Yesterday, the Government launched a 'study programme' to establish whether an effective General Anti Avoidance Rule (GAAR) could be developed to form part of the UK tax system. It also shut down, with immediate effect, some specific tax avoidance schemes relating to:
- the use of convertible securities in connection with raising intra group finance;
- group mismatch schemes using intra group loans or derivatives, the aim of which was to give rise to a tax deduction that was not matched by corresponding taxable receipts; and
- the use of accounting rules applying to loan relationships and derivative contracts, the effective result of which was to ensure that certain amounts were not fully recognised in a company's accounts and therefore potentially not brought into account for tax purposes.
New legislation will also be introduced to stop tax avoidance using so called disguised remuneration – ie schemes which are implemented to defer or completely avoid income tax or national insurance contributions.
Some very specific VAT and inheritance tax measures have also been announced.
These measures are addressed in more detail below.
A link to the recent Herbert Smith client bulletin on the GAAR can be found here.
The possibility of a GAAR
The Government will launch a 'study programme' which will be led by Graham Aaronson QC and a panel of experts to establish whether a UK GAAR could be developed which could meet the objectives of:
- deterring and countering tax avoidance in a fair way;
- providing certainty to taxpayers;
- ensuring that plans to declare the UK open for business with a competitive and simple tax system were not derailed; and
- minimising undue compliance costs for businesses and HM Revenue & Customs.
If the panel believe that a GAAR is viable or possibly viable, they have been asked to provide draft legislation and explanatory notes.
The panel will revert by 31 October 2011. There will be further public consultation before a GAAR is formally introduced.
If the panel suggests that a GAAR is viable, taxpayers and their advisors will be particularly keen to ascertain whether the large number of existing targeted anti avoidance rules will be repealed, and whether (and at what cost) they will be able to obtain binding clearances from HM Revenue & Customs. Stakeholders will also be very keen to review the form and structure of the proposed legislation before making a determination of whether this is a welcome development or not.
Legislation will be introduced to counter tax avoidance schemes that aim to reduce a group’s liability to corporation tax through asymmetrical tax treatment of intra-group loans or derivatives.
Yesterday's announcements will herald two legislative developments:
- legislation to tackle tax avoidance using loan relationships involving connected creditor and debtor companies where the debits exceed the credits; and
- more generic and principles based legislation aimed at strengthening the existing anti avoidance legislation in the loan relationships and derivative rules. It will ensure that groups of companies cannot use loan relationships or derivative contracts to reduce or defer their tax liability purely as a result of asymmetries in the way the group members bring amounts into account.
Loan relationships involving connected creditor and debtor where debits exceed credits
Broadly, existing legislation blocks schemes which involve the provision of intra-group finance through the use of convertible securities, the effect of which is to allow the debtor company a tax deduction for larger amounts than the credits on which the creditor company is chargeable because the two companies adopt different accounting methodologies in relation to those securities. The legislation effectively requires the creditor company to bring into account the amount that is taken as a deduction by the debtor company.
The current legislation will be extended to cover (and therefore block) schemes where:
- a company connected with the creditor company is or may become entitled or required to acquire shares in a company, or
- amounts are taken into account under the loan relationship rules in determining the chargeable profits of a controlled foreign company.
The new rules apply to any loan relationship to which a company is a party on or after 6 December 2010 but will not apply to amounts that relate to a time before that date. The legislation introducing the changes will appear in the Finance Bill 2011.
Principles based legislation
The proposed legislation will apply where two or more companies that are members of a group are party to a scheme with either of the following features:
- 'the scheme is one that, viewed at the outset, is practically certain to give rise to a tax advantage (broadly, a reduction in the amount of corporation tax otherwise payable) of a more than negligible amount arising from the asymmetrical tax treatment by the group members of a loan or derivative that forms part of the scheme; or
- group members enter into to the scheme for the main purposes of obtaining the chance of securing such an advantage'.
Where the relevant conditions are met, the proposed legislation will eliminate the tax advantage that would otherwise arise.
Legislation will be introduced to stop avoidance schemes using the accounting rules which apply to loan relationships and derivative contracts, the effective result of which was to ensure that certain amounts were not fully recognised (or were in fact derecognised) in a company's accounts and therefore potentially not brought into account for tax purposes.
The loan relationships and derivative contracts regimes are based on the principle that amounts brought into account for tax purposes as credits and debits are those that, in accordance with GAAP, are recognised in determining a company’s profit or loss for the period. In certain circumstances, GAAP may permit or require the loan or derivative, or amounts arising in respect of them, not to be recognised in determining the company’s accounting profits or losses for the period which may give rise to a tax advantage. Under the current tax rules, where a company derecognises a loan or derivative and its associated cash flows in accordance with GAAP, then, provided certain specified conditions are met, those amounts are brought into account for tax purposes as if the amounts had in fact been recognised in the accounts.
Going forward, where a company is (a) a creditor in a loan relationship or a derivative contract and (b) a party to tax avoidance arrangements, then that company will be required to prepare its corporation tax computations on the assumption that all such amounts are fully recognised in its accounts. Accordingly, in these circumstances, derecognition in the accounts will be overridden for tax purposes, and losses arising from derecognition will not be allowable.
For these purposes, 'tax avoidance arrangements' are those arrangements that have the obtaining of a tax advantage as their main purpose or one of their main purposes. 'Arrangements' denotes all arrangements, schemes and understandings of any kind.
The new legislation will apply from 6 December 2010 and will appear in Finance Bill 2011.
New legislation will be introduced to tackle arrangements involving trusts or other vehicles used to reward employees, which seek to avoid or defer the payment of income tax or national insurance contributions, including the provision of tax-advantaged alternatives to saving beyond the annual and lifetime allowances available in a registered pension scheme.
We can expect further announcements on this in due course. It will be interesting, in particular, to see how these rules interface with the forthcoming EU code on remuneration in the financial services sector which is focussing, in part, on deferred consideration.
Functional currency - investment companies
Draft legislation will be published on 9 December 2010 to counter avoidance involving changes in the functional currency of an investment company. The legislation will take effect for accounting periods beginning on or after 1 April 2011. This will ensure that when a UK resident investment company changes its functional currency, no foreign exchange gains or losses arising from loan relationships or derivative contracts will be brought into account for tax purposes in the first period of account using the new functional currency.
VAT and split supply contracts
Draft legislation will be introduced as part of Finance Bill 2011 to counter avoidance relating to the supply of services where arrangements have been made for the supply of printed matter that is ancillary to those services to be made by a different supplier.
Where the rules apply, the supply of printed matter will not benefit from zero rating. The legislation will come into force from the date of Royal Assent to the Finance Bill 2011, following consultation on the form of the legislation.