Something of a mixed bag of a Budget from a tax perspective, with further anti-avoidance provisions to add to those announced “early” during the course of March. Generally the headline grabbing tax reductions are balanced by additional charges elsewhere, and the overall story hints at what would be a welcome trend towards simplification rather than increasing complexity. The cut in the standard rate of corporation tax to 28%may grab headlines and give UK plc positive PR with potential inward investors, but the reduction in the general rate is fiscally offset by reductions in the rate of capital allowances (from25%to 20%). Environmental taxes continue to assume ever greater significance
Business Tax ReformPackage
The Budget 2007 announces significant reforms of the business tax system. The package has threemain elements:
- changes in the rate of onshore and small companies’ corporation tax;
- changes to the capital allowances regime governed by Parts 2, 3 and 4 of the Capital Allowances Act 2001; and
- increases in the levels of enhanced deductions available to companies in respect of their qualifying expenditure on research and development.
The stated aimof these reforms is to achieve threemain objectives:
- enhance the international competitiveness of UK based business;
- encourage growth, through investment and innovation; and
- ensure fairness across the tax system.
Themajor elements of the package will apply from2008/09, although certainmeasures will take effect from2007/08.
Corporation TaxMain Rates
With the notable exception of North Sea oil and gas activities, themain rate of corporation tax will be reduced from30%to 28%with effect from1 April 2008. This will affect companies with profits above what is deemed the upper relevantmaximumamount (currently £1.5million) and companies that are part of a group with profits above the upper relevantmaximumamount. Themain rate of corporation tax will remain at 30%for North Sea oil and gas ring fenced activity.
Corporation Tax Small Companies’ Rates
Changes will bemade to the small companies’ rate of corporation tax with effect from1 April 2007. The small companies’ rate for all profits apart fromring fenced profits will become 20%and themarginal small companies’ relief fraction will be adjusted from11/400 to 1/40. The small companies’ rate for ring fenced profits will remain at 19% from1 April 2007 and themarginal small companies’ relief fraction will remain at 11/400. The upper and lower limits for the small companies’ rate will remain unchanged so that the lower relevant maximumamount is £300,000 and the upper relevant maximumamount is £1.5million. It is proposed that the small companies’ rate of tax will increase to 21%in 2008/09 and 22%in 2009/10. Allowances (other than property based allowances)
A large number of changes to the capital allowances regime and the research and developments tax credits regime were announced in this year’s Budget. The introduction of these changes are phased over the 2007 and 2008 Finance Bills.We have summarised in this section themain changes, other than the real estate related changes which are dealt with below.
A number ofmeasures and changes have been announced:
- The temporary 50%rate of first-year allowances for small enterprises has been extended for a further year;
- A new annual investment allowance for the first £50,000 of expenditure on plant and machinery in the general pool will be introduced from2008/9, following consultation;
- The rate of writing down allowances for plant and machinery in the general pool will be reduced from25% to 20%, from2008/9;
- The rate of writing down allowances for long life asset expenditure will be increased from6%to 10%, from 2008/9; and
- A payable tax credit for losses resulting fromcapital expenditure on certain designated “green technologies” will be introduced, following consultation, from2008/9.
There were no changes announced to the capital allowance regime applicable to North Sea oil and gas activities.
Research and Development Tax Credits
Schedule 20 Finance Act 2000 provides relief for small and mediumsized companies undertaking qualifying research and development activities. Currently a 50%enhancement of qualifying expenditure can be claimed under the scheme (and this can lead to a payable credit for lossmaking companies).
Under the proposed changes, the enhancement for small and mediumsized companies will be increased to 75%of qualifying expenditure (under Finance Bill 2008).
In addition, the benefit of the enhanced expenditure and payable credits for small andmediumsized companieswill be extended, by Finance Bill 2007, so that it is available to companies with fewer than 500 employees (as opposed to 250, as at present) and which have an annual turnover not exceeding €100million (as opposed to €50million, as at present) and/or who have an annual balance sheet total not exceeding €86million (as opposed to €43million, as at present). This change will take effect froma date to be appointed by Treasury Order, following confirmation that this extension complies with EC state aid approval rules. Finally, the enhancement available to larger companies undertaking qualifying research and development activities (currently 25%) will be increased to 30%(under Finance Bill 2008).
Recognition of Stock Exchange and Definition of “listed for tax purposes”
Legislation will be introduced to allow HMRC to designate as a recognised Stock Exchange for tax purposes any investment exchange designated as a recognised investment exchange (RIE) by the FSA. The power to designate overseas exchanges will not be changed by this measure. Themeasure will also define the term “listed” asmeaning listed by the country’s listing authority and admitted to trading on a regulatedmarket (for EU countries). Elsewhere, it willmean listed on the local equivalent of an official list and admitted to trading on a market which is the local equivalent of a regulatedmarket.
Alternative Finance Arrangements
Legislation will be introduced in the Finance Bill 2007 to provide new rules on the taxation of certain types of investment bonds, known as “sukuk”, which satisfy the Shari’a law prohibition on paying or receiving interest. Sukuk arrangements allow assets to be held for the benefit of investors in certificates issued by a company. The benefits may include the payment of a return that is economically equivalent to interest and redemption of the certificates out of the proceeds fromthe disposal of the assets. These products replicate the economic effect of debt securities on which interest is payable, and the measures are intended to ensure that they are taxed on a par with equivalent conventional securities. Themeasures will have effect for arrangements entered into on or after 6 April 2007 for income tax purposes and 1 April 2007 for corporation tax purposes and in respect of profits and losses or amounts received or paid after those dates in respect of arrangements entered into before that date. Draft legislation containing the proposed provisions has been published to accompany the 2007 Budget.
The new provisions will build on the legislation introduced in the Finance Act 2005 and the Finance Act 2006 which enabled finance arrangements that are structured so that they do not involve the payment or receipt of interest to be taxed in a similarmanner to those involving interest. The new rules will provide that where the arrangementsmeet certain conditions amounts paid by the issuer to the holders of such bonds will be deductible under the tax rules on loan relationships in the hands of the issuer, and taxable as if they were interest where the holder is subject to income tax or under the loan relationship rules where the holder is subject to corporation tax.
A gain on disposal of a bond by a person other than a company will be taxable under capital gains tax rules, except where the bond will be treated under the new rules as a qualifying corporate bond, and will come within the loan relationships rules in the case of a company. Bonds that are convertible into, or exchangeable for, shares will be taxed in the same way as conventional convertible or exchangeable securities.
Arrangements fall within the legislation where a “bond holder” pays a sumofmoney (“capital”) to a “bond issuer”. The arrangementsmust specify the assets that are acquired andmanaged by the bond issuer to generate a return for the bond holder.
For tax purposes the bond holder is not treated as having any legal or beneficial interest in the assets and is not entitled to capital allowances. The bond issuer is also not treated as a trustee, or asmaking payments in a fiduciary or representative capacity.
Finance Act 2005, Section 83, provides for securitisation companies to be taxed on the basis of accounting standards in place before the introduction of the International Accounting Standards (for periods of account ending before 1 January 2008). In essence thiswas a piece of “placeholder” legislation, designed to giveHMRCtime to devise a permanent regime for securitisation companies under the newregime of the International Accounting Standards. Section 84 then provides the enabling power under which regulations can be introduced to establish a permanent regime for securitisation companies (ie, the regime that was introduced by SI 2006/3296, The Taxation of Securitisation Companies Regulations).
The proposal is,with effect fromthe date that FinanceBill 2007 receivesRoyal Assent, that powers be introduced to allowthe pre 1 January 2008 regime to be extended by regulation.We assume that by thisHMRCmean extended in time, although this is not clear fromthematerialswe have to date. In addition, regulation-making power will be introduced allowing the range of securitisations covered by the new permanent securitisation company regime to be extended.
Sale and Repurchase Agreements (“Repos”)
The current legislation at Sections 730A and 737C of the Income and Corporation Taxes Act 1988 is intended to tax repos in accordance with their accounting and economic substance, i.e. as financing transactions. The perception is that these rules have been exploited for tax avoidance purposes.
This systemwill be replaced, after consultation and on an effective date to be determined, with a simpler accountsbased regime under which profits and losses fromrepo transactions will be taken directly fromentries in accounts prepared under GAAP. This will be subject to adjustments that would ordinarily be required under the loan relationships regime.
Provisions Relating to Loss Buying
A number of anti-avoidancemeasures have been introduced in relation to the purchase of losses dealing with:
(i) Lloyd’s corporatemembers;
(ii sale of lessor companies, and
(iii) corporate capital loss and gain buying.
As a result of the tax treatment available to Lloyd’s corporatemembers, it has been possible to purchase a Lloyd’s corporatemember in run-off and to utilise its losses within the purchasing group. The Budget introduces legislation to prevent this.
Sale of Lessor Companies
Provisions introduced last-year relating to the seller of lessor companies aimed to prevent profitable groups from indirectly benefiting fromthe tax reliefs generated by an unrelated, generally loss-making group. However, these provisions were found to have certain flaws. Two changes weremade in the Pre-Budget Report, and yesterday’s Budget introduced a further amendment to tighten the rules relating to changes of control of lessor companies.
The Budget recognises that a loophole relating to Section 343 ICTA had not been fully closed. It was still possible to use Section 343 ICTA to extract leasing trades on a tax neutral basis in situations involving either partnership or consortiumownership of the lessor company. Accordingly, the operation of Section 343 ICTA has now been restricted in relation to leasing trades to situations where essentially the ownership structure of the purchasing company has sufficient correspondence to that of the selling company. These changes have effect fromyesterday.
Corporate Capital Loss and Gain Buying
HMRC have further tightened the rules introduced last year for corporate capital loss and gain buying.
Last year HMRC introduced legislation to prevent acquired losses being set against the acquired gains (and vice versa) where transactions were entered into as part of arrangements where themain purpose or one of themain purposes was such a setting off of reliefs against gains. A loophole in the legislation is being closed. As originally drafted, the legislation only applied to assets directly held by the purchased company. Accordingly, it was relatively straightforward to side-step the legislation by ensuring the offending asset was held by a subsidiary of the purchased company. The relevant change will apply to gains or losses realised fromyesterday onwards.
The legislation also contained a relief to prevent it applying in innocent situations where pre-2005 Pre-Budget Reform losses arose fromde-grouping deemed disposals. The conditions attaching to this have been simplified to ensure that relief is not necessarily lost following the takeover of a group of where the company that incurred the loss is sold or liquidated.
FilmTax Regime: Excluding Non-Cinema Production
The Finance Act 2006 introduced new tax rules for the production of films by companies. All such production activities were subject to the new regime set out in Schedule 4 Finance Act 2006, but certain films intended for theatrical release benefited fromreliefs set out in Schedule 5 Finance Act 2006.
The new rules enable companies to opt out of the entire Finance Act 2006 regime and to be taxed under normal tax principles.
Stamp Duty and Stamp Duty Reserve Tax: Reliefs for Exchange Intermediaries
Provisions will be included in Finance Bill 2007 to bring reliefs fromstamp duty and SDRT for intermediaries on securities exchanges into line with theMarkets in Financial Instruments Directive (MiFID). The effect of these changes will be that transactions in shares that are admitted to trading on a regulatedmarket underMiFID will not need to be reported to thatmarket, and intermediaries will not need to bemembers of thatmarket, for relief to be available. Draft legislation was published in February 2007. These provisions will take effect on 1 November 2007.
Remote Gaming Duty
Finance Act 2007 will contain legislation to introduce a new excise duty on the gaming profits of remote gaming operators at a rate of 15%.
Stamp Duty and Stamp Duty Land Tax: Reconstruction Reliefs
With effect fromthe day after Royal Assent to Finance Bill 2007, a company which holds some of its own shares will be able to claimrelief fromstamp duty and SDLT in respect of certain reconstructions and acquisitions without being obliged to cancel those shares or accept shares in the acquiring company. This will be achieved by providing that a company which owns its own shares will not be a shareholder for the purposes of the overall ownership test.
International Offshore Funds
The offshore funds regime in Chapter V, Part XVII of the Income and Corporation Taxes Act 1988 applies to certain types of open-ended company resident outside the UK and can operate to convert a capital return on a disposal or realisation of an investment in such a company into income for UK taxation purposes (unless, inter alia, the company is certified as a “distributing fund”). In considering whether a company is “open-ended” for this purpose, a test is applied of whether an investor is able to realise their investment in the company within a “reasonable period”. Despite the view held by the FSA that sixmonths would be reasonable in this context, the Government proposes to legislate for a seven year period to apply (with effect for accounting periods beginning on or after 1 January 2007).
This is potentially a very significant change and concerns have already been raised that the general nature of the Budget announcement could imply that even “closed-ended” companies with a scheduled share redemption date within seven years (but no interimright for investors to realise their investment) would be regarded as falling within the offshore funds rules. Further enquiries are beingmade of HMRevenue & Customs and we expect to issue further bulletins to provide further clarification in the near future.
Under existing law, an offshore fund cannot be certified as a “distributing fund” ifmore than 5%, by value, of the assets of the fund consist of interests in other offshore funds. In considering this test, an interest held by that fund in another offshore fund which is, or could be, a distributing fund itself is not considered to be an interest in an offshore fund.With effect for accounting periods beginning on or after 1 January 2007, it will be possible to “look through”more than one “tier” of investee fund to consider whether it should count as an offshore fund, or whether it could itself qualify as a distributing fund.
As announced in HMRC Tax Bulletin 79, a change will be made to the rules governing investment trust status to provide that offshore income gains will be excluded from counting towards the qualifying income test (that the company’s incomemust be derived wholly or mainly from shares or securities).
A minor change will also bemade to the offshore income gains rules to block potential claims for capital losses realised on a relevant disposal to be utilised against certain types of income. Such losses can only be utilised under the normal rules in the Taxation of Chargeable Gains Act 1992.
Treaty Financing Applications
The Government has stated that HMRCmay expedite its procedures for agreeing double taxation relief fromUK tax on loan interest paid to non-residents and extend the circumstances in which UK residents can enter into thin capitalisation agreements. They have stated that a detailed announcement in this regard will bemade later this spring.
Taxation of foreign profits
The Government will issue a consultation document later in the spring which will consider the taxation of foreign dividends received by UK companies and the controlled foreign companies rules.
Property Authorised Investment Funds
Further consultation has been announced into the possibility of applying a regime similar to that now in force for real estate investment trusts (REITs) to authorised investment funds investing in UK property. Broadly, the Government proposes that such funds could, on satisfying similar criteria to a REIT, elect into a regime offering equivalent tax benefits for funds and their investors. Further consultation will be based on the premise that only open-ended investment companies (OEICs) and not, for example, authorised unit trusts, could qualify to join such a regime, and that regulatory obligations to value funds each day would need to be satisfied via an appropriate “pooling”mechanismfor income derived fromproperty, UK corporate dividends and other sources. A technical paper, accompanied by a partial regulatory impact assessment, will be issued during the summer.
Industrial Buildings Allowances (IBAs) and Agricultural Buildings Allowances (ABAs)
IBAs and ABAs are to be phased out over a four-year period. In preparation for their eventual abolition, balancing adjustments and the recalculating of writing-down allowances will be withdrawn in respect of balancing events occurring on or after 21March 2007. The writing down allowance for the new holder of the interest will be based upon the previous owner’s acquisition cost less the amount of allowances he had already claimed before disposal. There are provisions for balancing adjustments and recalculation of writing-down allowances to remain in effect (a) where the balancing event occurs in pursuance of a relevant pre-commencement contract, or (b) in respect of qualifying enterprise zone expenditure.
Integral Fixtures -Writing Down Allowance
From2008-2009 the rate of writing down allowances on certain fixtures integral to a building will be set at 10% (rather than 25%). There will be consultation to determine the precise nature and scope of these provisions.
Business Premises Renovation Allowance
From11 April 2007, people or companieswho own or lease business property that has been vacant for a year ormore in designated disadvantaged areaswill be able to claimfull tax relief on their capital spending on the renovation or conversion of the property in order to bring it back into business use. Certain businesseswill be excluded fromthis provision.
Service Charges and Sinking Funds in the Private Sector - Relief From40%Trust Rate of Tax
This relief will be extended to income arising on service charges and sinking funds held on trust by private sector landlords in respect of United Kingdomproperties. It will apply to income arising on or after 6 April 2007. The relief reduces the amount of tax payable on income arising from such trusts to 20%. Since these funds are commonly held on deposit at banks and the interest is taxed at source, in many cases no further tax will be payable.
Brownfield Land Consultation
The Government has announced a consultation aimed at implementing a recommendation of the 2004 Barker review of Housing Supply and the 2006 Barker Review of Land Use and Planning that tax relief should be used to promote development on brownfield land (as opposed to greenfield land).
The consultation raises the possibility of extending and accelerating the current 150%remediation relief from corporation tax and an associated phased withdrawal of the exemption fromlandfill tax for waste derived from contaminated land that is sent to landfill sites.
The Government aims to set outmore definite proposals at the 2007 Pre-Budget Report. No changes will be introduced before 2008. The closing date for responses is 14 June 2007.
Construction Industry Scheme
Although not a Budget 2007 announcement, the revised Construction Industry Scheme, which applies a tax deduction regime to certain payments fromcontractors to subcontractors under contracts for construction operations, will take effect from6 April 2007.
Stamp Duty Land Tax: Anti-Avoidance Measures
Provisions included in Regulationsmade at the time of the Pre-Budget Report introducing anti-avoidancemeasures in relation to multiple transactions (Section 75A Finance Act 2003) and partnerships are to be incorporated in Finance Bill 2007 to put those provisions onto the statute book.
A number of changes will bemade to the provisions originally included in the Regulations, however, no detail of the nature of those changes is currently available.
In summary, the changes in respect of partnerships altered:
- themanner in which chargeable consideration was calculated on transfers into and out of partnerships;
- the legislation in respect of transfers of partnership interests; and
- the application of the group relief provisions to partnership transactions.
The effect of the changes in respect ofmultiple transactions was to disregardmultiple transactions which would otherwise result in a reduction in the SDLT charge, when compared with a direct transfer of the property, and to replace the actual transactions with a notional land transaction for SDLT purposes, the chargeable consideration for which is the largest amount of consideration given or received by or on behalf of one person in respect of the actual transactions.
Stamp Duty Land Tax: Exchanges of Land Between Connected Persons
Where “connected persons” exchange property, the two land transactions are currently treated as “linked transactions” for SDLT purposes.With effect fromRoyal Assent to Finance Bill 2007, the legislationwill be amended so thatwhere connected persons exchange land, the two land transactions will not be linked. The effect of this is to ensure that the rate at which SDLT is charged is determined by reference to the deemed consideration for each of the two transactions, rather than on the basis of the aggregate consideration.
Stamp Duty Land Tax: Relief for Shared Ownership Trusts
Legislation will be included in Finance Bill 2007 to extend the existing SDLT benefits available to shared ownership leases to shared ownership trusts. Shared ownership trusts have been introduced because shared ownership leases are not feasible for commonholds, but there is an interest in using commonholds to provide affordable housing. The new provisions will have effect in respect of transactions with an effective date which is on or after Royal Assent to Finance Bill 2007.
Stamp Duty Land Tax: Compliance
Provisions will be introduced in Finance Bill 2007 with the effect that payment of SDLT will no longer have to be sent to HMRevenue & Customs with the return, provided that it is paid by the filing date.
Further provisions will be introduced by regulations (which have not yet been published) to allow self-certificates (SDLT60s) to include a declaration by an agent of the purchaser, as an alternative to a declaration by the purchaser, in appropriate cases. This provision will bring self-certificates into line with SDLT returns, for which an agent has been able tomake the declaration since 2004.
Stamp Duty Land Tax: Surplus School Land
Obsolete stamp duty and SDLT reliefs for transfers of surplus school land will be repealed. Instead such transfers will be covered by the existing SDLT relief for statutory reorganisations. These changes will be introduced by Treasury Order and will take effect from25May 2007. The repeals will take effect fromRoyal Assent to Finance Bill 2007.
Stamp Duty Land Tax: Relief for New Zero Carbon Homes
As announced in the Pre-Budget Report 2006, a new relief fromSDLT will be introduced for the first sale of the vast majority of new zero carbon homes. This will have effect from1 October 2007 for five years, expiring on 30 September 2012.
To qualify for relief new homes will have to be certified as exempt. Exemption will be available, broadly, where a home has zero carbon emissions fromall energy use in the home averaged over a year. This will require the home to reach a very high energy efficiency standard and also to be able to provide onsite renewable heat and power. The Government’s Standard Assessment Procedure for the energy rating of dwellings will be used tomeasure whether new homes are zero carbon.
Complete exemption will be available for qualifying homes with a purchase price of up to £500,000.Where the purchase price exceeds £500,000, the SDLT liability will be reduced by £15,000 (equivalent to themaximumsaving available, being 3%of £500,000). The linked transactions rules will bemodified so that each new home which qualifies for the relief and is purchased at the same time will be treated separately, with the effect that themaximum relief of £15,000 is available for each home.
Planning Gain Supplement
The Government has indicated that it is considering responses to the various consultations on the introduction of a planning gain supplement. They have indicated that if after further consideration it continues to be deemed workable and effective it will be introduced but no earlier than 2009.
Empty Property Relief fromBusiness Rates
The duration of this relief will be reduced to threemonths for all properties and sixmonths for industrial and warehouse properties.
Tax Avoidance Using Employee Benefit Trusts
Anti-avoidance provisions in the Finance Act 2003 and the Income Tax (Trading and Other Income) Act 2005 prevent employers frommaking a deduction against their taxable profits to which they are not entitled. Under these provisions, the value of any deduction in respect of any employee benefit contribution is restricted to the amount that is actually paid or transferred to the employee within ninemonths of the end of the relevant accounting period in a formwhich gives rise to an income tax charge and NICs . HMRC perceive that schemes have been developed which attempt to “side-step” these rules by employers declaring a trust over assets which they already control, rather than making a payment to a third party intermediary. The employer subsequentlymakes a tax deduction in respect of the assets on which a trust was declared.
Amendments will bemade to the legislation tomake it clear that such self-declared contributions to employee benefit trusts are within the scope of Finance Act 2003 and ITTOIA anti-avoidance provisions.
Managed Service Companies
Under existing legislation, payments received by individuals providing their services through intermediaries (primarily service companies) are treated as earnings from employment where certain conditions aremet (the so-called “IR 35” provisions, within Chapter 8, Part 2 of the Income Tax (Earnings and Pensions) Act 2003). Broadly, these conditions are that if the intermediary is ignored, the terms under which the individual provides services to the client are such that the individual would be regarded as an employee of the client. Income tax and NICs are calculated after the end of the tax year in which the payments are received by the individual.Whether such provisions aremet is considered on a contract by contract basis.
The existing provisions in ITEPA dealing with intermediary service companies will cease to apply toManaged Service Companies (“MSCs”) and will be replaced withmore stringent conditions.MSCs will be defined in a new Chapter 9, Part 2 ITEPA by reference to certain criteria relating to both the characteristics of the company and of the business of the “MSC provider”. Broadly, anMSC provider will include businesses which are involved in promoting or facilitating the use of companies to provide the services of individuals. Certain exclusions, for example for employment agencies, will be drafted into the definition of anMSC.
All payments received by an individual providing their services through anMSC which are not already treated as employment income will be deemed to be employment income. TheMSC will be required to operate PAYE income tax and Class 1 NICs on all such payments at the time when the individual receives a payment and not after the end of the year, as with the current provisions.
New provisions will also be enacted such that where an MSC incurs a PAYE/NICs debt, and that debt cannot be recovered fromthe company, HMRCmay transfer the debt to specified persons. These will primarily be theMSC’s director and theMSC provider. Subject to certain restrictions, it will also be possible to transfer anMSC’s debt to persons who encourage, facilitate or are otherwise actively involved in individuals’ provision of their services throughMSCs.
These changes will take effect from6 April 2007 in respect of PAYE, froma date to be specified in relation to NICs, and from6 August 2007 in relation to the transfer of debt provisions.
More generally, it has been indicated that the level and extent to which labour income is extracted in dividends will continue to bemonitored.
Oil and Gas – North Sea
No changes were announced in respect of the taxation of North Sea oil and gas ring fence activities. In particular, the main rate of corporation tax remains at 30%for North Sea oil and gas ring fence activities (or 19%for “small” companies). This contrasts with the decrease announced in the “on-shore” corporation tax rate from30%to 28% and the increase in the “on-shore” small companies rate from19%to 22%over the next three years). In addition there were no changes to the capital allowances regime applicable to North Sea oil and gas ring fence activities.
Registration and Deregistration Thresholds
With effect from1 April 2007, the annual taxable turnover threshold, which determines whether an entitymust be registered for VAT, will increase from£61,000 to £64,000. The equivalent threshold that determines when an entity may apply for deregistration will increase from£59,000 to £62,000.
VAT Fuel Scale Charges
Where fuel is supplied by a business to an individual for use in “privatemotoring” then the business is required to account for VAT on that supply. The amount of VAT which must be accounted for is determined by reference to “scale charges” which are intended to represent the VAT-inclusive value of the fuel in respect of any one vehicle. Under the current rules, the amount of the scale charge depends upon the engine size of the relevant vehicle. For prescribed accounting periods beginning on or after 1 May 2007, the amount of any fuel scale charge will depend upon the CO2 emissions of the relevant vehicle (the lower the CO2 band, the smaller the VAT fuel scale charge).
Use of Land and Buildings (or other assets) Partly for Non-business Purposes
The Government announced the followingmeasures in relation to the use of assets for non-business purposes:
Measure 1 – legislation introduced in 2003 prevented businesses which acquired an asset to be used partly for business purposes fromallocating the asset wholly to business purposes and thereby recovering all the VAT charged upfront and thereafter accounting for VAT on the non-business use in each VAT return period, calculated by spreading the capital cost of the asset over an “economic life” andmultiplying the cost attributed to the VAT return period by the proportion of non-business use in that period (referred to as “Lennartz” accounting). Following an ECJ decision, HMRC will now repeal this legislation so that this formof accountingmay now be used by businesses. This will take effect from1 September 2007.
Measure 2 – the period over which VAT charges arise on non-business use of land and buildings will be brought into line with the existing capital goods scheme. Currently, it is HMRC’s policy that the period which is applied to land and buildings is amaximumof 20 years – from1 September 2007 this will be reduced to 10 years.
Measure 3 – from21March 2007 a surrender of an interest in land for no consideration will now expressly be deemed to be a supply of that land.
Transfer of A Going Concern
On the transfer of a business as a going concern, the requirements as to keeping of VAT records are to be amended so as to bring the regime into linewith other tax and regulatory regimes. The effectwill be that, save for a limited number of specialised cases, the seller of the businesswill retain the VAT records. Informationwill be required to be passed to the buyer where the buyer retains the seller’s VAT number. The change will take effect from1 September 2007.
Joint and Several Liability
Under the current rules, any VAT registered business receiving particular types of goods fromanother VAT registered business may be jointly and severally liable for VAT where they have reasonable grounds to suspect that VAT would go unpaid elsewhere in the supply chain. These rules apply to certain types of electronic goods – from 1 May 2007 thismeasure will now also apply to supplies of electronic equipment of a kind ordinarily owned by individuals and used by themfor the purposes of leisure, amusement or entertainment.
The primary legislation which imposes this joint liability (Section 77A VATA 1994) will be amended so as to enable the Treasury to extend or otherwise alter the circumstances in which a VAT registered person who receives prescribed goods is presumed to have had reasonable grounds for suspecting that VAT will go unpaid elsewhere in the supply chain.
Personal tax Homes Abroad Owned through a Company
Provisions will be included in Finance Bill 2008 to ensure that individuals who have bought or will buy a home abroad, will not face a benefit in kind tax charge for any private use of the property if purchased through a company.
Capital Gains Tax: A Targeted Anti- Avoidance Rule
As announced at the time of the Pre-Budget Report, a targeted anti-avoidance rule will be introduced in Finance Bill 2007 to counter schemes to create and use artificial capital losses. This extends the rule introduced in Finance Act 2006 which provides that a loss accruing to a company will not be allowable if it arose fromarrangements which had a tax advantage as theirmain or one of theirmain purposes. The newmeasure will extend this rule for companies to persons liable to CGT.Where a person has entered into arrangements and amain purpose of those arrangements is to gain a tax advantage by creating an artificial capital loss, the resulting loss will not be an allowable loss for the purposes of capital gains tax, income tax or corporation tax.
Venture Capital and EnterpriseManagement Incentive Schemes
A number of changes will bemade, inmost cases with effect from6 April 2007, to the rules governing the Enterprise Investment Scheme (“EIS”), Corporate Venturing Scheme (“CVS”) and Venture Capital Trust (“VCT”) scheme and the use of EnterpriseManagement Incentive (“EMI”) schemes. For the EIS, CVS and VCT scheme, the changes will set new limits on the number of employees allowed (50 or fewer) and the amount of capital a company can raise in any 12 month period (amaximumof £2million). In the latter case, no shares or securities within the issue that causes the company to exceed this limit will qualify for relief under the applicable scheme. A minor change will also bemade as regards these schemes to ensure that the activities of indirect, as well as direct, 90%subsidiaries of a company can be considered when determining whether a qualifying trade is carried on.
To be approved for tax relief, a VCTmust at all times hold at least 70%by value of its investments in “qualifying holdings”. A new rule will be introduced to provide that a disposal of investments that have been held for at least six months beforehand will be ignored, so that retention of cash proceeds pending reinvestment will not affect satisfaction of this test.
The existing sixmonth condition for an EIS company to invest at least 90%of its funds, in order for investors to claimrelief on their subscriptions as ifmade on the date the fund closed, has been extended to twelvemonths for funds with a closing date on or after 7 October 2006.
For all the above classes of scheme, new rules will be introduced to allow the transfer of intangible assets around a group of companies without impacting on qualifying status or investors losing their tax relief.
There will be an increase in IHT allowance to £350,000 in 2010/11.
The 2005 and 2006 budgets increased the IHT nil-rate band allowance above statutory indexation to £300,000 for 2007/8, £312,000 for 2008/9 and £325,000 for 2009/10. To the extent that the value of estates exceeds the nil-rate band they are taxed at 40%.
Pre-owned Assets (“POA”)
Where someone benefits fromassets that are subject to the POA income tax charge, they can elect instead for those assets to be treated as forming part of their estate for IHT purposes. Legislation to be introduced in Finance Bill 2007 will allow HMRC to accept elections for IHT treatment that would otherwise be too late.
Since 6 April 2005, income tax has been charged on the benefit people derive fromhaving free or low-cost enjoyment of assets they formerly owned or which they provided the funds to purchase.
Onemethod of removing this charge is to elect for IHT treatment on the relevant property in the future. If this option is to be elected, electionmust bemade by the Self Assessment deadline formaking a return for the tax year in which an individual is first liable for the POA charge. In an extension of this, the Finance Bill will allow HMRC to accept electionsmade after that deadline. Effectively, this legislation will apply to the 31 January 2007 deadline for 2005/06 cases and to future deadlines where a liability to the POA charge first arises in a later year.
This measure will take effect from21March 2007 but, given its effect of enabling late elections to be accepted fromthat date, itmay also apply to elections that were late before then.
The existing basic rate of income tax will be reduced from 22%to 20%. The existing 10%starting rate of income tax will be removed for earned income and pensions but will continue to be available for savings income and capital gains. These changes will come into effect for 2008/09. The personal allowance for those aged under 65 will increase in line with inflation. Personal allowances for those aged between 65 and 74, and those over 75 will increase by more than inflation over the forthcoming years.
The Upper Earnings Limit (“UEL”) for employee’s Class 1 NICs and the Upper Profits Limit (“UPL”) for the self-employed will be increased by £75 per week (£3,900 for the year) above indexation for 2008/09. The following year, the Basic Rate Limit will be increased by a further £800 above indexation, and both the UEL and the UPL will be aligned with the new point at which the higher rate of tax becomes payable after personal allowances have been taken into account.
Individual Savings Accounts: Increased Subscription Limits
With effect from6 April 2008, the amounts thatmay be subscribed into an ISA will be increased. Subscribers will be able to invest up to £3,600 per tax year in a cash ISA (the current limit is £3,000), and up to £7,200 per tax year in a stocks and shares ISA (the current limit is £7,000), subject to an overall annual subscription limit of £7,200 to both ISAs.
The distinction between amini andmaxi ISA will be removed fromApril 2008. After this date an individual will be able to subscribe to either a cash ISA, a stocks and shares ISA, or both.
Taxation of Foreign Personal Dividends
Provisions will be introduced to amend the systemof taxation for individuals in receipt of dividends fromnon-UK resident companies.
When dividends fromUK-resident companies are charged to tax, shareholders are entitled to a non-payable tax credit of one-ninth of the distribution. Tax is charged on the gross dividend received, including the tax credit, resulting in effective rates of tax for individuals on these dividends of 0%, 0%and 25%, for lower rate, basic rate and higher rate taxpayers respectively.
From6 April 2008, the proposed changes will extend the non-payable credit of one-ninth of the distribution to individuals in receipt of dividends fromnon-UK resident companies, subject to certain conditions. A person will qualify for the non-payable dividend tax credit if they own less than a 10%shareholding in the distributing non-UK resident company, and in total they receive less than £5,000 of dividends a year fromnon-UK resident companies
Residence and Domicile
The review of the residence and domicile rules as they affect the taxation of individuals is ongoing.
Increase to Gift Aid Benefit Limits
The limits on the value of benefits that donors may receive frommaking donations to charities if those donations are to qualify for Gift Aid relief will be changed. The proportional limits will be as follows:
- 25%of the value of the donation, where the donation is less than £100;
- £25, where the value is between £100 and £1,000; and
- 5%of the value, where the donation exceeds £1,000.
The overriding limit on the value of benefits received by a donor in a tax year fromdonations will increase from£250 to £500.
The limits apply for benefits resulting fromdonationsmade by individuals on or after 6 April 2007 and by companies in an accounting period ending on or after 6 April 2007. The limits will also apply where individuals receive benefits frommaking donations to Community Amateur Sports Clubs, which are treated as charities for Gift Aid purposes. These new limits will come into effect for benefits received fromdonationsmade on or after 6 April 2007.
Charitable Lottery Tax Relief
The existing regulatory framework for lotteries will soon be replaced by the Gambling Act 2005. The Finance Bill will amend tax law to refer to the relevant sections of the 2005 Act so that, under the new regime, charities continue to benefit fromthe exemption fromtax on the profits of certain lotteries.
Following the passage of the Income Tax Act 2007 (ITA), the Income and Corporation Taxes Act 1988 lottery tax relief provisions will only apply to charitable companies while charitable trusts will be governed by an equivalent provision in the ITA.
Both of these amendments will take effect on 1 September 2007, the day the relevant provisions of the Gambling Act 2005 take effect.
Secondments to Charities and Educational Institutions
Where an employer temporarily seconds an employee to a charity or educational institution, the employer can continue to deduct salary costs fromprofits as if the employee were still working for the employer. Tax law will be amended so that the restriction on deductions where such costs are not paid within nine months of the end of the relevant accounting period that was inadvertently disapplied to employers that pay income tax does apply to them.
Themeasure will apply to salary costs paid on or after 6 April 2007.
VAT: Charities and the “change of use”
Charities that have obtained zero-rating for their supplies of new buildings or construction services under HMRC concession ESC 3.29 will no longer be liable for any “self-supply” VAT charge when there is a “change of use” of the building froma relevant charitable purpose to non-qualifying use within 10 years of the zero rate having been obtained. This change applies from21March 2007. HMRCwill no longer enforce the chargewhen there has been a “change of use” thatwas not envisagedwhen the zero-ratingwas obtained under the concession.However, if it is apparent that, at the time that zero-ratingwas obtained, it was intended that non-qualifying usewould exceed 10% within the 10-year period,HMRCwill consider that the original supply should never have been zero-rated in the first place. Charities that have paid a “change of use” charge in the last three yearsmay be entitled to a refund. This changemay also affect charities that obtained zero-rating under the zerorating provisions of the VAT Act 1994 rather than ESC 3.29.
Amending Legislation for Trust Modernisation
Part of the TrustModernisation programme legislation was included in Finance Act 2006.
However two omissions have come to light, in respect of which rectifying legislation is to be included in Finance Bill 2007.
An omission in the wording of section 686A Income and Corporation Taxes Act 1988means that where a company is buying back its own shares, trustees who are shareholders would be charged tax on the entire payment received rather than on the amount in excess of the original subscription price. Associated sections 481 and 482 of the Income Tax Act 2007 will also be amended by Finance Bill 2007.
In addition, payments falling within section 686A Income and Corporation Taxes Act 1988 are those received by trustees which are chargeable event gains on certain types of life insurance policy, capital redemption policy or life annuity contract. The legislation relating to the tax pool (687 Income and Corporation Taxes Act 1988), by which the tax credits given to beneficiaries of a discretionary trust are covered by the tax paid by the trustees, was not amended by Finance Act 2006 to ensure that a notional tax credit of 20%on chargeable event gains fromsome of these policies does not enter the tax pool.
Section 687 Income and Corporation Taxes Act 1988 has subsequently been replaced by section 498 Income Tax Act 2007, therefore it is the latter which is being amended to reflect this omission.
The first of these rectifications will come into effect on or after 6 April 2006 and the second on or after 6 April 2007.
The Government has announced a range of technical measures to be introduced by Finance Bill 2007 designed to improve the simplified pensions tax rules introduced with effect from6 April 2006. Themeasures announced will have effect from6 April 2006 and will include:
- The exclusion fromtaxation of certain “minor benefits” provided by former employers to retired former employees – the specified non-cash benefits on which there is no tax charge is to be expanded to include a numbinheritance tax pension rules - to allow the exemption frominheritance tax charges to operate within the same time frame as the registered pension scheme rules allowfor the payment of lump-sumbenefits following the death of a schememember; and
- Anti-avoidancemeasures – namely to ensure that (1) unauthorisedmember or employer payments under a registered pension scheme er of exemptions similar to those received by employees;
- Amendment to cannot reduce the overall tax charge on the scheme and themember or employer, and (2) the flexibility announced in the 2006 Pre-Budget Report in respect of registered pension schemes paid early on ill-health grounds does not prevent existing anti-avoidancemeasures fromapplying
Personal term assurance
Finance Bill 2007 will include a provision that individuals will no longer be entitled to tax relief on pension contributions that are used to pay premiums under personal term assurance policies. As announced in the 2006 Pre-Budget Report, “pipeline” policies will not be affected.
- For contributions under occupational schemes - this will have effect for contributionsmade on or after 1 August 2007, unless the application for the policy was received before 29March 2007 and the policy was taken out before 1 August 2007; and
- For contributions under other registered pension schemes - this will have effect from6 April 2007, unless the application for the policy was received before 14 December 2006 and the policy was taken out before 6 April 2007.
Relief which under thesemeasures remains available for contributions paid on or after 1 August or 6 April 2007 (as appropriate) will be lost if the policy to which the contributions relate is varied so as to increase the sum assured or lengthen the term.
This measure does not affect relief available for contributions paid by employers.
Alternatively secured pension (ASP) rules Provisions will be included in Finance Bill 2007 so that funds of untracedmembers of registered pension schemes will not become ASP funds on thatmember’s 75th birthday. Effectively the funds of suchmembers will be held in suspense. Any funds currently held as ASP funds will, from6 April 2007, cease to be so held.
Schemes will be required to take reasonable steps to trace amember.While themember cannot be traced therewill be no requirement to operate aminimumincome on these pension arrangements. Theminimumincome requirement will apply tomembers who are subsequently traced and who fail to decide on the level of income to be drawn. The level of theminimumincome for an ASP will be set at 55%of the annual amount of a comparable annuity for a 75 year-old. Associated changes will bemade to the ASP provisions in the Inheritance Act 1984 (unauthorised payments charges on ASP funds). The value of the remaining funds on the death of an untracedmember will be treated as part of their inheritance tax chargeable estate. There will be a tax charge where remaining funds of amember are transferred on their death to othermembers of the scheme. These provisions will have effect from6 April 2006.
Environment and transport Landfill Tax
The standard rate will be increased from£21 per tonne to £24 per tonne, and then further to £32 per tonne. The lower rate (which applies to inactive wastes disposed at specified landfill) will be increased from£2 per tonne to £2.50 per tonne.
Changes are to be introduced to the systemof awarding credits against landfill tax for contributions to bodies enrolled under the Landfill Communities Fund (LCF), including the following:
- Themaximumcredit claimable by landfill site operators against their annual landfill tax liability, for contributions made to bodies enrolled under the LCF is to be reduced from6.7%to 6.6%.
- Environmental bodies enrolled under the LCF will no longer have to submit independently audited accounts to the regulatory body each year, unless requested to do so. The relevant period for which theymust submit details of income and expenditure will be standardised to a 12 month period.
- Contributionsmade by a landfill site operator before 1 April 2003 will no longer be qualifying contributions if they are spent on sustainable waste projects unless there is a contract or documented record in place before 1 April 2007 committing these funds to such a project.
Landlord’s Energy Saving Allowance
The scope of the allowance (which allows landlords to deduct fromtheir taxable profits the cost of installing certain energy saving items) will be extended as follows:
- expenditure on floor insulation will qualify for the allowance;
- the £1,500 cap on expenditure will apply per property (rather than per building);
- the allowance will be available until 2015;
- the allowance will be available to corporate landlords who let residential properties (subject to state aid approval fromthe European Commission).
Microgeneration: Tax treatment of Renewables Obligation Certificates
Where a householder has installed a domestic microgeneration system, and receives Renewables Obligation Certificates (ROCs) fromOfgemin respect of that system, he/she will be exempt fromincome tax on the acquisition of the ROC, and fromcapital gains tax on any disposal of the ROCs (provided that the systemis used primarily to generate electricity for the house and not for the purposes of trading ROCs).
Auctions of emissions allowances under the EU Emissions Trading Scheme
Legislation is to be introduced to set out the basis for the auctioning of allowances of carbon dioxide frompermitted installations (under the EU Emissions Trading Scheme).
The rate of aggregates levy is to be increased from£1.60 per tonne to £1.95 per tonne, with effect from1 April 2008. The 80%relief available to registered operators in Northern Ireland will continue to apply.
There will be an exemption fromaggregates levy for aggregate removed fromthe ground along the line or proposed line of any railway, tramway ormonorail for the purposes of improving,maintaining or constructing it (rather than for the purpose of extracting the aggregate).
Climate Change Levy
The rates of climate change levy on commodities (including electricity and gas) are to be increased in line with inflation. Where a certificate is required to be given by a customer to a commodity supplier in order to obtain a relief fromclimate change levy, the rules are amended so that the customer no longer needs to provide such certificate before receiving the supply. The scope of the penalty for submission of an incorrect certificate will be extended to include circumstances where the certificate becomes incorrect after its initial submission.
Where a commodity is to be permanently exported from the UK or (in the case of a commodity other than electricity or gas in a gaseous state) subject to an onward supply, the availability of the exemption fromclimate change levy will no longer be conditional on a customer notification of the export/onward supply (provided that there is supplier certification).
Where supplies aremade to a facility that is the subject of a certificate given to HMRC by the Secretary of State for the Department of Environment, Food and Rural Affairs stating that the facility should be taken as covered by a climate change agreement, and the suppliesmay consequently be eligible for an 80%relief fromclimate change levy, such relief shall now no longer be conditional on HMRC publishing details of the facility concerned. The procedures for such reduced-rate supplies shall also be aligned with the certification regime applying to other reliefs.
Hydrocarbon Oils Duty
Excise duty rate increases are to be introduced from 1 November 2007, and on 1 April 2008 and 1 April 2009. Following expiry of the UK’s derogations fromthe Energy Products Directive, from1 November 2008 fuel used for the purposes of private pleasure flying and private pleasure boating will no longer benefit fromthe current reduced and exempt rates of duty.
Investment Managers – Carbon Trading
Rules apply to permit UK resident investmentmanagers to carry on discretionary fundmanagement activities in the UK on behalf of offshore funds without exposing the funds to potential liabilities to UK tax on trading profits. The “investmentmanagement exemption” presently contains a list of transactions thatmay be undertaken by amanager for this purpose.With effect from21 days after the necessary Regulations are laid before Parliament (expected to be on 22March 2007), this list will be extended to include transactions in carbon emissions credits and similar instruments.
Changes to the Income Tax and Corporation Tax EnquiryWindows, Powers to Require Online Filing and Effective Date of Payment by Cheque
Under the current law in relation to income tax self-assessment, where a return is received on time the enquiry window runs until the anniversary of the statutory filing deadline. Under the change to be introduced, the enquiry window will close one year after the date of delivery of the return. The changes to enquiry windows will apply to income tax self-assessment returns for 2007/08 and subsequent tax years and company tax returns for accounting periods ending after 31March 2008. There will be changes to the regulationmaking powers to require online filing such that there will be a single set of regulation making powers that apply to all taxes and duties for which HMRC is responsible. The timetable for the introduction of online filing has been put back to give businessmore time to prepare. It is also proposed to introduce provisions to enable regulations to bemade that allow cheque payments of VAT and corporation tax to be treated asmade at the point that funds have cleared into HMRC’s account.
Changes to Self-Assessment Tax Return
Legislation will be included in Finance Bill 2007 introducing different filing dates for paper and online self-assessment tax returns. For 2007/08 tax returns and those for subsequent years, there will be two separate filing dates for income tax self-assessment tax returns. For paper returns, there will be a new date of 31 October. In respect of the tax year 2007/08 that will be 31 October 2008. For returns filed online the date will remain at 31 January – for tax year 2007/08 that will be 31 January 2009. In respect of taxpayers filing paper returns who want HMRC to calculate their tax liability for them, the cut-off date will change from 30 September to 31 October to align with the new paper return filing deadline.
Review of Powers and Safeguards: New Criminal Investigation Powers and Safeguards
Following on froma consultation published in January 2007
– Criminal Investigation Powers: Publication of Draft Clauses and Explanatory Notes, provisions will be introduced in Finance Bill 2007 to provide consistent powers and safeguards for all HMRC’s criminal investigations. Under current rules, Section 114 of The Police and Criminal Evidence Act 1984 and consequential Order applies provisions of that Act to investigations and persons detained by Customs & Excise. The newmeasure will amend this provision so that the relevant provisions apply to all HMRC criminal investigations.
The relevant powers and safeguards in PACE which are being extended relate to: applying tomagistrates and judges for search warrants, applying to judges for court orders to obtain evidence frompeople other than the suspect, arresting suspects, search upon arrest and questioning.
The Government has decided not to proceed with proposals for a newManagement Act at this time. HMRC Review of Powers, Deterrents and Safeguards: Penalties for Incorrect Returns
A new single penalty regime for incorrect returns for income tax, corporation tax, PAYE, NIC and VAT will be introduced. A range of factors will be taken into account in calculating the amount of the penalty, including: the amount of tax understated, the nature of the behaviour giving rise to the understatement and the extent of disclosure by the taxpayer. There will be: no penalty where a taxpayermakes amistake,moderate penalties for failure to take reasonable care, higher penalties for deliberate action and still higher penalties for deliberate action with concealment. There will also be a provision whereby each penalty may be substantially reduced where the taxpayer makes a disclosure (takes active steps to put right the problem), which will be increased if such disclosure is unprompted.
HMRC have published two papers in relation to their dealings with large business “Making a difference: delivering the review of links with large business” and “HMRC approach to compliance riskmanagement for large business”. The former of these sets out an outline delivery plan in relation to the commitmentmade by HMRC in November 2006 to deliver all the proposals contained in the “2006 Review of Links with Large business”. These include formal consultation in summer 2007 on new clearance processes and advanced rulings. Also, from1 June 2007 there will be an extension of advance clearance applications for substantial shareholdings exemption and for stamp duty land tax fromFinance Act 2007 (effectively removing the time limit of four Finance Acts fromCOP 10 applications in relation to these two areas of legislation).
In relation to compliance riskmanagement the HMRC paper sets out how they will assess tax risk and states that low risk customers can expect far fewer interventions and risk reviews only every two to three years (or longer) whilst higher risk customers will have at least annual risk reviews.
The emphasis of the approach is to vary HMRC activities in response to the level of risk.
Tax Treatment of General Insurers’ Reserves
The Government proposes to introduce legislation in Finance Bill 2007 to repeal the current rules (Section 107 Finance Act 2000 and SI 2001/1757) dealing with the tax treatment of general insurers’ reserves.
The proposal follows a long consultation with interested parties. The current rules were introduced tomeet HMRC’s concerns that general insurers were able to defer tax by “over-reserving”. The rules require general insurers to compare the amount that they originally reserved to pay claimsmade by policyholders with the later cost of settling those claims, andmake a tax adjustment if there is a difference.
One feature of the current rules is that they contain an election to disclaimreserves for tax purposes. The disclaimer election effectively permits insurers to recognise tax deductions up to the amount of the reserves in periods of their choice, and HMRC is concerned that this has caused a significant loss of tax to the Exchequer. The consultation also concluded that the current rules are disproportionately complex in comparison with the tax risk that they seek to address.
The repeal will take effect for periods of account ending on or after the date that Finance Bill 2007 receives Royal Assent. General insurance companies should therefore still be able to make a disclaimer election for the period of account ended 31 December 2006.
The proposal is to repeal all of the current tax rules dealing with the tax treatment of general insurers’ reserves, subject to a transitional provision which will allow a limited disclaimer election to bemade for the first period of account ending after Royal Assent (under which the amount that can be disclaimed is expected to be capped at 10%of the technical provisions for that period). The tax treatment of general insurers’ reserves will then follow the commercial accounting treatment subject to a new measure to protect the Exchequer against future tax loss.
Thismeasure will contain, according to the Supplementary Note published on Budget Day, a standard setting out the maximumacceptable provision for tax purposes, an information power to require the delivery of a breakdown of the provision set for a period, and a power to require the production of a report froman appropriately qualified person. However, HMRC have said that it is expected that tax enquiries into the quantumof provisions will be rare. One effect of the repeal of the rules is that insurance companies are concerned about the effect on the ability to use losses. It is good to see that HMRC has announced that it will consult with industry on the effect of the repeal on the availability of group relief.
Insurance PremiumTax (IPT)
The Government has announced proposals to amend the IPT definition of “premium”. IPT is charged as an inclusive amount within the premiumfor a taxable insurance contract. The amendment is intended tomake it clear that this definition of “premium” includes any payment received by, or on behalf of, an insurer for the provision of a right to a third party to require the insurer to provide, or offer to provide, cover under a taxable contract of insurance. The change has been proposed because of concern that such payments do not fall within the current IPT definition of “premium”. Themeasure will have effect on and after 22 March 2007.
A consultation will also be undertaken to review the requirement for overseas insurers to appoint a tax representative for IPT, and whether an IPT registration threshold might be appropriate.
Lloyd’s Tax Rules
The following announcements affect Lloyd’s:
- New rules effective fromBudget Day to prevent “loss-buying” fromLloyd’s corporatemembers by unconnected parties;
- The Government has already at Pre-Budget Report announced that Finance Bill 2007 will rectify the inability of Lloyd’s members to pass losses under section 343 ICTA;
- There is to be consultation on the extension of the equalisation reserves tax rules to Lloyd’smembers;
- Exclusion of Lloyd’smembers fromthe restriction on sideways loss relief for individuals in partnership.
Life insurance companies
Given the substantial amount of change in progress in relation to the taxation of life insurance companies, this section is necessarily only a whistle-stop tour focusing on themore substantive life insurance tax points emerging fromthe Budget.
InMay 2006, HMRC published a formal consultation document, “Life Assurance Company Taxation: A Technical Consultative Document”, aimed at simplifying certain aspects of tax law relating to life assurance companies.
The consultation was initially divided into four strands as follows:
- Amalgamations – there are a number of categories of life assurance business which are taxed similarly but which are required for largely historical reasons to be ring-fenced. This group was considering whether they could be amalgamated and whether there was a case for including permanent health insurance business, which is not life assurance business and is taxed on a Case I basis.
- Transfers of business – this group were considering whether it was possible to streamline and simplify the complex body of law which had grown up to deal with FSMA Part VII transfers.
- Apportionments – consideration was to be given to improving the highly complex set of rules governing the methodology for determining the allocation of investment return to different categories of business. We have not commented on this workstreamin the note as we understand that no firmproposals have yet beenmade.
- Losses and group issues – this “catch-all” workstreamconsidered the quantumand utilisation of losses of life assurance companies, together with sundry other issues such as the taxation of intra-group dividends.
A fifth strand emerged during consultation as a result of continuing uncertainty as to HMRC’s Crown Option.
Although HMRC have referred to this as the “nuclear option” (a termwhich well describes both its rarity and its apparent current legislative effect), the working groups considered it appropriate to discuss the need for legislative certainty with HMRC at a time when both tax (section 83YA FA 1989 – taxation of investment reserves) and regulatory changes (for example CP 06/16 – relaxation of insurance reserving in some circumstances) were illustrating that companiesmight come within Crown Option territory on a one-off basis.
There is also a workstreamdealing with some particular tax issues affecting friendly societies, for which the tax regime operates differently in some respects than for ordinary life insurance companies.
The PBR 2006 announcements reflected the first outcomes of the consultation process. The Budget 2007 announcements reflect the developments that have taken place since the PBR 2006. The workstreams are continuing to work on any outstanding issues.
Transfers of Business
There was consensus between HMRC and the industry fromthe outset of the consultation that the transfers of business legislation needed to be simplified and clarified and draft legislation published with the PBR 2006 was directed at this aim. However it became clear in recent discussions that there was still substantive work to be done (for example to deal with part transfers). Therefore it has been decided that although the transfers of business provisions will be included in the Finance Bill there will be a regulatory power to amend (and in some cases to add to)much of the primary legislation by Treasury Order. The regulatory power will lapse at 1 April 2008.
It is not possible to say before the publication of the Finance Bill which provisions will still come into force on 1 January 2007, though we believe that the streamlining of themain “Iminus E” neutrality rules for capital gains assets and certain tax reliefs (the removal of the purpose test and statutory clearance procedure) should come into force for transfers taking effect on or after that date. The “Case I” provisions (most significantly the rules dealing with transferor and transferee where assets are or are not extracted fromthe long-terminsurance fund environment, and the targeted anti-avoidance rule) are expected to come into force not from1 November 2007 (as announced in PBR) but froman appointed day. HMRC have indicated that the working assumption is that this would be 1 April 2008.
The transfers of business legislation included in the Finance Bill differs fromthat announced in the PBR 2006 in a number of ways. Some of themore important changes are set out below:
- the extension of the targeted anti avoidance provision to catch cases where “one of themain purposes” (as opposed to the “sole ormain purpose”) of the arrangements is to obtain a Case I tax advantage (a drafting extension which no doubt the working group will wish to discuss with HMRC);
- a new section 444ABD which willmake it clear that a profit or loss on transfer is treated as a Case I profit or loss;
- removal of the provision (currently section 444AC and proposed in PBR to re-emerge as 444ACZA) to eliminate a deficit in the transferee (this would seem consistent with the approach taken in new section 444ABD);
- removal of some of the restrictions which were proposed to be placed on section 444AC (exemption of profit recognised in a transferee on receipt of a Part VII transfer)
- alteration of the TAAR so that it counteracts only the Case I effect of a “tainted part” of the Case I arrangements.
Other changesmade are to deal with whole and part business transfers separately, and to ensure that the provisions dovetail properly with other statutory provisions such as section 83YA.
Amalgamation of business categories
The Government announced in the PBR 2006 that the “5-1” proposal would be implemented, ie, the five life assurance categories of business currently taxed under Schedule D Case VI – pension business, overseas life assurance business, ISA business, child tax credit business and life reinsurance business – will be taxed as one category, called gross roll-up business.
The amalgamation of business categories work streamhas refined the draft clauses that were announced in the PBR 2006. However it remains the case that pension business losses brought forward at commencement of these provisions will be ring-fenced against a proportion of the gross roll-up business, a proportion which is intended to represent what would have been PB profits.
Legislation will be published in the Finance Bill 2007 and will have effect for accounting periods beginning on or after 1 January 2007.
The Crown currently has the option to assess the investment income of a life insurance company either on a trading basis under Case I of Schedule D or on the “I minus E” basis.
It is in fact relatively unusual for HMRC to require a life insurance company to self-assess on the Case I basis. Furthermore HMRC’s Life AssuranceManual contains text setting out circumstances in which the Crown is likely to or unlikely to exercise the option. Howevermany life insurance companies consider this text inadequate as protection against what they perceive as an unacceptable tax risk. HMRC stated intention was therefore to “codify” the “Crown Option” to provide greater certainty for the life insurance industry while at the same time protecting the Exchequer.
The uncertainty facing life insurance companies as to when a discretionary rule such as the “Crown Option”might be applied has been underlined by events in 2006. Tax (section 83YA FA 1989 – taxation of investment reserves) and regulatory (CP6/16 – relaxation of the strict rules on calculation of reserves) changes have shown that companiesmight have been imperilled by the “Crown Option” for a single period.
The Crown Option will be replaced by legislation in the Finance Bill 2007 which willmake it certain when life insurance companies will be assessed on a Case I basis. There will also be changes to the I minus E basis to ensure that tax is always paid on the higher of the profit computed on a Case I basis and that computed on under the I minus E basis. The difference will be added to the I minus E basis profit (but an equal and opposite amount will be added to carried forward expenses).
It will still be possible for a company tomove between I minus E and Case I if their circumstances change. However under the Finance Bill 2007 changes, tax reliefs which are currently lost if the Crown Option is exercised will be preserved when a company comes into the Actual Case I basis and will be a subsequent change back if there is a subsequent change back to the I minus E basis. There will also be transitional provisions to allow any unused Case VI losses to convert to a Case I loss on a permanent change to a Case I basis (and vice versa).
The new legislation will also provide that life insurance companies whose business is substantially gross roll-up business (see amalgamations, above) will be taxed on an Actual Case I basis. Pure reinsurers will remain taxed on an Actual Case I basis.
The PBR 2006 contained draft Finance Bill clauses aimed at eliminating a disincentive to the transfer of business from a Friendly Society to a life insurance company other than a Friendly Society.
Currently the exempt status of the business is lost on a transfer to a company other than another Friendly Society. The intention of the legislation is to permit the retention of the exempt status on a transfer of tax exempt life or endowment business. However the premiumsmust not be increased after the transfer, even within the current exemption threshold. Furthermore the transferee will not be permitted to write new tax-exempt business.
It was intended that the PBR 2006 changes would come into force on 1 November 2007, however this date has now been brought forward to Royal Assent.
The Government announced through the Budget that the Finance Bill 2007 will also contain legislation which will allow tax exempt “other” business to be transferred from a friendly society to an insurance company while retaining the tax exemption.
The Finance Bill 2007 will also containmeasures to prevent the loss of tax exemption where the limits in section 464 ICTA are breached as a result of the assignment of a policy other than formoney ormoney’s worth.
Discussions on a simplified regime for smaller friendly societies and discussions on the transfers of business between friendly societies are on-going. No proposals in respect of eithermeasure are expected in the Finance Bill 2007.
Losses and Group Issues Section 83(3) FA 1989
The PBR 2006 included proposals to repeal section 83(3) FA 1989 which restricts losses where there is an addition to the transferee’s long termfund in connection with an insurance business transfer (which includes a total reinsurance), and its associated provisions. This repeal will be contained in the Finance Bill but the commencement date is linked to the transfers of business commencement date and is therefore uncertain at present. It is expected that the repeal will be such that no adjustment can occur after commencement, even if the addition or transfer took place prior to commencement.
The Government announced in the Budget 2007 that legislation will be included in the Finance Bill 2007 (and effective from1 January 2007) to take both income and valuationmovements arising fromstructural assets out of the scope of section 83 FA 1989. “Structural assets” are assets which are part of a life insurer’s infrastructure rather than assets held to be turned over in the course of the insurer’s trade. The legislation will define structural assets to include shares in and loans to insurance dependants and will include a regulatory power to add to or amend this definition.
This legislation will deal with a long-standing industry concern about double taxation where a company’s profits are taxed again when a dividend is paid to the long-term insurance fund. It also deals with HMRC’s concern about the obtaining of a write-down for tax purposes of the value of structural assets.
Connected party loss rules – disposals of holdings in OEICs and AUTs
Where a loss results fromthe disposal of an asset by one company to another connected company, relief for loss against chargeable gains is restricted to set off against gains arising on disposal between the same connected parties.
This rule can operate unfairly where life insurers dispose of units in authorised investment fundsmanaged by a company which is in the same group. The Finance Bill 2007 will include legislation to remove the restrictions for life companies with effect for losses accruing in periods of account beginning on or after 1 January 2007.
Reserve Releases Following FSA
Consultation Papers CP06/16 and CP06/12
Changes to FSA reserving rules at 31 December 2006 posed a particular challenge as HMRC and the industry discussed what, if anything, needed to be done given the prospect of an abnormal profit and one-off significant tax charge.
In a welcomemeasure HMRC agreed with industry that it would be appropriate for life insurance companies to have the benefit of a deferral of the tax effect of the changes, with the tax to be spread into later periods. An order is expected to be laid shortly containing the detailed provisions.
Life insurance companies have requirements for capital which cannot normally bemet by straightforward borrowing (due to regulatory constraints) and so a variety of more complex financial arrangements including contingent loans and financial reinsurance contracts are used to fund long-termbusiness.
Legislation will be introduced in the Finance Bill 2007 to improve the tax treatment of contingent loans. A tax charge will only be imposed when the arrangements are used to generate a transfer of surplus to shareholderswhichwould not have existed without the arrangements, or which exceeds 125%ofmean transfers in the three previous periods. It will also recognise that where such surplus is generated and brought into account for tax, a compensating adjustmentmay be needed in later periods.
The new rules will have effect for periods of account beginning on or after 1 January 2007.
Consultation on the possibility of giving other types of financing arrangements the same tax treatment as contingent loans will proceed in conjunction with the consultation on securitisations involving insurance SPVs (see below).
HMRC are currently consulting on the taxation of insurance special purpose vehicles (“ISPVs”), both fromthe point of view of the cedant company and also fromthe point of view of the ISPV itself. This consultation remains at an early stage and a date for implementation of any proposals has not been announced.
Purchased Life Annuities
The requirement that an Officer of HMRCmust determine the tax-exempt capital element of a Purchased Life Annuity (PLA) calculated by the insurer is to be removed. The measure will have effect on or after a date to be appointed by Treasury Order, which will coincide with revised PLA regulations taking effect. This is an administrative simplification.
Life Insurance Policies and Commission Arrangements
Legislation will be introduced in the Finance Bill 2007 to clarify that where premiums ofmore than £100,000 are paid into a policy in a tax year and the policy is surrendered, matures or is assigned formoney ormoney’s worth before the end of the third tax year after that in which the premiums are paid, only the net premiumafter any commission rebate is allowable in the gain computation. It will also apply where commission is reinvested into a policy as premium. The legislation will include an anti-fragmentation rule.
Themeasures will apply to policies and contractsmade on or after 21 March 2007 and existing policies and contracts where the benefits secured are increased on or after that date, either by variation of the policy or contract or by the exercise of an option in the policy or contract.
This change ismade to counteract arrangements under which investors can receive investment return froman insurance bond tax-free.
The European Commission’s review of the VAT treatment of financial services and insurance is still on going. The Commission’s summary response to the 2006 consultation will be published shortly and a proposal for legislative change is expected later this year.
As announced in the PBR 2006, from1 April 2007 businesses will have to declare to the best of their knowledge and belief that their proposed specialmethod for calculating input tax recovery is fair and reasonable. HMRC will have the right to set it aside if the person signing the declaration knew or ought reasonably to have known that it was not fair and reasonable.