What is expected to be Gordon Brown's final Budget as Chancellor produced two surprise tax reductions, with both basic rate income and corporation tax falling 2 per cent. But the effect of both is largely neutralised, in the case of income tax by the removal of the 10 per cent starter rate on earnings, and in the case of corporation tax by a reduction in capital allowance benefits.

There were no major structural changes in the tax system, but many piecemeal measures ranging from anti-avoidance provisions to a 5 per cent Value Added Tax (VAT) rate for "smoking cessation" products. But tax managers who breathed a sigh of relief may find this was premature - a consultation is promised on the treatment of non-UK dividends and CFCs which will also extend into a review of the interest relief system. This may also impact on the review proposed in relation to the financing of private equity transactions.

A major topic in the background papers to the Budget is the relationship between large businesses and HM Revenue & Customs (HMRC), with the suggestion being offered of an advance clearance procedure. To counterbalance this, a new penalty regime was announced, together with new powers to investigate promoters who are suspected of failing to comply with the disclosure scheme requirements.

The City benefits from a new regime for UK based securitisation vehicles, further provisions to promote Islamic financing products and carbon credit trading, and extended Stamp Duty Reserve Tax (SDRT) reliefs to enhance the attraction of the UK as a financial centre following MiFID.

Some "hot topics" from previous Budgets have still not emerged, but remain in the background. Planning Gain Supplement may be introduced (not earlier than 2009) if "after further consideration it continues to be deemed workable and effective". The residence and domicile review is still "ongoing". The current "Green" hot topic was the beneficiary of a smattering of provisions, but there was no major headline grabbing initiative.

This briefing sets out details of the proposals of most relevance to our clients. As usual, full details await the publication of the Finance Bill, likely to be in early April. Some measures have immediate effect, some apply from the date of Royal Assent to the Finance Bill (likely to be mid to late July) and some (the tax rate cuts) do not apply until 2008/9.

Key developments for headlight sectors



Corporation tax rates

From 1 April 2007 the small companies’ rate of corporation tax will be increased to 20 per cent.

From 1 April 2008 the main rate of corporation tax will be reduced to 28 per cent for companies with profits of £1.5 million or more. In addition, new rules will be introduced to set the main rate of corporation tax for oil companies' ring fenced profits at 30 per cent.

Business tax reform package


The Chancellor has announced several measures changing the way in which businesses will be taxed. These are a mixture of headline-grabbing reductions in rates and increases in "popular" reliefs, set against reductions in less glamorous reliefs such as industrial buildings allowances. These changes broadly split into three categories.

Corporation tax rates

The main change for large corporates is the change in the headline rate of corporation tax which will be reduced from 30 per cent to 28 per cent from April 2008. If the implementation follows previous years, this change in rate will be apportioned across the accounting period of a company that straddles April 2008 so as not to give a particular advantage to any given company depending on where its year end falls.

Conversely, the Chancellor has increased the small companies’ rate of corporation tax from 19 per cent to 20 per cent from 1 April 2007. This rate will increase in subsequent years to 21 per cent in April 2008 and 22 per cent in 2009. It is expected that the implementation regime will be as for the mainstream corporation tax rate. This measure will apply (broadly speaking) to companies with profits below £1.5 million and the "relevant fraction" for companies with profits between £300,000 and £1.5 million will change from 1/40th to 11/400ths.

The two changes described above will not apply to companies with profits from oil extraction and oil rights in the UK and the UK continental shelf (ring fenced profits).

Plant and machinery allowances and industrial and agricultural buildings allowances

The changes below will all apply from April 2008 except where stated.

Again, the measures under this heading are a mixture of measures that offer new or increased benefits to business tax-payers, combined with measures that take away existing benefits. The main change is to the rates of writing down allowances for plant and machinery, which will be reduced from 25 per cent to 20 per cent for general plant and machinery expenditure and will be increased from 6 per cent to 10 per cent for long-life asset expenditure. Both of these changes will take effect from April 2008, and will apply to historic expenditure as well as new expenditure. It is understood that it is likely (although this has not yet been finalised by HM Revenue & Customs (HMRC)) that there will be some form of apportionment for the accounting period of any business straddling April 2008.

Between April 2008 and 2010, writing down allowances on industrial and agricultural buildings will be gradually phased out. This measure also involves the withdrawal of all balancing adjustments in respect of balancing events occurring on or after 21 March 2007 unless a contract has already been concluded or unless the expenditure relates to qualifying enterprise zone expenditure. This means that, from 21 March 2007, it will not be possible to "refresh" the industrial buildings allowances on a building by selling it to a third party.

From April 2008, the temporary 50 per cent rate of first year allowances for small enterprises will be replaced by a new annual investment allowance for the first £50,000 of expenditure on plant and machinery for small enterprises. The details of this have yet to be fleshed out and will be the subject of consultation. In the meantime, the temporary regime will be extended until April 2008.

Regulations will also be introduced that will allow the business premises renovation allowance, brought in by the Finance Act 2005, to commence. This 100 per cent initial allowance will be available for expenditure incurred on renovating a property that has been vacant for a year or more in a designated disadvantaged area of the UK so that the property is brought back into business use. This legislation will have effect for qualifying expenditure incurred on or after 11 April 2007.

There are further provisions which will be introduced in April 2008 that are the subject of further consultation and possibly State Aid clearance. Broadly speaking, these are:

  • provisions that will allow for writing down allowances at 10 per cent on certain fixtures which are integral to a building
  • provisions that will generate tax credits for losses resulting from capital expenditure on designated green technologies, including a 100 per cent allowance (which may be treated as a payable tax credit for loss-making companies) for expenditure on biofuels plants that meet certain criteria.

The Government has also announced a review of the classes of assets that qualify for enhanced capital allowances, particularly so that qualifying combined heat and power plants will need to have the capability to use solid refuse fuel in order to qualify for the enhanced allowance.

None of the above will affect the capital allowances regime for North Sea oil and gas ring-fenced activities, which will retain their existing treatment.

Research and development tax credits

There are two proposals in relation to the regime for small and medium enterprises (SMEs) in relation to research and development tax relief.

First, the rate at which a small company will be able to obtain research and development tax credits will increase from 150 per cent to 175 per cent. However, it appears from the relevant press release that the net value of this credit will not change, as there is reference to it remaining at 24 per cent of the original expenditure. It therefore seems that the rate at which credit is given for the expenditure may also be changed, although there is no detail of this.

Second, the rules will also be changed to double the size of companies that will qualify for the SME tax credit. Companies will now qualify for the greater rate of relief if they have fewer than 500 employees (previously 250), their annual turnover does not exceed €100 million (previously €50 million) and/or their balance sheet total does not exceed €86 million (previously €43 million).

The rate at which research and development tax credits are given to large companies will also be changed from 125 per cent to 130 per cent, again with affect from April 2008.

These regulations are subject to State Aid approval from the EU.


Review of HM Revenue & Customs' (HMRC) relationship with large business

HMRC have published a document entitled "Making a difference: delivering the review of links with large business" in which it outlines the results of the review undertaken during 2006, with a view to implementing the results during 2007 and 2008.

These results focus on three main areas:

  • improved ability of tax-payers to obtain advance rulings and clearance for transactions
  • improving the availability of HMRC guidance on legislation
  • introducing a more risk-based approach to large business taxation, so that those who are seen as low risk by HMRC will have reduced compliance obligations (although those that HMRC perceive to be high risk may suffer an increased compliance burden).

As part of this, there are several announcements of specific changes on which there will be consultation commencing in the summer. Some of the more significant examples of this are:

  • a system of binding advance rulings on "all relevant taxes" will apply from the Pre-Budget Report 2007 (likely to be in December)
  • an extension to the COP10 clearance system relating to stamp duty land tax and substantial shareholding relief, without time limit
  • transfer-pricing enquiries will be more effectively project-managed with an aim to complete them within 18 months
  • the document contains a list of guidance which is expected to be updated or drafted during 2007 and, from the 2008 Budget, all HMRC guidance will be published alongside the legislation to which it relates.

These measures are generally to be welcomed as businesses prefer to have certainty before implementing a new structure or reorganisation. However, there is a price to pay in that HMRC will no doubt require more information to be provided in order to give binding clearances and will require information to be provided more quickly in order to match their own commitment to reduce investigation times. It remains to be seen whether HMRC can meet the deadlines that businesses will require when implementing complex and fast-moving corporate transactions.

Insurance companies

Life insurance companies

The Finance Bill 2007 will contain potentially very significant changes to the tax treatment of life insurance companies. Historically, life insurance companies have generally been subject to tax on the so-called I minus E basis. HM Revenue & Customs (HMRC) has always had the option to require the profits to be computed in a similar way to most other corporate tax-payers under the provisions of Case I of Schedule D (ie, by reference to their trading profits). Since May 2006, HMRC has been consulting on the future rules for life insurance companies. As a result of that consultation, the Finance Bill 2007 will set out when a company will be taxed either on the I minus E basis or under Case I of Schedule D. If the I minus E basis would give rise to a lower tax charge, the profits computed on that basis will be adjusted so that tax is accounted for on the higher of the two bases. In addition to these changes, there will be various other changes:

  • the structural assets held in a life insurer's long-term insurance fund will be taken out from the charge to profits under Case I of Schedule D
  • relieving provisions will be introduced so that certain anti-avoidance rules on capital losses will not apply when units in authorised unit trusts and OEICs managed by a company in the same group as the life insurance company are sold
  • there will be relieving provisions to apply when a friendly society transfers a tax exempt business to an insurance company
  • measures will be introduced to combat perceived anti-avoidance in the way in which life insurance companies use contingent loans and financial reinsurance contracts to meet their requirements for capital. In addition, HMRC will consult on whether financial reinsurance and capital contributions should be treated in the same way as contingent loans.

Tax treatment of general insurers' reserves

As announced in the 2006 Pre-Budget Report, following an informal consultation with the industry and a general review of the current regime, the Government has confirmed that the Finance Act 2007 will repeal all the current tax rules dealing with the tax treatment of general insurers' reserves. It is proposed that the tax treatment of these reserves will follow the commercial accounting treatment, although the Government is going to continue informal consultation with the industry as regards the replacement rule.

The current rules require general insurers to compare the amount that they originally reserved to pay claims made by policyholders with the later cost of settling those claims, and make a tax adjustment if there is a difference. In addition the rules contain an election (the "disclaimer election" or "section 107(4) election") which while not designed for this purpose has been used to change the normal timing for tax losses to arise; this has enabled groups of companies to obtain the most beneficial tax treatment. The election was often used alongside a change in ownership to pass the benefit of the losses to a new owner of the insurance company. The changes can be seen as complementing the rules blocking the purchase of such losses.

The new rules are to apply to periods of account ending on or after the date that the Finance Bill 2007 receives Royal Assent. The repeal will be subject to a short transitional provision.

Amendments to sale of leasing companies rules

On 21 March 2007 amended draft legislation has been published, which aims to counter two types of scheme which attempt to circumvent the rules which impose a tax charge on the sale of a leasing company. These were originally announced on 22 November 2006, but have now been further extended.

When a leasing company is sold, or there is a change in a company’s interest in a business of leasing plant and machinery which it carries on in partnership, that company is deemed to receive an additional amount of taxable income on the date of the change of ownership. On the following day, which is the first day of a new accounting period, the company is deemed to pay a deductible amount equal to the amount of taxable income it was deemed to receive on the previous day.

The amount of the deemed income and deemed expense is equal to the net book value of plant and machinery and the net investment in finance leases of plant and machinery shown in that leasing company’s accounts for all plant and machinery less the tax written down value of the plant and machinery.

The first type of scheme sought to reduce the amount of the tax charge by reducing the amount of the net book value or the net investment shown in the leasing company’s accounts. The draft legislation seeks to counter any scheme which produces this reduction, or any scheme which increases the amount of the deductible expense, if one of the main purposes of the scheme is to decrease the amount of the tax charge or increase the amount of the expense. The new rules also seek to combat any scheme which aims to ensure that a leasing company is not treated as carrying on a business of leasing plant and machinery. It does this by ignoring the reduction in the amount of taxable income or increase in the amount of the deductible expense, which otherwise would have occurred.

The second kind of scheme exploited a mismatch between the sale of leasing company rules and the rules which provide that where a trade is transferred intra-group, there is no balancing event for capital allowances purposes on the transfer of the trade and the transferee inherits the transferor’s capital allowances position. This previously enabled a leasing trade to be transferred outside of a group for the purposes of the sale of leasing company rules without triggering the tax charge imposed by these rules. The draft legislation counters this by providing that the transfer of a trade of leasing plant and machinery can only be made intra-group on a tax neutral basis under the trade transfer provisions if the transferee and the transferor are also in the same group for the sale of leasing company rules and if, in a consortium case, the ownership is identical and in a partnership case the whole trade is transferred.

Tax loss-buying - Lloyd's companies

Legislation enables the surrender of trading losses between members of groups and consortia provided certain conditions are met. These conditions include the following requirements:

  • the trading losses must arise in the current accounting period
  • the group or consortia relationship must exist during that accounting period in which the losses arise.

The tax rules governing corporate members of the Lloyd’s insurance market follow the special accounting rules applicable to Lloyd’s. As a result, profits and losses of an underwriting year will not be recognised for 36 months. For example, any trading losses of the underwriting year 2007 will arise or be recognised in 2010.

These provisions have enabled companies and institutions to buy loss-making Lloyd’s corporate members (who are going into run-off), change the group structure and obtain the tax relief when the losses arise at the later date.

The Finance Act 2007 is to introduce legislation which will effectively close down the market for buying loss-making corporate members by requiring the group or consortia relationship to be in existence on the last day of the underwriting year in which the business giving rise to the loss was written. Such relationship must then be retained until the first day of the year in which the loss is declared. It should be noted that the draft legislation states that where the corporate member writes an amount of insurance business which is insignificant when compared with that written by it in the preceding underwriting year (or the only business written in that year consists of the acceptance of reinsurance to close premiums), that underwriting year will not be regarded as a year within which the member writes insurance business. This is designed to prevent shortening of the period by writing a new insurance policy.

The proposed changes are to take effect immediately as they are being brought in with effect from 21 March 2007.

Corporate capital loss and gain buying

Targeted anti-avoidance rules were introduced in December 2005 in order to prevent groups of companies from securing a tax advantage where a company changes ownership and one of the main purposes of the arrangement is to allow the new owners to access the capital losses or gains of the acquired company. Under the current rules, where there is a change in ownership and one of the main purposes of the transaction is to obtain a tax advantage (through the deduction of a capital loss from a capital gain) such loss can only be deducted if both the gain and the loss are from assets owned by the same company or group before the change.

On the face of the legislation, it might have been possible to circumvent this, in particular through the use of a subsidiary acquiring a new asset after a change in ownership of its parent. The shares in the subsidiary are then disposed of, but since those shares are themselves pre-change assets the loss or their disposal would in theory be available to shelter any gain arising from the disposal of the new asset acquired by the subsidiary.

The Finance Act 2007 is to introduce legislation that will close this loophole, and will apply to losses or gains accrued or realised on or after 21 March 2007.

In addition, legislation is to be introduced that will ensure that losses arising prior to December 2005 as a result of a de-grouping event are still eligible for offset against gains arising on other pre-change assets (whether owned by that company or another within the same group prior to the de-grouping event) even where there has been a takeover of the original group, or where the company that incurred the loss is sold or liquidated.

Purchase of own shares - shares held by discretionary trusts

When a company purchases or redeems its own shares, part of the payment received by its shareholders will be subject to income tax, unless the buy-back satisfies the requirements for capital gains treatment. Even if capital gains treatment is not available, not all of the amount received will be subject to income tax, as only the income element of the payment is subject to income tax - ie, the excess of the amount received by the shareholder over the original subscription price for the shares which are bought back.

Trustees of discretionary trusts are subject to income tax at special rates (the "special trust rates") on their income, and the Taxes Act specifically provides that these rates apply to the "income" element of the amount received on a buy-back of shares, even if the amount received is capital for the purposes of trust law. This provision was amended by the Finance Act 2006, to bring other receipts within the scope of the special trust rates. Inadvertently, the amendment also extended the amount which was subject to the special trust rates on a buy-back - the entire amount received on the buy-back was subject to the special trust rates, not just the income element. On 9 October 2006, the Government announced that legislation would be included in the Finance Bill 2007 to rectify this and another omission. Draft legislation was issued, for consultation, on 9 February 2007, and the Government has confirmed that the rectifying legislation will be included in the Finance Bill 2007.

This change will be backdated to 6 April 2006.

Corporate reconstructions - reliefs from stamp taxes

Corporate reconstructions may involve shares or real estate being transferred from one company to another. Where both companies are members of the same group, relief from stamp duty and stamp duty land tax may be available under the "group relief" rules. Certain reconstructions involve the transfer of assets to a company which is not part of the group, but which is (or will become) owned by the group’s shareholders. This is often the case in a demerger, or a court sanctioned scheme of reconstruction under section 425 Companies Act 1985 (eg, to facilitate the return of capital to shareholders). In such cases, stamp duty group relief will not be available, and relief from stamp duty and stamp duty land tax will only be available (if at all) if the conditions for "reconstruction" relief are satisfied.

The conditions for reconstruction relief include a number of technical requirements. In order to satisfy these requirements, it can be necessary to take additional steps which add to the complexity of the transaction. In recent Finance Acts, some of these technical requirements have been relaxed, removing some of the traps in this legislation. The Government has now announced a further limited relaxation of these technical requirements. The requirements which are to be relaxed are the requirement that each shareholder in the transferor company must also be a shareholder in the transferee, and the requirement that each shareholder has the same proportionate holding in the transferee as it had in the transferor. The Government has recognised that these requirements can be problematic where a company has bought back its own shares and holds those shares in treasury, as it would have either to cancel those shares or acquire shares in the company to which shares or land is to be transferred. The Government has announced that legislation is to be introduced which will treat such a company as not being a shareholder for these purposes. Accordingly, it will not need to be a shareholder in the transferee company (or cancel the shares which it has bought back) to obtain the relief.

This change will take effect from the date the Finance Bill 2007 receives Royal Assent.


In order to calculate the taxable profits of a securitisation company, that company must first draw up its accounts in accordance with either UK generally accepted accounting practice (GAAP) or International Financial Reporting Standards (IFRS). For accounting periods beginning on or after 1 January 2005, all companies which are listed or issue listed debt are required to prepare their accounts in accordance with IFRS. In addition, GAAP has been amended so as to converge with IFRS. The impact of IFRS, especially IAS 39, and some aspects of GAAP, particularly FRS 26 (which incorporates IAS 39 into GAAP) is uncertain. IAS 39 and FRS 26 require the recognition for accounting purposes of movements in the fair value of financial instruments such as swaps which could lead to profits or losses for accounting purposes and consequently for tax purposes, which bear little or no relation to the company's cash position. This concern is particularly acute for securitisation companies which retain little surplus cash. This uncertainty of tax treatment may lead to problems in achieving or maintaining the desired rating and could lead to an increased cost in raising securitisation finance.

These issues led to HM Revenue & Customs (HMRC) introducing a temporary regime for accounting periods beginning on or after 1 January 2005 and ending before 1 January 2008. Under the temporary regime, a securitisation company may prepare its tax computations on the basis of GAAP as it would have applied on 31 December 2004 and as a result there will be no requirement to establish a fair value for financial instruments. On 21 March 2007, the Chancellor announced that the temporary regime will be extended, although no indication has been given of the length of such extension. It is thought that one of the reasons behind such extension is to allow securitisation companies more time to prepare for the new permanent regime.

In December 2006, regulations were made to create a new permanent regime for securitisation companies. Currently the regime will only apply where securitisation companies elect to fall within the regime. Under this regime, a securitisation company is only taxed on the small amount of profit that it retains. The Government has announced that the regulation-making power which allowed the permanent regime to be introduced is to be amended so that a wider range of securitisation companies (eg, asset holding companies) can benefit. HMRC has been considering for some time whether the new regime should apply to property holding companies in real estate structures or insurance special purpose companies and whole business securitisation companies, and confirmation of whether these types of company will be included is eagerly awaited.

Sale and purchase agreements (repos)

In the Pre-Budget Report the Government announced that it would consult on a new comprehensive regime for taxing companies in respect of certain repos.

A repo is, commercially, a form of borrowing whereby a company (the repo seller) sells securities, with an agreement to repurchase those or similar securities in the future, at a price that reflects what would have been the interest payable by the repo seller if the transaction had been structured as a loan. Where the repo purchaser receives a coupon on the security during the repo term, the repo purchaser will make a payment to the repo seller equivalent to the coupon received (a "manufactured payment"), reflecting the fact that the repo seller remains the economic owner of the securities.

The current tax rules ensure that the repo purchaser is taxed on the coupon received on the securities held, and obtains relief for the manufactured payments made. The Government has expressed concern that the current legislation operates in a highly mechanical fashion, enabling it to be exploited by arrangements which generate tax deductions which the Government regards as artificial.

The Government has announced that the new legislation will, as proposed by HM Revenue & Customs during the consultation process, tax repos in accordance with their accounting treatment as collateralised loans. This is to be achieved by bringing such repos within the loan relationships regime in the Finance Act 1996; ie, the parties will generally be taxed on the basis of the entries in their accounts (as prepared in accordance with applicable UK accounting standards). The repo seller, rather than the repo purchaser, will be taxed on the dividends on the shares which are the subject of the repo (ie, the shares which it has transferred to the repo purchaser), and the manufactured payment will not be subject to tax in the hands of the repo seller nor tax deductible for the repo purchaser. Although the new legislation will be included in the Finance Bill 2007, it will only apply to repos entered into on or after an appointed day. The Government has confirmed that this will not be until the current round of consultation is completed, to provide time for consultation to ensure that the introduction of the legislation does not have unforeseen consequences.

Business and indirect taxes

Reform of film tax relief

The Finance Act 2006 introduced new rules to benefit the British film industry. These rules provide a new regime for taxing film production companies, in respect of films which commenced principal photography on or after 1 April 2006. Broadly, the making of each film is treated as a separate trade of the production company. Such trade does not commence until either pre-production starts or the production company begins earning income from the film. This means that a production company cannot get tax relief for expenditure on a film until it begins its trade. Where a production company is making a film which is intended for cinematic release, it receives an additional deduction which relates to the cost of making the film.

The Chancellor has announced that film production companies will be able to opt out of the rules contained in Finance Act 2006. Such election can be backdated so that it covers all films which started principal photography in the two years prior to the election being made. Once an election is made, it is irrevocable and applies to all films which start principal photography in or after the period in which the election is made.

This measure is likely to be of little interest to film production companies who produce films for cinematic release. This is because making an election would cost them the additional deduction which reflects the cost of making the film. However, certain production companies produce films which are not intended for cinematic release. These companies could benefit by electing out of the Finance Act 2006 regime. Such an election would mean that they could be treating as carrying on a single trade of producing films, with the result that they may be able to receive an earlier deduction for their expenses. In addition, capital allowances should be available on the production company’s capital expenditure on the film.


Online filing

HMRC have published their aims for the future of online filing of tax returns by both corporates and individuals, reporting the results of a review undertaken since 2005 by Lord Carter. The proposals advocate an increase in online filing both by increasing the requirement to do so, in the case of corporates, and by increasing the incentives for individuals to file online.

Detailed proposals will be worked out over the next year with a view to implementation with an aim that substantially all tax returns will be filed online by 2011-2012. From the tax year 2007-2008, there will be changes to the dates on which individuals file tax returns. Paper returns will have to be filed by 31 October following the tax year (i.e. three months earlier than currently); online returns, as now, will have to be filed by 31 January.

Stamp duty - reliefs for exchange intermediaries

Changes will be made to the existing reliefs for exchange intermediaries to bring the legislation into line with the Markets in Financial Instruments Directive (MiFID), which effectively liberalises financial regulation in the European Union and which comes into effect on 1 November 2007. The changes will remove the requirement that, in order to obtain relief from stamp duty and stamp duty reserve tax on purchases by intermediaries, the purchase must be carried out on, or reported to, an exchange or multilateral trading facility of which the intermediary is a member. Instead it will be enough that the shares in question are admitted to a regulated market under MiFID.

SDLT - payment of tax and self-certification

Changes to the existing SDLT legislation will be made in the Finance Bill 2007 allowing payment of SDLT and filing of the corresponding SDLT Land Transaction Return to be made at different times. Filing and payment will continue to fall due within 30 days of the effective date of the transaction (normally completion).

Where a self-certificate can be provided instead of an SDLT Land Transaction Return (eg, where the transaction is for no chargeable consideration), new regulations will, in certain cases, enable the purchaser's agent to make a declaration on behalf of the purchaser, rather than the purchaser itself having to make the declaration, that the self-certificate is to the best of its knowledge correct and complete. These regulations will be made by HM Revenue & Customs (HMRC) at a later, unspecified, date.

SDLT and alternative finance products

With effect from 22 March 2007 a change to the SDLT legislation will provide for interests held by financial institutions in certain Islamic compliant mortgages to be exempt interests for SDLT purposes. The exemption will apply to the most common form of Islamic mortgage, the diminishing Musharaka/Ijara arrangements. This is welcome news as it will, in conjunction with the changes announced to the tax treatment of sukuks, enable such products to be placed within securitisation structures. This change effectively puts Islamic securitisation on a level playing field for SDLT purposes with conventional mortgage backed securitisations.

 SDLT - anti-avoidance measures

Temporary regulations made on 6 December 2006 will be replaced and amended by provisions in the Finance Bill 2007 to counter certain SDLT avoidance schemes. Details of the amendments are not yet available, but, in simple terms, the regulations currently provide that where additional steps are inserted into a land transaction, so that the amount of SDLT payable is less than would have been payable had those steps not been inserted, those steps will be disregarded. The new provisions will have effect for transactions with an effective date on or after the date on which the Finance Bill 2007 receives Royal Assent. However, the existing regulations will remain in force until such date.

SDLT relief for new zero carbon homes

With effect from October 2007, until April 2012, all new zero carbon homes with a value of up to £500,000 will be exempt from SDLT. If the purchase price is greater than £500,000, the SDLT liability will be reduced by £15,000, with the balance due in the normal way. The new relief will be brought in by regulations which will set out the qualifying criteria requiring zero carbon emissions from all energy use in the home over a year. In order to achieve zero carbon emissions:

  • the fabric of the building will be required to reach a very high standard of energy efficiency
  • heat and power must either be generated in the home, on the development, or through other local community arrangements, and must be renewable
  • the use of appliances must not generate carbon emissions.

The relief will only apply to new homes and is therefore not available on second and subsequent sales, on existing homes, or for commercial property.

In addition to the regulations, there will be a certification process for all new homes and qualification for the relief will be dependent on homebuyers having the certificate. Further details of this certification process will be released in due course, but it is understood that the certificate will not be provided by HMRC.

SDLT - relief for shared ownership trusts

The SDLT benefits enjoyed by shared ownership leases will be extended by the Finance Bill 2007 to apply to shared ownership trusts, thereby enabling purchasers of commonhold (as opposed to leasehold or freehold) properties provided by qualifying bodies to benefit from SDLT relief.

Shared ownership trusts have been developed to make the acquisition of commonholds available to those seeking affordable housing. Under such trusts, legal title to the property vests in the trustees, and a declaration of trust gives the purchaser a beneficial share in the property and the exclusive right to occupy the property in consideration for the purchaser making regular payments (effectively rent). In addition, the purchaser can make capital contributions which effectively reduce the regular payments. The SDLT relief enjoyed by shared ownership leases will apply to shared ownership trusts. Since the property is bought in instalments, SDLT would normally be paid on each instalment; instead it will only be paid on the first and last instalment (deemed to be where the buyer’s share goes beyond 80 per cent). Alternatively, purchasers can elect to pay SDLT on a one-off basis on the market value of the property, or on the value of the maximum share that can be purchased.

For these purposes, qualifying bodies include housing authorities, housing associations and development corporations. The relief will apply to transactions involving shared ownership trusts with an effective date on or after the date on which the Finance Bill 2007 receives Royal Asset.

SDLT - exchanges of property between connected persons

New measures will be introduced with the effect that where individuals who exchange property are connected (such as husbands and wives), the two transactions will no longer be treated as linked transactions for the purposes of calculating the rate of SDLT payable. For example, if property worth £300,000 is exchanged for property worth £220,000, the new rate applicable will be 1 per cent on the property worth £220,000 and 3 per cent on the property worth £300,000. Until the change, the charge is at 4 per cent on the aggregate of £520,000.

This change will be contained in the Finance Bill 2007 and will have effect for land transactions on or after Royal Assent.

Insurance Premium Tax (IPT)

IPT is charged on the receipt of a premium by an insurer, as an inclusive amount within the premium, if the premium is received under a taxable insurance contract.

The Finance Act 2007 will introduce legislation to clarify the definition of "premium" so that it specifically includes "payments received by, or on behalf of, an insurer for a right to require the insurer to provide cover under a taxable contract of insurance".

As currently drafted, the definition of "premium" could arguably exclude fees, paid to an insurer on the understanding that it may (or may not) be required to enter into an insurance contract, from the scope of IPT. This is because the payment to the insurer would not be received under the insurance contract itself. The proposed clarification will ensure that such fees are brought within the tax charge as of 22 March 2007.


Assets used partly for non-business purposes

HMRC have published a new measure to give effect to a decision of the ECJ from 2005. In summary, the decision in Charles & TS Charles-Tijmens held that it was unlawful for member states to operate the VAT system in such a way as to disapply the "Lennartz" method of accounting for VAT on the acquisition of an asset which was to be used partly for business and partly for non-business purposes. The UK VAT system did not allow Lennartz accounting for interests in land, buildings or other products of the construction industry. Since that decision, HMRC have applied the principles of the decision by concession. The Lennartz method effectively allows the taxpayer to defer the time by which it has to account to HMRC for the input VAT on the asset.

The new rules will provide that, on acquisition of an asset to be used only partly for business purposes, a business will be entitled to reclaim input VAT on the acquisition as usual (ie, taking account of any existing partial exemption method). It will also provide that such VAT will be recovered by HMRC over the course of time as the asset is used otherwise than for the purposes of the business in proportion to that use.

The rules will also make it clear that the period over which VAT is to be recovered on land and buildings is ten years (in line with the capital goods scheme), rather than the 20-year period that is currently operating by concession. There will be transitional rules where Lennartz accounting has already been used on the 20-year basis.

The rules will also make it clear that the surrender of an interest in land should also be regarded as a supply for these purposes.

The rules will come into force on 1 September 2007.

Carousel fraud

The Chancellor has announced changes to the VAT provisions targeted at carousel fraud. Carousel fraud is one of the most significant issues facing EU tax authorities, with billions of pounds being stolen by fraudsters every year. Goods used in carousel fraud tend to be small in size and high in value, such as mobile phones and computer chips. In 2003, provisions were introduced that were aimed at customers who bought imported goods from missing traders. These provisions provided that purchasers of telephones, computers and their parts and accessories could be held jointly and severally liable for the VAT on the purchase if they knew, or had reasonable grounds to suspect, that VAT would go unpaid elsewhere in the supply chain. From 1 May 2007 the list of goods to which these provisions apply will be extended by adding certain categories of electronic equipment, of a kind ordinarily owned by individuals and used by them for the purposes of leisure, amusement or entertainment. It will also be clarified that satellite navigation systems are included as computer equipment. The Chancellor has also paved the way for the Treasury to extend the circumstances in which a person is presumed to have reasonable grounds for suspecting that VAT will go unpaid elsewhere in the supply chain.

VAT: transfer of a going concern

The seller of a business transferred as a going concern will be required to keep his business records after transfer, except in the few cases where the buyer takes over the seller’s VAT number.

The seller will also be required to make such information available to the buyer as the buyer needs to comply with his VAT obligations.

This change in requirement reflects existing practice under which the seller generally agrees to retain his own past records on behalf of the buyer, with a clause allowing for inspection by the buyer.

The change takes effect from 1 September 2007.

Consultation on tax incentives for development of brownfield land

The Chancellor has announced a consultation into the tax incentives for cleaning up contaminated land. The consultation is concerned with land remediation relief and the exemption from landfill tax for waste from contaminated land. These tax reliefs are designed to incentivise developers and others involved to clean up contaminated land. The consultation covers:

  • the extension of land remediation relief to long-term derelict land
  • focusing relief on development
  • accelerating the availability of land remediation relief
  • extending land remediation relief to the removal of Japanese Knotweed
  • ending the exemption from landfill tax for waste from clearing contaminated land

The consultation closes on 14 June 2007. Any legislation needed following the consultation will not be enacted before 2008.

 Changes to the landfill tax regime

Landfill tax is payable in connection with waste disposed of at licensed landfill sites and is designed to encourage businesses and the public sector to produce less waste, thereby reducing the amount of waste going to landfill sites. The Chancellor has announced increases in the rates of landfill tax for relevant waste disposals at landfill sites made, or treated as made, on or after 1 April 2007. The standard rate of landfill tax will be increased from £21 to £24 per tonne from 1 April 2007, and then increased further to £32 per tonne from 1 April 2008. From 1 April 2008 the lower rate of landfill tax applicable to inert waste will also be increased from £2 to £2.50 per tonne.

The Chancellor has also announced changes to the landfill tax credit scheme. The landfill tax credit scheme allows landfill operators to obtain tax credits against their annual landfill tax liability by making contributions to various approved environmental bodies. The maximum percentage credit will be reduced from 6.7 per cent to 6.6 per cent. These changes will take effect from 1 April 2007.

Employers and employees

Income tax rates

From 6 April 2008 the starting rate of income tax, currently ten per cent, will be removed from earned income and pensions. It will, however, continue to apply to savings income and capital gains. Also, from 6 April 2008 the basic rate of income tax will be reduced to 20 per cent.

National insurance contributions (NICs)

The Upper Earnings Limit for employee's Class 1 NICs and the Upper Profits Limit for self-employed Class 4 NICs will be increased from 6 April 2007 to £670 per week (£34,840 per year) and from 6 April 2008 to £720 per week (£37,400 per year).

From 6 April 2009 the Upper Earnings Limit and the Upper Profits Limit will be aligned with the threshold amount at which higher rate income tax is payable.

Employee share schemes

Employee benefit trusts

Since 2003, when calculating an employer's taxable profits for an accounting period a deduction can only be claimed for contributions to an Employee Benefit Trust (EBT) for that period if employees receive a benefit from the trust in a form which leads to an income tax and National Insurance Contributions (NICs) charge during that period or within nine months of the end of it. If a deduction cannot be claimed for the period in which the contribution was made, it can be claimed for a subsequent period when the benefits are actually provided to the employees, provided they are subject to tax and NICs on them.

Some people have taken the view that this deferral of the tax deduction will not apply if an employer, instead of making a payment to an EBT, declares a trust for the benefit of employees over assets which it already holds (eg, over a bank account). The Finance Act 2007 will contain provisions "to put beyond doubt" that proceeding in this way will not side-step these provisions (and will also limit deductions for arrangements which enhance the value of assets held for the benefit of employees). An employer making a contribution in this way on or after 21 March 2007 will only be able to claim a deduction if it would have been able to claim it for a contribution to an EBT. It will be interesting to see whether HM Revenue & Customs (HMRC) proceed to challenge through the courts deductions claimed by employers for these types of arrangements implemented prior to 21 March 2007.

Enterprise management incentives

The beneficial tax treatment of options granted under an Enterprise Management Incentive (EMI) arrangement, established in relation to a group of companies, can sometimes be lost if the business is reorganised and a trade relating to the exploitation of intangible assets is transferred within the group. Legislation to be included in Finance Act 2007 will prevent this happening in certain circumstances.

Managed service companies

Following on from the Government’s action in previous years against tax avoidance using personal service companies, the Chancellor has announced that the Finance Bill will contain specific legislation relating to "managed service companies" (MSCs). An MSC is a company owned by a worker or group of workers but run by an "MSC provider". This normally undertakes the incorporation, administration and management of an MSC (or, in some cases, a series of MSCs) on behalf of the worker, deducting a fee for doing so and arranging for the worker to be paid.

The worker’s services are provided to a client through the MSC in a way which would usually constitute an employment relationship between them. HM Revenue & Customs (HMRC) have struggled to recover what they see as the full amount of income tax and NICs payable by such individuals and the proposed legislation contains fairly draconian powers of recovery.

The proposed legislation will require that, from 6 April 2007, any income received by individuals providing services through MSCs will be treated as employment income, if it is not already so treated. The MSC will be responsible for operating PAYE in respect of any income tax due on payments received after that date and for collecting employee’s NICs and paying employer’s NICs from a date yet to be specified.

In the event that HMRC cannot recover any income tax or NICs from the MSC, HMRC may seek to recover this liability from certain other individuals or entities. The Government has proposed that any liability arising on or after 6 August 2007 may be transferred to MSC providers, their directors and any individuals associated with them (assuming the Finance Bill has received Royal Assent by that date).

If any PAYE or NICs owing are not recovered from any of these persons, any liability arising on or after 6 January 2008 may also be transferred to any person who encourages, facilitates or is otherwise actively involved in the provision of the individual’s services through the MSC.

Whilst the vast majority of companies will not be involved in instituting MSC-type arrangements for their employees, they should nevertheless be aware that promoting such schemes or taking an active role in their implementation may lead to a potential PAYE and NICs liability.

Company cars and fuel

Company car tax is calculated by applying "the appropriate percentage" to the list price of the car. What is the appropriate percentage is related to the CO2 emissions of the car and, for cars fuelled by petrol, it ranges from 15 per cent to 35 per cent. From 6 April 2008, the appropriate percentage will be discounted at two per cent if the company car has been manufactured to run on E85 fuel.

The tax charge which arises when an employee is given fuel to use on private journeys in his company car will not increase in 2007/8. However, the basis on which the VAT fuel scale charges are calculated is changed for accounting periods beginning on or after 1 May 2007. The charge will now relate to the car's CO2 emissions, rather than its engine size. This will bring the VAT fuel scale charges in line with the basis used for calculating company car and fuel benefit-in-kind charges on employees.

Foreign homes owned through a company

Most directors (and "shadow directors") are subject to a benefit-in-kind charge if accommodation is provided for their use by a company of which they are a director. This applies to a director of a company specifically set up to own a property abroad for the use of his family just as much as it applies to a director of a listed company who is provided with a flat by that company.

In most cases, individuals who have set up or acquired companies just to purchase a property abroad will not realise that such a charge can arise. HMRC have announced that there will be legislation in the Finance Act 2008 which will ensure that there will not be a benefit-in-kind tax charge in relation to the private use of such property provided certain conditions are met. The legislation will have retrospective effect. In the meantime, HMRC will not seek to tax anyone if the following conditions are met:

  • the property is the company’s only or main asset
  • it has not been funded by a connected company
  • holding the property is the company’s main activity
  • individuals own the company which owns the property.

It is likely that similar conditions will apply when the legislation is enacted.

Alternatively Secured Pension (ASP) Rules

What is an ASP?

ASP is the formal name for the rules allowing a member of a pension scheme who reaches age 75, to draw down income, and avoid having to buy an annuity. These rules were introduced from 6 April 2006, and allowed a member to draw an income of between 0 per cent and 70 per cent of the annuity which he could have bought with the fund (subject to income tax). This amount was retested annually but always on the basis of the annuity a 75 year old could have taken. On death, any remaining funds could be used (by a transfer lump sum death benefit option) to provide a dependants’ pension. If there were no dependants, then the funds could be paid to charity, or transferred to the pension funds of other members in the same scheme, or in limited circumstances, be repaid to the employer with a tax charge. There was an inheritance tax charge on ASP funds remaining on the member’s death, which applied to any funds not paid as pension benefits to a dependant or to charity.

What are the changes?

The provisions on members’ and dependants’ ASPs are tightened up. There will be a requirement to draw a minimum income from a member’s or dependant’s ASP fund. A higher maximum annual withdrawal from an ASP fund has also been introduced. A tax charge is introduced where ASP funds remaining on the death of a member or a dependant of a member are transferred to the pension funds of other members in the same scheme.

The detail

  • there will be a minimum income requirement of 55 per cent of the annual amount of a comparable annuity (for a 75 year old). Failure to comply with this requirement will mean that the scheme administrator will become liable to a 40 per cent tax charge on the difference between the minimum income limit and the amount paid as pension income in that year.
  • the maximum annual withdrawal of income that will be permitted from an ASP fund will be 90 per cent of the annual amount of a comparable annuity (for a 75 year old).
  • there will no longer be a transfer lump sum death benefit option. Therefore, an unauthorised payment charge of up to 70 per cent will be imposed where on the death of a member or on the death of a dependant of a member any remaining ASP funds are transferred to the pension funds of other members of the scheme.
  • the changes will have effect on and after 6 April 2007. The unauthorised payment charges on the death of the ASP member will only have effect where the member or dependant dies on or after 6 April 2007.
  • associated changes will be made to the ASP provisions in the Inheritance Act 1984 (IHTA) arising from the unauthorised payments pension charges on ASP funds. For deaths on or after 6 April 2007, IHT will be calculated on the basis that the IHT nil rate band will be set in priority against the estate of the member excluding ASP funds.
  • some pension schemes have been unable to trace members who have attained age 75, to pay their benefits. The Finance Bill will include a provision that if a scheme has taken reasonable steps to trace a member, then the funds will, on the missing member’s 75th birthday, become held "in suspense", and will not become ASP funds. Where a member is subsequently traced, he will have the choice which was available at age 75, to take an annuity or an ASP.

Changes to tax relief on personal term assurance

Term assurance policies are life insurance policies that only pay benefits on the death or critical illness of an insured person. As part of pension tax simplification at 6 April 2006, a term assurance policy could be sold with tax relief so long as it terminated before the insured’s 75th birthday. The insured person received tax relief on contributions under the scheme that was used to pay for the term assurance policy.

The change which will be introduced in the Finance Bill 2007 will mean that individuals will no longer get tax relief on pension contributions that are used to pay premiums under personal term assurance policies.

The Finance Bill will also provide new powers to pass secondary legislation to enable the Government to act quickly to remove relief from any new products sold with a view to avoiding these new restrictions on tax relief.

Technical changes to new pension regime

Various changes have been made, effective from 6 April 2007, which are mainly designed to ensure that the pensions tax rules continue to meet the original intentions of the simplified regime. These are, in brief:

  • individuals who have rights to an enhanced lifetime allowance will find it easier to make transfers between pension schemes without losing those rights
  • ill health pensions may now be reduced at the discretion of the scheme administrator
  • pension commencement lump sums - a technical amendment which allows a pension commencement lump sum to be paid in certain circumstances after a member attains age 75
  • a payment of lump sum death benefit may be made within two years of the date of notification, rather than within two years of the member’s death. This timing will be mirrored for IHT, so that the scheme funds will not attract IHT
  • unsecured pension fund - a review of the annual maximum withdrawal from an unsecured pension fund may be permitted more frequently than every five years
  • winding up lump sums - an administrative amendment has been made to help speed up scheme wind-up
  • establishment of pension schemes - instead of having to belong to one of a number of categories set out in current legislation (bank, insurance companies etc.) a person will now need permission from the FSA in order to establish a (non occupational) registered scheme
  • a change to the pension tax rules on property held by a investment-regulated pension scheme where it holds property indirectly through a UK REIT
  • certain non cash benefits for retired former employees may be provided, which will be exempt from tax, similar to those received by employees
  • an anti-avoidance change which will prevent unauthorised employer payments being structured to reduce the overall tax charge.


Taxation of personal dividends

The Chancellor has announced the introduction of legislation to simplify the system of taxation for individuals holding shares in companies resident for tax purposes outside the UK. UK companies pay dividends out of profits on which they have already paid corporation tax. To take account of this, individuals receiving dividends from UK resident companies are entitled to a tax credit to offset against any income tax that may be due on their dividend income. A tax credit, representing one-ninth of the dividend received, satisfies the tax liability for basic rate tax payers and reduces the effective rate of tax for higher rate tax payers from 32.5 per cent to 25 per cent. From 6 April 2008, this tax credit will also be available to individuals receiving dividends from companies resident for tax purposes outside the UK, provided that certain conditions are satisfied. A person will qualify for the dividend tax credit if they own less than a 10 per cent shareholding in the non-UK resident company and receive less than £5,000 of dividends in a tax year from non-UK resident companies. The Government is also considering whether the dividend tax credit can be made available to individuals who do not meet these conditions without creating the scope for abuse.

It has been widely anticipated that the dividend tax credit would be extended to dividends received from companies resident in other Member States of the European Union (EU), following a succession of rulings by the European Court of Justice that provisions imposing a different treatment for domestic dividends from shares from foreign companies are contrary to the principle of free movement of capital. On the one hand, by extending the availability of the tax credit to dividends from all companies worldwide, the Chancellor has gone further than was expected. On the other hand, in restricting it to dividends totalling less than £5,000 per year, the Chancellor may not have complied fully with the UK's obligations under the Treaty of Rome. 

Islamic finance


As expected, the Chancellor has announced that sukuk (which is the plural of sakk), Sharia’ah-compliant bonds, are to be brought within the “alternative finance” regime which has been introduced over the past three years to cater for other Islamic finance methods such as Murabaha, Ijara and diminishing Musharaka products.

Sukuk arrangements are common outside the UK, particularly in Muslim countries, but, until now, could not be issued by UK companies or invested in by UK investors without an unfavourable tax treatment. The changes announced in the Budget are very welcome and should pave the way for UK-based bond issues and securitisations in a Sharia’ah-compliant form.

In simple terms, sukuk are certificates which entitle the holder to the economic return arising from a portfolio of assets held by the issuer. The assets, and the arrangements relating to their holding and disposal, are such that the return received by sukuk holders will be equivalent to the return which they would receive on an interest-bearing debt security. The main tax problem with such arrangements at present is that the issuer, if UK resident, will be taxable on the profits received in respect of the assets but will not be entitled to any deduction for payments which it makes to the sukuk holders in respect of those profits. This problem is solved under the proposed new legislation by treating the income payments as if they were payments of interest so that the issuer will get a deduction in computing its tax liability. In addition, there are provisions which equate sukuk to traditional debt securities for other tax purposes such as the “qualifying corporate bond” regime and the tax treatment of discounts.

There is clearly a concern, almost certainly justified, that the introduction of a beneficial regime for such products could open the door to tax avoidance schemes. Accordingly, there are a number of conditions which will need to be met for arrangements to fall within this regime. These include:

  • the payments made to the sukuk holders must not exceed a reasonable commercial return on the amounts subscribed
  • the arrangements must fall to be treated as a financial liability of the issuer under International Accounting Standards
  • the sukuk must be listed on a recognised Stock Exchange. This will also have the effect that there should be no UK withholding tax in respect of the payments.

This change is particularly welcome as it will enable financial institutions which have granted Sharia’ah-compliant mortgages over the last three years (taking advantage of the alternative finance provisions which have already been introduced) to securitise those mortgages in a tax-efficient manner. In this context, it has also been announced that certain forms of Islamic mortgages, such as diminishing musharaka, will be exempt from stamp duty land tax when held by financial institutions. This change is essential if Islamic mortgages of UK land and buildings are to be securitised.

Norton Rose has been, and continues to be, very active in lobbying for the introduction of the alternative finance regime for Islamic finance products, including these changes in respect of sukuk. The announcement and the draft legislation which has been released are extremely welcome and, when considered in the context of assurances for further changes to be made (for example in respect of takaful, an Islamic insurance product) could well result in the UK becoming the hub for the global Islamic finance market.

"Green" assets

Carbon credits trading

Under arrangements put in place under the Kyoto Protocol, it is possible to trade carbon credits, which can, for instance, give the holder the right to emit greenhouse gases. Under current law, if a non-UK resident sells the credit using an agent based in London, unless care is taken, there is a risk that the non-resident will be exposed to UK tax on the profit that it makes. This is because unlike other forms of investment products, carbon credits have not fallen within the investment managers' exemption. This relief provides for an exception to the general rule that the activities of a UK agent may bring the non-UK principal into the charge to UK tax; it allows UK investment managers to buy and sell shares and securities without this risk arising. The carbon credit industry have lobbied for the buying and selling of carbon credits to be treated in the same way; the Chancellor has announced that this will be done from mid-April 2007.

This change will be welcomed by the industry, as it should remove one deterrent to the development of a UK-based market in carbon credits. There is one word of caution; the precise terms of the investment managers' exemption are currently the subject of discussion between HM Revenue & Customs (HMRC) and the investment industry. It is to be hoped that any changes to it will not mean that the benefit of its extension to carbon credits is reduced.

Auctions of emissions allowances

Phase 2 of the European Union Emissions Trading Scheme (EUTS) will begin on 1 January 2008. In line with this, the Finance Bill 2007 will contain provisions dealing with the auctioning of allowances.

Microgeneration : Renewables Obligations Certificates

When householders install microgeneration technology to generate electricity, they are eligible for Renewables Obligations Certificates (ROCs). These ROCs can then be sold by the householder. There has been a concern that the receipt and the sale of the ROCs could give rise to a tax charge for the householder. In a welcome development, the Finance Bill will expressly provide that no such charge will arise, provided that the microgeneration is primarily to meet the needs of the house.

Individual Savings Accounts (ISAs) and Personal Equity Plans (PEPs)

Two sets of draft regulations have been published, one relating to ISAs and the other to PEPs. The effect of the regulations relating to PEPs is that all PEPs will be converted into stocks and shares ISAs. The regulations relating to ISAs remove the distinction between maxi and mini ISAs and allow transfers to be made from the cash component of an ISA to the stocks and shares component without the investment limit for that tax year being affected.

From 6 April 2008 the amount which an individual will be permitted to invest will be increased to £3,600 per tax year for cash ISAs and £7,200 per tax year for stocks and shares ISAs. This will be subject to a maximum of £7,200 per tax year being invested in aggregate.

Venture Capital Trusts (VCTs) and Enterprise Investment Scheme (EIS)

There have been some detailed changes to the rules covering EIS, VCTs, the Corporate Venturing Scheme (CVS) (Venture Capital Schemes) and the Enterprise Management Incentive (EMI). Unless otherwise stated, these changes have effect from 6 April 2007.

An EIS now has up to 12 months to invest 90 per cent of funds raised (compared with a previous time limit of six months). This applies to all funds closing after 6 October 2006.

A new cap of £2 million (an “investment limit”) in any 12 month period is to be set on money raised by a company, or a group, if that money is to qualify for relief under any Venture Capital Scheme. If the limit is exceeded none of the shares or securities in the issue causing the breach will qualify for relief.

Any company, or group, raising funds under a Venture Capital Scheme must have no more than 50 full time equivalent employees at the date of issue of the relevant shares or securities.

The employee test and investment limits will not apply to investments made out of funds raised by VCTs before 6 April 2007, nor to EIS or CVS shares issued before Royal Assent.

A qualifying trade of a Venture Capital Scheme parent company can now be carried on through a 90 per cent subsidiary of a 100 per cent subsidiary, or through a 100 per cent subsidiary of a 90 per cent subsidiary as well as through a direct 90 per cent subsidiary.

A VCT will have six months after disposing of an investment that it has held for at least six months in which to reinvest for the purpose of the 70 per cent qualifying holdings test.

The "inadvertent breach" guidance will be replaced with new HM Revenue & Customs regulations.

New rules will enable relevant intangible assets to be moved around within groups without the EMI companies losing their qualifying status or investors in Venture Capital Schemes losing their tax relief.

Offshore funds regime

Multi-tiered funds

The restriction on the investments of multi-tiered offshore funds will be removed with effect for accounting periods beginning on or after 1 January 2007.

At present, an offshore fund cannot be certified as a "distributing fund" where more than 5 per cent by value of the assets of that fund consist of interests in other offshore funds, unless that offshore fund is itself a "distributing fund". This gives rise to the "three-tier" problem. In simple terms, if an offshore fund has more than 5 per cent of its investments in another offshore fund, which itself has more than 5 per cent of its investments in another offshore fund, the top fund cannot be certified as a distributing fund, even if the two subsidiary funds could be so certified. The effect of the change is that, in determining whether the top fund is a distributing fund or not, it will not be tainted by holdings of more than 5 per cent in other offshore funds at any level in the structure, provided that those offshore funds are themselves distributing funds.

The importance of distributor status is that if a UK resident disposes of a material interest in an offshore fund which has not been certified by HM Revenue & Customs as a distributing fund at all times during the period of ownership, any gain on the disposal will be treated as income, and not as a capital gain.

This problem has always been nonsensical in the context of offshore look-through vehicles, such as Jersey property unit trusts, where the income of the underlying fund is treated as income of the investors in the top fund, particularly since the legislation is aimed at funds which roll up income offshore. Accordingly, this change is very welcome.

Change in definition of "offshore fund"

In a confusingly drafted press release, HM Revenue & Customs have announced what it describes as a "minor" change. Depending on the interpretation of the press release, however, this could have material implications for many offshore companies. Under one interpretation, the definition of "offshore fund" would no longer be tied to the Financial Service Authority’s regulatory definition of an open-ended investment company. Instead, the test of whether an open-ended company falls within the offshore funds regime would be by reference to whether the investor can realise their relevant proportion of the net asset value of the company within seven years. This would bring within the offshore fund regime a number of offshore investment companies which are not currently within it. However, the press release states that "the change will mean that a seven year reasonable period to realise the investment will apply to decide if an open-ended company is within the regime". This seems to suggest that the change will only apply to open-ended companies, which is clearly circular. This point will need to be clarified as a matter of urgency.

In addition, two genuinely minor changes will be made as follows:

  • it will be made clear that any loss arising on the disposal of units or shares in non-qualifying funds will be a capital loss
  • the meaning of "eligible income" for approved investment trusts will exclude offshore income gains, so that such gains will remain taxable in the hands of the investment trust.

Capital gains tax: artificial capital losses disallowed

New rules will apply where a person enters into arrangements, a main purpose of which is to gain a tax advantage by creating an artificial capital loss. In such cases, any resulting loss will not be an allowable loss for tax purposes.

This change extends an anti-avoidance rule that was already in place for companies, to other persons (individuals, personal representatives and trustees) for capital losses arising on disposals on or after 6 December 2006.

Definitions of “recognised stock exchange” etc

A shareholder’s entitlement to claim certain tax reliefs is dependent upon whether the shares in which he invests are “listed on” a “recognised stock exchange”. In some cases, the relief in question is only available if the shares in question are so listed; eg, the stocks and shares component of an ISA must comprise shares or securities which are so listed. Other reliefs are only available for shares or securities which are not listed on a recognised stock exchange; eg, business asset taper relief or inheritance tax relief.

Currently the definition of “recognised stock exchange” is limited to the London Stock Exchange (LSE), and certain other non-UK exchanges. Accordingly, no UK markets other than the LSE are recognised stock exchanges. The Government has announced legislation to give HM Revenue & Customs (HMRC) power to designate certain other UK markets as recognised stock exchanges, namely any investment exchange which is designated as a “recognised investment exchange” (RIE) by the Financial Services Authority (FSA). The current list of exchanges which have been designated as RIEs by the FSA comprise (in addition to the LSE): EDX London Ltd, ICE Futures, LIFFE Administration and Management, NYMEX Europe Limited, The London Metal Exchange Limited and virt-x Exchange Limited.

Although the LSE is a recognised stock exchange, HMRC accepts that shares in AIM companies are not “listed” on that exchange. Accordingly, shares in such companies potentially qualify for reliefs such as business asset taper relief, but cannot be held in the stocks and shares component of an ISA. This is based on HMRC’s interpretation of the term “listed”, which is not specifically defined in the legislation. The Government has announced legislation to define the term “listed”. As the definition proposed by the Government follows the interpretation currently applied by HMRC, it is not expected that this will result in shares (eg, in AIM companies) which previously qualified for, for example, business asset taper relief ceasing to do so.

These changes were originally announced in a written ministerial statement on 20 February 2007, as part of a package of measures to “modernise the tax system to remove obstacles to competition and expand choice in trading financial instruments in the UK”.

Both changes will take effect from the date the Finance Bill 2007 receives Royal Assent, although it is not clear whether HMRC will exercise the power to add RIEs to the list of recognised stock exchanges at that time, or at a later date.


Insurance policies

Life insurance policies and commission arrangements

The Finance Bill will contain provisions ensuring that, for the purposes of working out a gain on a life insurance policy, account will be taken of commission rebated back to the policyholder where the premiums exceed £100,000 in any one year. When a person realises a gain in relation to their life insurance policy (on the occurrence of a so-called chargeable event), the amount chargeable to tax is based on the amount of that gain less the premium that was paid. Under the law as it currently stands, no account is taken of commission rebated back to the policyholder either directly or by way of a reinvestment in the policy. The law is to be changed to provide that only the "net" amount will be allowed as a deduction in computing the gain where the premiums exceed £100,000 in any year. This has been designed specifically to block certain structures where life policies are taken out for a short period of time and much of the value is realised by rebate of the commission.

Purchased life annuities

At present, HM Revenue & Customs have to determine the tax-exempt capital element of a purchased life annuity (PLA). This requirement is to be repealed, permitting the re-write of the PLA regulations. The change will apply from an appointed day following consultation.

Property Authorised Investment Funds (AIFs)

Following the introduction of Real Estate Investment Trusts (REITs) on 1 January 2007, the Government has been considering the taxation of AIFs which invest in property. The Chancellor has today announced a framework for the taxation of AIFs as a basis for further discussions with the industry and its representative bodies. The framework will broadly move the point of taxation from the AIF to the investor, with the result that the investors will face broadly the same tax treatment as they would have had they owned real property (or REIT shares) directly. Access to the new regime will be available only to AIFs whose investment portfolio comprises predominantly real property or shares in REITs. Any new regime would not be mandatory simply because the property holding requirements were met; rather AIFs meeting the requirements would be able to elect into the regime. As for REITs, property income will have to be ring-fenced so that it remains identifiable as it passes through a property AIF and out to its investors. Investors will be taxed as if they were entitled to the income from the real property or REIT shares directly. To enable property AIFs to price daily (as required by Financial Services Authority regulations) while ring-fencing property income, AIFs will be required to operate three separate pools for different types of income. The pools will be "property income", "other taxable income" (primarily interest and non UK dividends) and "UK dividend income". Investors will receive up to three types of distribution each year, a property income distribution, an interest distribution and a UK dividend. Each of these distributions will be subject to UK tax applicable to that form of income in the hands of the recipient.

Any new property AIF regime will be available only to AIFs established as Open-Ended Investment Companies (OEICs). Existing property authorised unit trusts will have to convert to OEICs if they wish to take advantage of any new regime. Given the open-ended structure of AIFs under the proposed regime, further consultation will be required in order to design conditions relating to diversity of ownership. The Government does not envisage that there will be an entry or membership charge for any new property AIF regime. Subject to how the discussions progress, the Government aims either to publish a technical paper in the summer setting out proposals for how each part of the framework will operate, or, if significant progress is made on technical detail, to move directly to draft legislation on which it will invite further consultation. However, the proposals are welcome, particularly in the context of launching new property funds for whom the cost of incorporating as a REIT and having to pay 4 per cent SDLT on property acquisitions and a 2 per cent entry charge on joining the REIT regime will normally be prohibitive.