation as to why the information is needed or prevent a third party financial institution from revealing the existence of a FIN to the relevant taxpayer. Consistent with HMRC's existing information powers, HMRC cannot compel production of documents covered by legal professional privilege.
The changes are to be introduced in almost identical form to those proposed in July 2020, despite robust criticism from the House of Lords Economic Affairs Finance Bill Sub-Committee. In its report published on 19 December 2020, the Committee concluded that the proposed powers were poorly targeted and lacked safeguards (such as consent from a Tribunal to issue the notice) which would prevent their arbitrary use. Moreover, the Committee found that the need for the increased powers afforded by a FIN were not supported by the evidence provided to it. The updated proposal does not expressly address the Committee's concerns any further than as set out in the prior July 2020 draft.
The measure will also correct a drafting error in Schedule 36 Finance Act 2008 governing increased daily penalties for failure to comply with an information notice. The existing legislation created confusion as to the process by which increased daily penalties are approved and assessed. The amendments make it clear that it is for the Tribunal to determine the maximum amount of an increased daily penalty and the date from which it may be applied, and for HMRC to assess and notify the taxpayer of any such penalties.
Freezing of thresholds
The Chancellor remains committed to maintaining the promise made in the 2019 Conservative arty manifesto not to raise the rates of income-tax, NIC, or VAT, despite the dramatic change to the economy that has occurred since the 2019 election. With no room for manoeuvre on rates, the Chancellor has instead frozen various thresholds to deliver a tax rise in real terms.
Income tax thresholds will be maintained at 2020 to 2021 levels for the 2021 to 2022 tax year, with a small increase of GBP 270 in the personal allowance to GBP 12,570 (and a corresponding increase in the higher rate threshold to GBP 50,270) for the 2022 to 2023 tax year, which will be maintained until 2025 to 2026.
For inheritance tax, the nil-rate band and residence nil-rate band thresholds of GBP 325,000 and GBP 175,000 respectively will be maintained at the 2020 to 2021 level until 2025 to 2026, along with the residence nil-rate band taper at GBP 2 million.
The pensions lifetime allowance will also be maintained at GBP 1,073,100 until 2025 to 2026, departing from the Government's previous intention to increase the lifetime allowance in line with the Consumer Price Index.
The annual exempt amount for capital gains tax will be maintained at GBP 12,300 for individuals and GBP 6,150 for trusts until 2025 to 2026, which may be seen as a positive by taxpayers following the Office of Tax Simplification's recommendation that the amount be reduced if its operation is designed to exempt de-minims gains.
VAT registration threshold remains consistent
Continuing the theme of maintaining current thresholds to capture a broader range of taxpayers in real terms, the Chancellor is maintaining the VAT registration and deregistration thresholds at their current level until 31 March 2024. The current VAT registration threshold is GBP 85,000 of taxable turnover, and the VAT deregistration threshold is GBP 83,000 of taxable turnover. The Chancellor sold the freeze as a means of providing certainty to businesses, though also pointed out that the UK threshold is significantly higher than in other jurisdictions. There has been much discussion about the distortive impact this can have, with many businesses operating at just below the threshold in order not to have to register. With the threshold frozen at this level for the medium term, this issue will continue.
VAT - continued support to hospitality and tourism sector
In order to support businesses, and allow them to take greater advantage of a summer potentially free of restrictions on social activities, the temporarily reduced rate of 5% VAT on certain supplies relating to hospitality and tourism will be extended for a further six months, until 30 September 2021. To ease the re-introduction of the standard rate of VAT on such supplies, an interim reduced rate of 12.5% VAT until 31 March 2022, with the standard rate of VAT applying from 1 April 2022.
SDLT - continued support to the housing market
The boost to activity in the housing market delivered by the increase in the Stamp Duty Land Tax (SDLT) nil rate band threshold to GBP 500,000 during summer 2020 looks set to continue, with the initial deadline of 31 March 2021 extended for three months until 30 June. To ease the transition back to normal rates of SDLT, the nil rate band will be lowered to GBP 250,000 from 1 July until 30 September, before returning to GBP 125,000 from 1 October.
What has not changed?
Lastly, given the unprecedented nature of the times we are in, where there is cause to re-examine a great many things, not least how the broader tax system works, an important aspect of today's announcements is what has not changed.
There were a number of proposals circulating prior to the Budget, some radical in their nature, which have not made it into today's announcement. These include:
- An online sales tax;
- An excess profits tax;
- Changes to the rate of capital gains tax (possibly to equalise with income tax rates);
- Changes the amount of tax relief afforded to pension contributions;
- A wealth tax; and
- Even possibly a solidarity surcharge to fund the NHS.
None of these features in today's Budget. Indeed, viewed in the round, today's Budget could be seen as quite conservative. The support that has been provided to the economy during the pandemic continues for the time being, and that is to be funded by an increase in corporation tax alongside the freezing of various thresholds to impose an inflation-induced tax rise.
Whether this is all the Chancellor intends to do remains to be seen. The Government has moved to ensure that changes to the tax system which do not have an immediate fiscal effect are announced outside of the Budget on 23 March. We may see more radical proposals surface in the form of consultation documents on that date, so watch this space.