Tax Bulletin - Summer 2016

Tax Bulletin
Summer 2016
Tax Bulletin: Summer 2016
Welcome to the much anticipated first edition of the Taxation Bulletin.
We are the Freeths tax team, an experienced and skilled team of taxation specialists advising both
corporate and private clients from all sectors in a wide range of taxation matters. We have become
recognised leaders in many areas and have particular expertise on how UK law affects corporation tax,
mergers and acquisitions, company restructuring, investments and we also have a lot of experience in the
complexities of property taxation, VAT, Stamp Duty and SDLT planning. Our team is made up largely of
dual qualified lawyers and chartered tax advisors and we are delighted to have been voted in the top tier for
Corporate Tax in the Legal 500 guide.
This Taxation Bulletin aims to provide quarterly updates on important changes to UK Law affecting taxation
to ensure that you remain informed and enabled to respond in the best way for you and your business. This
first edition will discuss recent changes to the disguised remuneration rules, the annual tax on enveloped
dwellings, restrictions on finance costs for landlords, and the taxation of money’s worth.
If you would like further information on any of the updates covered in this issue, or if you wish to
discuss a matter of taxation with us, please contact a member of the tax team:
Robert Neal
[email protected]
+44(0)845 634 1729
Adrian Hackett
[email protected]
+44(0)845 077 9601
Claire Boyce
[email protected]
+44(0)845 274 6947
Richard Ferguson
[email protected]
+44(0)845 030 5787
Matthew Switzer
[email protected]
+44(0)845 634 1738
Disguised Remuneration Avoidance Schemes: Budget 2016 Changes
Following the success of HMRC’s Employee Benefit Trust (EBT) settlement opportunity, the
government has introduced new measures to combat disguised remuneration schemes.
The changes will affect anyone who has used and/or continues to use a
disguised remuneration scheme, such as a remuneration trust, EBT or
EFRBS loan back scheme. Companies with outstanding loans under
such disguised remuneration schemes will have to pay income tax and
NIC (under PAYE) on the remuneration received by the employee
unless action is taken either to repay the loans or to reach a settlement
with HMRC in respect of the tax due on the loan.
Disguised remuneration rules
Disguised remuneration schemes are designed to reward employees by making a contribution to a third
party, usually a trust, which either makes a loan to an employee or “ear-marks” funds to be paid at a later
date. Promoters of disguised remuneration schemes claim that the remuneration received by the employee
falls outside the scope of income tax and NIC.
As a result, the disguised remuneration legislation (Part 7A ITEPA 2003) was brought in to tackle the
growing trend of rewarding employees through third parties. There is no doubt that HMRC considers
disguised remuneration schemes to be a form of tax avoidance.
The changes
1. Previously, any investment returns on amounts settled on a trust or otherwise with a third party were
not liable to tax as earnings (under Part 7A) when distributed to the employee. Only the original
settlement was liable to tax as earnings. This relief will no longer be available unless a settlement is
reached with HMRC and the income tax and NIC on the original loan is accounted for on or before
30 November 2016. The effect of this change means that the whole of the original sum settled, plus
any investment returns, will be treated as earnings under Part 7A.
2. New legislation will be implemented so that all outstanding loans that fall within the disguised
remuneration legislation (irrespective of when the loan was made) will be taxed under PAYE and
NIC in April 2019 unless the matters are settled or the loans are repaid by this date.
3. Relief is currently available where an employee gives consideration for the loan, for example where
the employee purchases shares from an EBT. From 16 March 2016 this relief will not be available
where there is a tax avoidance motive.
4. HMRC will be able to transfer the liability for PAYE to the employee where there is difficulty
recovering PAYE from the employer. Furthermore, where a loan is treated as earnings of more than
one person, HMRC may now apportion the tax charge between the employees on a just and
reasonable basis.
5. It is intended that further legislation will follow in the Finance Bill 2017 to put beyond any doubt that
schemes which result in a loan or other debt being owed to an employee through a third party,
whatever the intervening steps, will be within the scope of Part 7A.
Points to note
Sale of a company with a disguised remuneration scheme
Often a buyer of a company with outstanding loans under a disguised remuneration scheme will not
proceed with the acquisition without an indemnity and potentially a retention to cover any litigation and
additional tax, interest and penalties that may arise in respect of the scheme.
Trustees’ fees
Trustees often charge unreasonably high fees for their services, in some cases up to 20% of the amount
loaned to the trust. Scheme promoters claim that a corporation tax deduction is usually available in respect
of the trustee’s fees. However, we have known cases where HMRC have denied the deduction on the basis
that the fees were not incurred wholly and exclusively for the purposes of the business.
Furthermore, HMRC usually require that any settlement reached in respect of the scheme is conditional on
the trust being terminated within 3 months of a settlement being reached. Companies looking to settle with
HMRC should bear in mind that trustees will also charge high fees for closing the trust. Companies should
therefore ensure that there are either sufficient funds remaining in the trust or within the company to cover
these fees.
Purchasing Residential Property Valued Over £500,000 Through a Corporate
Vehicle?
The scope of the annual tax on enveloped dwellings (ATED) has been broadened from 1 April 2016
to include residential properties valued at £500,000 or more. Reliefs do not apply automatically and
must be claimed by submitting an ATED return.
The ATED rules impose an annual tax charge on high value residential UK property held by corporates. The
rules are designed to dissuade individuals from purchasing residential properties in corporate wrappers for
the purpose of avoiding tax.
Scope of the ATED charge
Residential properties are only caught by the ATED charge where they consist of a single-dwelling, the
value of which exceeds the ATED threshold. A single-dwelling means accommodation that is suitable for
occupation as a home. Therefore, a building consisting of a number of self-contained flats would contain a
number of single-dwellings. For ATED purposes each flat will be assessed separately and whether a flat is
subject to the ATED regime will depend on whether the value of that individual flat exceeds the ATED
threshold.
Previously, only single dwellings with a value of £1m or more fell within the
ATED charges. However, with effect from 1 April 2016, dwellings valued
£500,000 to £1m are now subject to an ATED charge of £3,500 per year.
Bringing properties valued between £500,000 and £1m into the ATED
regime also means that these properties are now subject to the ATEDrelated
capital gains tax charge at 28% on disposal. It should also be
noted that properties of this value have been within the scope of the 15%
higher rate stamp duty land tax since 20 March 2014.
Reliefs
There are a number of reliefs available to clients who fall within the scope of the ATED regime, these
include reliefs for:
 property letting businesses
 property developers
 property traders
 employee occupiers
 social housing providers
 financial institutions
 farmhouses
 houses open to the public
Although the majority of those caught by the changes will be eligible for relief, the reliefs do not apply
automatically and must be claimed through the submission of a completed ATED return (or a relief
declaration return) within 30 days of the start of the chargeable period. For those falling within the ATED
regime for the first time from April 2016 (because they hold residential properties valued £500,000 to £1m)
they were required to submit an ATED return before 30 April 2016 (whether or not a relief is available).
Penalties and interest will be payable for late returns.
Restrictions on Finance Costs for Landlords
Rules restricting the relief for finance costs available to individual landlords were announced in the
Summer Budget 2015 with effect from April 2017. The recent Budget 2016 (Budget) announces
amendments to the legislation to clarify some of the uncertainty that surrounds the application of
these changes in particular circumstances.
Background
Currently landlords of residential property can deduct mortgage interest payments (and other finance costs
incurred for their property letting business) from income when calculating taxable profits. With the use of
interest only buy-to-let mortgages residential landlords are able to mitigate taxes extremely effectively.
As announced in the July 2015 Budget, as part of the
Government’s plans to improve access to the property
market for first-time buyers and increase the portion of
owner-occupied housing, the Finance (No. 2) Act 2015
introduces new restrictions on this relief. These changes will
be phased in over a four year period beginning with the
2017/18 tax year with the effect that by 2020 finance costs
incurred on dwelling-related loans will no longer be
allowable deductions for income tax purposes. This will
mean that individual residential landlords will no longer be
able to deduct mortgage interest from property income when
calculating taxable profits. These restrictions will not affect
companies or landlords of commercial property, but will
affect individuals who have taken out loans to finance shares in a property letting partnership.
In place of the current allowance, the changes will introduce a “tax reducer” that will reduce the tax liability
on property income for such landlords by an amount equal to the basic rate of income tax (as applied to the
lesser of: the finance costs disallowed; or the rental profits of the relevant tax year). This tax reducer will
also be restricted to an annual limit equal to the individual’s “adjusted total income”, which is total taxable
income (after available reliefs) less savings income, dividend income and personal allowances for the
relevant tax year. Any unused amount of the tax reducer can be carried forward to the subsequent tax year.
A basic example is included below, based on the following assumptions:
 gross rental income is £70,000 per year
 finance costs are £50,000 per year
 the individual’s adjusted total income is more than £10,000
 the individual is a higher rate taxpayer
Before changes After changes
(in 2020)
Gross rental income £70,000 £70,000
Finance costs (allowable) £50,000 £50,000
Rental profits £20,000 £70,000
Tax @ 40% £8,000 £28,000
Tax reducer (£50,000 x 20%) (£10,000)
Net tax £8,000 £18,000
The tax reducer (at the current income tax basic rate of 20%) is applied to the disallowed finance costs
(£50,000) as this amount is lower than annual rental profits (£70,000). It is also assumed that the
individual’s total annual adjusted income is greater than £10,000 and so the tax reducer is not restricted but
is fully used up and not carried forward.
These changes will be phased in over a period of four years with the proportion of disallowed finance costs
which is deductible being reduced by 25% per year. As the tax reducer is a function of the deductible
finance costs, this will correspond with a 25% annual increase in the proportion of finance costs against
which the tax reducer applies. This is demonstrated in the table below:
Tax year Proportion of finance
costs allowable
Percentage of finance
costs used in the tax
reducer
2017/18 75% 25%
2018/19 50% 50%
2019/20 25% 75%
2020/21 0% 100%
Budget 2016 clarifications
The additional amendments to the legislation that were announced in the recent Budget clarify the incoming
changes by confirming:
 that individual beneficiaries of deceased persons’ estates are entitled to the basic rate tax reducer;
 that the total income annual limit on the tax reducer applies where the finance costs or property
profits exceed total income for any given year;
 “total income” for the purposes of the annual limit on the tax reducer means net taxable income after
any other reliefs have been applied; and
 that any carried forward tax reducer can still be used in a subsequent year in which property income
where there is no restriction on finance costs in that year (for example, because the loan has been
repaid).
These clarifications are greatly welcomed and ensure that the tax reducer is able to be carried forward and
will not be lost to landlords for as long as they receive rental income. However, it should be highlighted that
this tax reducer is not a relief as such. It is applied after the tax calculation for any given tax year, meaning
that many landlords may find that these changes inflate their taxable income and push them into a higher
income tax band. When acting along with other changes affecting buy-to-let landlords, these changes may
force many highly geared buy-to-let landlords out of the market.
Taxing Money’s Worth
The Budget 2016 (Budget) brought confirmation that trading income and property income received
in non-monetary form must be brought into account when calculating taxable profits for income tax
and corporation tax purposes from 16 March 2016.
The changes
Changes to the Income Tax (Trading and Other Income) Act 2005 were announced in the Budget and will
be implemented through the Finance Bill 2016 but with effect from 16 March 2016. The provisions confirm
that in transactions involving the receipt of non-monetary value (that is, ‘money’s worth’), an amount of
money equal to that value must be accounted for as trading or property income when calculating taxable
profits for income tax and corporation tax if the value would have been accounted as such if it were in
monetary form. The Government understands that these provisions merely clarify the existing position
rather than introduce substantive changes to the law.
Is this a tax on cryptocurrencies?
A cryptocurrency (like BitCoin) is a digital unit of
exchange (currency) which can be used to buy goods
and services from participating businesses.
Encryption techniques are used to regulate the
generation of units of tokens and verify the transfer of
funds. This process of generation is decentralised and
so generally operates on a peer-to-peer network
completely independent of a central bank.
Since their emergence, there has been wide-spread
international uncertainty as to whether national governments are able to enforce the taxation of these
cryptocurrencies and therefore concerns amongst national governments (including the UK) that these digital
currencies provide an unprecedented super tax haven and pose a significant threat to the revenue base of
national jurisdictions. Firstly, there are significant practical difficulties in governments taxing or even
regulating crpytocurrencies. As cryptocurrencies are generally “mined” peer to peer rather than being issued
by a central authority users are not necessarily required to present any personal details and are able to
remain completely anonymous, hiding funds behind the veil of cyber secrecy. There is also no use of
financial intermediaries on a peer to peer network who would be able to disclose user information to tax
authorities. Secondly, there is ideological opposition to the taxation of cryptocurrencies. Many users of
digital currencies argue that governments have no right to tax these currencies when they operate in
cyberspace on a peer-to-peer network entirely independent from national jurisdictions and the central
banking systems which they control.
Given the international rise in the popularity of cryptocurrencies, HMRC issued some provisional guidance
on the tax treatment of cryptocurrencies in 2014 and became the first national jurisdiction to do so. Here
HMRC confirmed that cryptocurrencies would be subject to income tax, corporation tax and chargeable
gains tax under the normal rules applying to UK taxation.
The recent changes in the Budget further confirm that HMRC are determined to tax all forms of value that
function as income, whether or not this is in monetary or non-monetary form, physical or virtual. These
recent changes would therefore further support HMRC’s intention to treat cryptocurrencies the same as
traditional forms of currency for the purposes of taxation even if it is unwilling and unable to recognise it as a
currency for the purposes of regulation.
Is the better route for cryptocurrencies to use a mutual trading structure?
On the basis that a person cannot trade with and make a profit from himself, no tax arises from transactions
between members within a mutual structure. Any surplus effectively represents contributions from members
in excess of requirements rather than profit or capital gain. This may present an ideal structure for
cryptocurrencies. Cryptocurrencies operating within a mutual structure would allow for the formalising of
debit and credit between members without any tax leakage.
HMRC will only recognise mutual trading where there is:
 trading activity;
 a complete unity, as one class, between the contributors to the mutual and the participators;
 arrangements in its rules that ensure that the surplus on winding up returns back to the contributors
(‘members’) and preventing the surplus going elsewhere;
 a reasonable relationship between the amount a person contributes and the amount distributed to
them on winding up; and
 arrangements entitling the contributors some level of control of the mutual’s funds (i.e. participation
in the management of the organisation).
Case Studies
Snapshots of recent matters related to this issue’s articles.
Disguised remuneration: EFRBS and EBTs
We recently acted for a client with a number of EFRBS in reaching settlements with HMRC under the EBT
settlement opportunity. We negotiated a favourable payment plan for the client. As part of the settlement,
our client was able to claim a corporation tax deduction. By settling with HMRC outside of court, we were
able to minimise the cost by avoiding litigation and provide certainty for our client in respect of their tax
liabilities.
Amongst other related matters, we also currently act for a client who is selling his shares in a company that
has a remuneration trust under which the client has benefitted. The buyer is unwilling to proceed with the
acquisition whilst the liabilities of the outstanding loans under the trust remain. We have entered into a
settlement with HMRC in order for the sale to proceed, and have secured a settlement with no penalties.
Given the changes to the disguised remuneration scheme legislation, in particular HMRC’s firm view that
such schemes constitute tax avoidance, it may become increasingly unusual for HMRC to take such
favourable positions in respect of any settlement going forwards.
ATED changes and SDLT
In another recent matter, we assisted a client in transferring residential
property to an associated company as part of a reorganisation. By both
structuring the transaction in a way which recognised the number of
distinct dwellings making up the property and completing the transaction
before 1 April 2016, we were able to ensure that the property fell outside
the scope of the ATED regime, secure the old rates of SDLT, and obtain
multiple dwellings relief. This resulted in a saving of over £100,000 in
SDLT.
Employee incentives – salaried members rules
Last month we acted for the founding partner of a wealth management LLP in relation to the services of a
member provided on a consultancy basis. We submitted an application to HMRC for non-statutory
clearance in relation to the treatment of earnings under the partner’s existing consultancy agreement for
income tax purposes. We asked HMRC whether earnings passing under such consultancy arrangements
fell outside the salaried members rules (and therefore avoided being taxed as if the consultants were
employees) on the basis that they were not earned in the consultant’s “capacity as a member of the LLP”
but rather in their capacity as a self-employed consultant. HMRC responded negatively, indicating that
evidence would need to be provided demonstrating that the services were performed in “separate and
distinct” capacity from the consultant’s role as a member of the LLP for them to fall outside the salaried
members rules. Consequently, by advising that the client contracts in a way which ensures that at least 21%
of the consultants’ income is tied to the profitability of the LLP (thus falling within one of the exemptions to
the new “salaried members rules”), we were able to prevent the agreement from being caught by the rules
and being taxed as employment income. This will secure a significant tax saving for the individual
concerned.
Finance cost restrictions and other changes affecting buy-to-let landlords
A variety of recent changes to the law have targeted buy-to-let landlords, including the finance cost
restrictions for residential landlords, the additional property SDLT surcharge, and the removal of wear and
tear allowance. In light of these changes, we have been acting for a number of clients on the efficient restructuring
of their property letting businesses going forwards. This has involved advising on the efficient
transfer of property under a structure that escapes the SDLT surcharge (where possible) and advising on
the reorganisation of one client’s property letting business into a structure including a property letting
company and a property development company.
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